<PAGE> 1
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 MARCH 31, 2000
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 000-25857
================================================================================
PERSISTENCE SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3138935
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1720 SOUTH AMPHLETT BLVD., THIRD FLOOR
SAN MATEO, CALIFORNIA 94402
(Address of principal executive offices, including zip code)
(650) 372-3600
(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 [ ]
As of April 28, 2000, there were 19,510,773 shares of the registrant's Common
Stock outstanding.
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INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2000 AND
DECEMBER 31, 1999.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE
MONTHS ENDED MARCH 31, 2000 AND 1999.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE
MONTHS ENDED MARCH 31, 2000 AND 1999.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
ITEM 3. QUALITATIVE AND QUANTITATIVE 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.
PERSISTENCE SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF
----------------------------
MARCH 31, DECEMBER 31,
2000 1999
-------- --------------
(UNAUDITED) (EXTRACTED)[1]
<S> <C> <C>
Assets:
Current assets:
Cash and cash equivalents $ 19,529 $ 22,300
Short-term investments 5,819 7,352
Accounts receivable, net 5,681 5,685
Prepaids and other current assets 846 1,187
Total current assets 31,875 36,524
Property and equipment, net 1,243 1,051
Purchased intangibles, net 4,591 1,447
Deposits 86 70
-------- --------
Total assets $ 37,795 $ 39,092
======== ========
Liabilities and Stockholders' Equity:
Current liabilities:
Accounts payable $ 1,308 $ 1,370
Accrued compensation and related benefits 2,760 1,804
Other accrued liabilities 1,518 1,194
Deferred revenues 1,986 2,015
Current portion of long-term obligations 304 337
-------- --------
Total current liabilities 7,876 6,720
Long-term obligations, net of current portion 307 354
-------- --------
Total liabilities 8,183 7,074
-------- --------
Stockholders' equity:
Common stock 60,375 57,467
Unamortized deferred stock compensation (958) (1,206)
Notes receivable from stockholders (161) (161)
Accumulated deficit (29,634) (24,072)
Accumulated other comprehensive loss (10) (10)
-------- --------
Total stockholders' equity 29,612 32,018
-------- --------
Total liabilities and stockholders' equity $ 37,795 $ 39,092
======== ========
</TABLE>
[1] The condensed consolidated balance sheet as December 31, 1999 has been
extracted from the consolidated financial statements as of that date, and
does not include all the information and footnotes required by generally
accepted accounting principles for complete financial statements.
See notes to condensed consolidated financial statements.
3
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PERSISTENCE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------
MARCH 31, MARCH 31,
2000 1999
-------- --------
(UNAUDITED)
<S> <C> <C>
Revenues:
Licenses $ 2,881 $ 2,116
Service 1,329 747
-------- --------
Total revenues 4,210 2,863
-------- --------
Cost of revenues:
Licenses 50 42
Service 715 580
-------- --------
Total cost of revenues 765 622
-------- --------
Gross profit 3,445 2,241
Operating expenses:
Sales and marketing 5,998 2,015
Research and development, excluding
amortization of purchased intangibles 2,013 1,806
General and administrative 867 383
Amortization of purchased intangibles 496 -
-------- --------
Total operating expenses 9,374 4,204
-------- --------
Loss from operations (5,929) (1,963)
Interest income 380 63
Interest and other expense (13) (15)
-------- --------
Net loss $ (5,562) $ (1,915)
======== ========
Basic and diluted net loss per share $ (0.29) $ (0.27)
======== ========
Shares used in calculating basic
and diluted net loss per share 18,968 7,044
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
4
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PERSISTENCE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999
-------- --------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (5,562) $ (1,915)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 272 141
Amortization of deferred stock compensation 99 504
Change in allowance for doubtful accounts 324 -
Changes in operating assets and liabilities:
Accounts receivable (320) (439)
Prepaids and other currents 341 (9)
Accounts payable (62) (77)
Accrued compensation and benefits 956 1
Other accrued liabilities 324 362
Deferred revenues (29) (253)
Deferred rent - (24)
-------- --------
Net cash used in operating activities (3,657) (1,709)
-------- --------
Cash flows from investing activities:
Change in short-term investments 1,533 -
Property and equipment additions (372) (94)
Purchased intangibles additions (173) -
Deposits (16) (2)
-------- --------
Net cash provided by (used in) investing activities 972 (96)
-------- --------
Cash flows from financing activities:
Sale of convertible preferred stock, net - 4,142
Sale of common stock, net of repurchases (6) 156
Repayment of capital lease obligations (80) (45)
-------- --------
Net cash provided by (used in) financing activities (86) 4,253
-------- --------
Net increase (decrease) in cash and cash equivalents (2,771) 2,448
Cash and cash equivalents - beginning of period 22,300 4,938
-------- --------
Cash and cash equivalents - end of period $ 19,529 $ 7,386
======== ========
Noncash investing and financing activities:
Common stock issued for purchased intangibles $ 3,063 $-
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
5
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Persistence Software, Inc. and subsidiary (the Company) develops and
markets transactional application server and dynamic caching software products
that comprise the Internet software infrastructure for high-volume,
high-performance electronic commerce applications.
2. BASIS OF PRESENTATION
The condensed consolidated financial statements included in this filing
on Form 10-Q as of March 31, 2000 and for the three month periods ended March
31, 2000 and 1999 have been prepared by the Company, without audit, pursuant to
the rules and regulations of the Securities and Exchange Commission for interim
financial statements. Certain information and footnote disclosures normally
included in complete financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The December 31, 1999 balance sheet was extracted from
audited financial statements as of and for the year ended that date, but does
not include all disclosures required by generally accepted accounting principles
for complete financial statements. However, the Company believes that the
disclosures are adequate to make the information presented not misleading. These
consolidated financial statements should be read in conjunction with the annual
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K as of and for year ended December 31, 1999
filed with the Securities and Exchange Commission.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the Company's condensed
consolidated financial position as of March 31, 2000, its condensed consolidated
results of operations for the three month periods ended March 31, 2000 and 1999,
and its cash flows for the three month periods ended March 31, 2000 and 1999,
have been made. The results of operations and cash flows for any interim period
are not necessarily indicative of the operating results and cash flows for any
future interim or annual periods.
3. NET LOSS PER SHARE
Basic net loss per common share excludes dilution and is computed by
dividing net loss by the weighted average number of common shares outstanding
for the period (excluding shares subject to repurchase). Diluted net loss per
common share was the same as basic net loss per common share for all periods
presented since the effect of any potentially dilutive securities is excluded as
they are anti-dilutive because of the Company's net losses.
The following is a reconciliation of the numerators and denominators
used in computing basic and diluted net loss per share (in thousands, except per
share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------
2000 1999
-------- --------
<S> <C> <C>
Net loss (numerator), basic and
diluted .......................... $ (5,562) $ (1,915)
======== ========
Shares (denominator):
Weighted average common shares
outstanding ................... 19,336 7,688
Weighted average common shares
outstanding subject to
repurchase .................... (368) (644)
-------- --------
Shares used in computation,
basic and diluted ............. 18,968 7,044
======== ========
Net loss per share, basic and
diluted .......................... $ (0.29) $ (0.27)
======== ========
</TABLE>
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As of March 31, 2000 and 1999, the Company had securities outstanding
which could potentially dilute basic earnings per share in the future, but were
excluded from the computation of diluted net loss per share in the periods
presented, as their effect would have been anti-dilutive. Such outstanding
securities consist of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
2000 1999
----- -----
<S> <C> <C>
Convertible preferred stock -- 7,698
Shares of common stock subject to repurchase 337 657
Outstanding options 3,475 1,388
Outstanding warrants -- 81
----- -----
Total 3,812 9,824
----- -----
</TABLE>
4. COMPREHENSIVE INCOME
For all periods presented, the Company had no comprehensive income items
other than net loss.
5. ACQUISITION
In March 2000, the Company acquired 10BaseJ, Inc. for 140,000 shares of
common stock valued at the stock's fair market value on the acquisition date of
$3.1 million. The acquisition was accounted for using the purchase method of
accounting. The acquisition cost is included in purchased intangibles and is
being amortized over the estimated useful life of three years.
6. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires companies to record
derivatives on the balance sheet as assets or liabilities measured at fair
value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting. SFAS No. 133 will be effective for the Company's
year ending December 31, 2001. The Company is currently evaluating the impact of
SFAS No. 133 on its financial statements and related disclosures.
7
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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 consolidated
financial statements as of December 31, 1999 and 1998 and for each of the years
ended December 31, 1999, 1998, and 1997, included in our Annual Report on Form
10-K as of and for year ended December 31, 1999 filed with the Securities and
Exchange Commission. In addition, this Management's Discussion and Analysis of
Financial Condition and Results of Operations and other parts of this Form 10-Q
contain forward-looking statements that involve risks and uncertainties. Words
such as "anticipates," "believes, "plans," "expects," "future," "intends, and
similar expressions identify forward-looking statements. These statements are
not guarantees of future performance and are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
expressed or forecasted. Factors that might cause such a difference include, but
are not limited to, those discussed in the section entitled "Additional Factors
That May Affect Future Results" and those appearing elsewhere in this Form 10-Q
and our Annual Report on Form 10-K as of and for year ended December 31, 1999
filed with the Securities and Exchange Commission. Readers are cautioned not to
place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date hereof. We assume no obligation to
update these forward-looking statements to reflect actual results or changes in
factors or assumptions affecting forward-looking statements.
OVERVIEW
We are a leading provider of transactional application server software
products that comprise the Internet software infrastructure for high volume,
high performance electronic commerce applications. We were incorporated and
began operations in 1991. Our first products incorporated patented
object-to-relational mapping and caching technologies, which have since become
the foundation for our PowerTier product family. From 1992 to 1996, we
introduced a variety of enhancements to these products, including a patented
data transformation technology for mapping objects to database tables, and
caching capabilities.
In 1996, we developed our PowerTier transactional application server,
which integrates all of the previously released Persistence products with new
shared transactional caching technologies, which enable multiple users to
simultaneously access the same cached data. We first shipped our PowerTier for
C++ transactional application server in 1997. Sales of PowerTier for C++
accounted for the majority of our revenues in 1997, 1998, and 1999, during which
years we added a professional services staff to enable our customers to
implement PowerTier more rapidly. We were one of the first companies to adopt
and implement the EJB specification. In 1998, we introduced PowerTier for EJB,
which customers have frequently purchased together with PowerTier for C++. Our
most recent version of PowerTier for EJB is currently in use by several major
customers and was commercially released in March 2000. We currently plan to
continue to focus product development efforts on enhancements to both the
PowerTier for C++ and the PowerTier for EJB products.
Our revenues, which consist of software license revenues and service
revenues, totaled $4.2 million in the three months ended March 31, 2000 and $2.9
million in the three months ended March 31, 1999. License revenues consist of
licenses of our software products, which generally are priced based on the
number of users or servers. Service revenues consist of professional services
consulting, customer support and training. Because we only commenced selling
application servers in 1997, we have a limited operating history in the
application server market. We expect that, as a percentage of total revenues,
sales of PowerTier for EJB transaction servers will increase and sales of
PowerTier for C++ will decrease in the future.
We market our software and services primarily through our direct sales
organizations in the United States, the United Kingdom, France, Germany, Hong
Kong and Shanghai. Revenues from PowerTier licenses and services to customers
outside the United States represented $1.4 million, or 33% of total revenues, in
the three months ended March 31, 2000, $4.1 million, or 28% of total revenues,
in 1999 and $2.9 million, or 29% of total revenues, in 1998. Our future success
will depend, in part, on our successful development of international markets for
our products.
Historically, we have received a substantial portion of our revenues
from product sales to a limited number of customers. Sales of products to our
top five customers accounted for 44% of total revenues in the three months ended
March 31, 2000, 35% of total revenues in 1999, and 55% of total revenues in
1998. In the future, it is possible that a relatively few large customers could
continue to account for a relatively large proportion of our revenues.
To date, we have sold our products primarily through our direct sales
force, and we will need to continue to hire many more sales people in order to
meet our sales goals. In addition, our ability to achieve significant revenue
growth will depend in large part on our success in establishing and leveraging
relationships with systems integrators and other third parties.
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For 1997 and prior years, we recognized revenues in accordance with the
American Institute of Certified Public Accountants Statement of Position 91-1.
Commencing in 1998, we began recognizing revenues in accordance with the
American Institute of Certified Public Accountants Statement of Position 97-2,
"Software Revenue Recognition," as amended by Statements of Position 98-4 and
98-9. Our adoption of these new standards has not to date had a material effect
on our revenue recognition. Future implementation guidance relating to these
standards may result in unanticipated changes in our revenue recognition
practices, and these changes could affect our future revenues and earnings.
We recognize license revenues upon shipment of the software if
collection of the resulting receivable is probable, an executed agreement has
been signed, the fee is fixed or determinable and vendor-specific objective
evidence exists to allocate a portion of the total fee to any undelivered
elements of the arrangement. Undelivered elements in these arrangements
typically consist of services. For sales made through distributors, revenue is
recognized upon shipment. Distributors have no right of return. We recognize
revenues from customer training, support and consulting services as the services
are performed. We generally recognize support revenues ratably over the term of
the support contract. If support or professional services are included in an
arrangement that includes a license agreement, amounts related to support or
professional services are allocated based on vendor-specific objective evidence.
Vendor-specific objective evidence for support and professional services is
based on the price when such elements are sold separately, or, when not sold
separately, the price established by management having the relevant authority.
Arrangements which require significant modification or customization of software
are recognized under the percentage of completion method.
Since inception, we have incurred substantial research and development
costs and have invested heavily in the expansion of our sales, marketing and
professional services organizations to build an infrastructure to support our
long-term growth strategy. The number of our employees increased from 81 as of
March 31, 1999 to 137 as of March 31, 2000, representing an increase of 69%. As
a result of investments in our infrastructure, we have incurred net losses in
each fiscal quarter since 1996 and, as of March 31, 2000, had an accumulated
deficit of $29.6 million. We anticipate that our operating expenses will
increase substantially for the foreseeable future as we expand our product
development, sales and marketing and other staff. In addition, we expect to
incur substantial expenses associated with sales personnel, referral fees,
marketing programs and increased administrative expenses associated with being a
public company. Accordingly, we expect to incur net losses for the foreseeable
future.
We believe that period-to-period comparisons of our operating results
are not meaningful and should not be relied upon as indicative of future
performance. Our prospects must be considered in light of the risks, expenses
and difficulties frequently encountered by companies in early stages of
development, particularly companies in new and rapidly evolving markets. We may
not achieve or maintain profitability in the future. Our success depends
significantly upon broad market acceptance of our PowerTier for EJB application
server. Because Sun Microsystems controls the EJB standard, we need to maintain
a good working relationship with them to develop future versions of PowerTier
for EJB, as well as additional products using the EJB standard. Our performance
will also depend on the growth and widespread adoption of the market for
business-to-business electronic commerce over the Internet.
RESULTS OF OPERATIONS
POTENTIAL QUARTERLY VARIABILITY
Our quarterly operating results have fluctuated significantly in the
past, and may continue to fluctuate in the future, as a result of a number of
factors, many of which are outside our control. These factors include:
- our ability to close relatively large sales on schedule;
- delays or deferrals of customer orders or deployments;
- delays in shipment of scheduled software releases;
- demand for and market acceptance of our PowerTier for C++ and
PowerTier for EJB products;
- the possible loss of sales people;
- introduction of new products or services by us or our competitors;
9
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- annual or quarterly budget cycles of our customers;
- the level of product and price competition in the application server
market;
- our lengthy sales cycle;
- our success in expanding our direct sales force and indirect
distribution channels;
- the mix of direct sales versus indirect distribution channel sales;
- the mix of products and services licensed or sold;
- the mix of domestic and international sales; and
- our success in penetrating international markets and general
economic conditions in these markets.
The typical sales cycle of our products is long and unpredictable, and
is affected by seasonal fluctuations as a result of our customers' fiscal year
budgeting cycles and slow summer purchasing patterns in Europe. We typically
receive a substantial portion of our orders in the last two weeks of each
quarter because our customers often delay purchases of our products to the end
of the quarter to gain price concessions. Because a substantial portion of our
costs are relatively fixed and based on anticipated revenues, a failure to book
an expected order in a given quarter would not be offset by a corresponding
reduction in costs and could adversely affect our operating results.
Our license revenues in the first quarter of 2000 were lower than those in the
fourth quarter of 1999 and our license revenues in the first quarter of 1999
were lower than those in the fourth quarter of 1998. In the future, we expect
this trend to continue, with the fourth quarter of each year accounting for the
greatest percentage of total revenues for the year and with an absolute decline
in revenues from the fourth quarter to the first quarter of the next year.
The results of operations and cash flows for any interim period are not
necessarily indicative of the operating results and cash flows for any future
interim or annual periods.
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
Revenues
Our revenues were $4.2 million for the three months ended March 31, 2000
and $2.9 million for the three months ended March 31, 1999, representing an
increase of 47%. International revenues were $1.4 million for the three months
ended March 31, 2000 and $626,000 for the three months ended March 31, 1999. In
the three months ended March 31, 2000, sales of software licenses to Cisco
accounted for 12% of total revenues.
License Revenues. License revenues were $2.9 million for the three
months ended March 31, 2000 and $2.1 million for the three months ended March
31, 1999, representing an increase of 36%. License revenues represented 68% of
total revenues for the three months ended March 31, 2000 and 74% of total
revenues for the three months ended March 31, 1999. The increase in software
license revenues was primarily due to sales of our new PowerTier for EJB
application server and the increased size and productivity of our sales team.
Service Revenues. Our service revenues were $1.3 million for the three
months ended March 31, 2000 and $747,000 for the three months ended March 31,
1999, representing an increase of 78%. The increase in service revenues was
primarily due to an increase in customer support fees related to increased sales
of our PowerTier platform. Service revenues represented 32% of total revenues
the three months ended March 31, 2000 and 26% of total revenues for the three
months ended March 31, 1999.
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Cost of Revenues
Cost of License Revenues. Cost of license revenues consists of
packaging, documentation and associated shipping costs. Our cost of license
revenues was $50,000 for the three months ended March 31, 2000 and $42,000 for
the three months ended March 31, 1999. As a percentage of license revenues, cost
of license revenues were 2% for each of the three months ended March 31, 2000
and 1999.
Cost of Service Revenues. Cost of service revenues consists of personnel
and other costs related to professional services, technical support and
training. Our cost of service revenues was $715,000 for the three months ended
March 31, 2000 and $580,000 for the three months ended March 31, 1999,
representing an increase of 23%. This increase was primarily due to increased
staffing in our support organization to support a greater installed base of
customers. As a percentage of service revenues, cost of service revenues were
54% for the three months ended March 31, 2000 and 78% for the three months ended
March 31, 1999. In particular, cost of service revenues as a percentage of
service revenues may vary between periods due to our use of third party
professional services.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and bonuses earned by sales and marketing personnel,
travel and entertainment, and promotional expenses. Our sales and marketing
expenses were $6.0 million for the three months ended March 31, 2000 and $2.0
million for the three months ended March 31, 1999, representing an increase of
198%. This increase was primarily due to our investment in our sales and
marketing infrastructure, which included significant personnel-related costs to
recruit and hire sales people and sales engineers, their compensation, including
sales commissions, advertising and travel expenses, additional sales office
costs, professional services and trade show expenses. Sales and marketing
expenses represented 143% of total revenues for the three months ended March 31,
2000 and 70% of total revenues for the three months ended March 31, 1999. We
believe that a continued increase in our sales and marketing efforts is
essential for us to maintain our market position and further increase acceptance
of our products. Accordingly, we anticipate we will continue to invest in sales
and marketing for the foreseeable future, and sales and marketing expenses will
increase in future periods.
Research and Development. Research and development expenses consist
primarily of salaries and benefits for software developers, product managers and
quality assurance personnel and payments to outside software developers. Our
research and development expenses were $2.0 million for the three months ended
March 31, 2000 and $1.8 million for the three months ended March 31, 1999,
representing an increase of 11%. This increase was primarily related to an
increase in employee and consultant software developers and program management
and documentation personnel hired to support product development. Research and
development expenses for the three months ended March 31, 1999 also include a
one-time $303,000 compensation charge associated with the issuance of common
stock to an investor at a price which was less than the deemed fair value for
accounting purposes. Research and development expenses represented 48% of total
revenues for the three months ended March 31, 2000 and 63% of total revenues for
the three months ended March 31, 1999. We believe that a continued increase in
our research and development investment is essential for us to maintain our
market position, to continue to expand our product line and to enhance our
technology. Accordingly, we anticipate that we will continue to invest in
product research and development for the foreseeable future, and research and
development expenses are likely to increase in future periods.
General and Administrative. General and administrative expenses consist
primarily of salaries, benefits and related costs for our finance,
administrative and general management personnel. Our general and administrative
expenses were $867,000 for the three months ended March 31, 2000 and $383,000
for the three months ended March 31, 1999, representing an increase of 126%.
This increase was primarily the result of the hiring of additional finance and
administrative personnel, additional professional services and insurance costs
associated with being a public company. General and administrative expenses
represented 21% of total revenues for the three months ended March 31, 2000 and
13% of total revenues for the three months ended March 31, 1999. We believe that
our general and administrative expenses will continue to increase as a result of
the expenses associated with our growth and being a public company, including
annual and other public reporting costs, directors' and officers' liability
insurance, investor relations programs and accounting and legal expenses.
Amortization of Purchased Intangibles. Amortization of purchased
intangibles was $496,000 for the three months ended March 31, 2000 and none for
the three months ended March 31, 1999.
Net Interest Income. Net interest income consists primarily of earnings
on our cash, cash equivalent and short-term investment balances, offset by
interest expense related to obligations under capital leases and other
borrowings. Net interest income was $367,000 for the three months ended March
31, 2000 and $48,000 for the three months ended March 31, 1999, representing an
increase of $319,000. This increase was earned on the net proceeds received from
our initial public offering of common stock on June 24, 1999. We expect that net
interest income will decrease as we continue to use our net proceeds from our
initial public offering.
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Stock-Based Compensation. Some options granted and common stock issued
during the years ended December 31, 1999 and 1998 and during 1997 have been
considered to be compensatory, as the estimated fair value for accounting
purposes was greater than the stock price as determined by the board of
directors on the date of grant or issuance. Total deferred stock compensation
associated with equity transactions as of March 31, 2000 was $958,000, net of
amortization. Deferred stock compensation is being amortized ratably over the
vesting periods of these securities. Amortization expense was $99,000 in the
three months ended March 31, 2000 and $504,000 in 1999.
Provision for Income Taxes. Since inception, we have incurred net
operating losses for federal and state tax purposes and have not recognized any
tax provision or benefit.
We have placed a full valuation allowance against our net deferred tax
assets due to the uncertainty surrounding the realization of these assets. We
evaluate on a quarterly basis the recoverability of the net deferred tax assets
and the level of the valuation allowance. If and when we determine that it is
more likely than not that the deferred tax assets are realizable, the valuation
allowance will be reduced.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our business primarily through our
initial public offering of common stock in June 1999, which totaled $34.1
million in aggregate net proceeds, and private sales of convertible preferred
stock, which totaled $19.9 million in aggregate net proceeds, through March 31,
2000. We have also financed our business through a loan in the principal amount
of $800,000 and capitalized leases. As of March 31, 2000, we had $25.3
million of cash, cash equivalents and short-term investments and $24.0 million
of working capital.
Net cash used for operating activities was $3.7 million in the three
months ended March 31, 2000 and $1.7 million for the three months ended March
31, 1999. For each of the three months ended March 31, 2000 and 1999, cash used
for operating activities was attributable primarily to net losses and increases
in accounts receivable. Those increases were primarily offset by depreciation
and amortization, amortization of deferred stock compensation and deferred
revenues, and for the three months ended March 31, 2000, a decrease in the
allowance for doubtful accounts and an increase in accrued compensation and
benefits.
Net cash provided by (used in) investing activities was $972,000 for the
three months ended March 31, 2000 and $(96,000) for the three months ended March
31, 1999. For the three months ended March 31, 2000, cash was provided by
investing activities through the conversion of short-term investments into cash
and cash equivalents. For each of the three month periods, cash used in
investing activities primarily reflected investments in property and equipment
and deposits. For the three months ended March 31, 2000, cash used in investing
activities also consisted of additions of purchased intangibles.
Net cash provided by (used in) financing activities was $(86,000) for
the three months ended March 31, 2000 and $4.3 million for the three months
ended March 31, 1999. Cash provided by financing activities during the three
months ended March 31, 1999 was primarily attributable to proceeds from the
issuance of preferred stock.
We have credit facilities with Comerica Bank. Under those credit
facilities, the Company has a $5.0 million revolving line of credit facility
available through August 15, 2000 and a second equipment financing facility for
an amount up to $1,000,000 under which drawdowns are available through July 15,
2000. As of March 31, 2000 we had no borrowings outstanding under the
revolving line of credit facility or the second equipment financing facility. As
of March 31, 2000, we had a promissory note in favor of Comerica, under which
$534,000 out of an original $800,000 was outstanding. We are required to make
principal payments of $22,222 per month plus interest of 7.75% per annum on the
unpaid principal balance, payable in 24 monthly installments. The credit
facilities with Comerica Bank are collateralized by substantially all of our
assets, including our patents and intellectual property.
Although we have no material commitments for capital expenditures, we
anticipate a substantial increase in capital expenditures and lease commitments
consistent with our anticipated growth in operations, infrastructure and
personnel. We also may increase our capital expenditures as we expand into
additional international markets.
We believe that the our current cash, cash equivalents and short-term
investments, will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next year. If cash generated
from operations is insufficient to satisfy our liquidity requirements, we may
seek to sell additional equity or debt securities or to obtain a credit
facility. If additional funds are raised through the issuance of debt
securities, these securities could have rights, preferences and privileges
senior to holders of
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common stock, and the term of this debt could impose restrictions on our
operations. The sale of additional equity or convertible debt securities could
result in additional dilution to our stockholders, and we may not be able to
obtain additional financing on acceptable terms, if at all. If we are unable to
obtain this additional financing, we may be required to reduce the scope of our
planned product development and marketing efforts, which could harm our
business.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued accounting
statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
This statement requires companies to record derivatives on the balance sheet as
assets or liabilities measured at fair value. Gains or losses resulting from
changes in the values of those derivatives would be accounted for depending on
the use of the derivative and whether it qualifies for hedge accounting. SFAS
No. 133 will be effective for us beginning in 2001. We are currently evaluating
the impact of SFAS No. 133 on our financial statements and related disclosures.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
You should carefully consider the following risks in addition to the
other information contained in this Quarterly Report on Form 10-Q and our Annual
Report on Form 10-K as of and for the year ended December 31, 1999 filed with
the Securities and Exchange Commission. The risks and uncertainties described
below are intended to be the ones that are specific to our company or industry
and that we deem to be material, but are not the only ones that we face.
We Have A Limited Operating History In The Application Server Market.
Because we only commenced selling application servers in 1997, we have a
limited operating history in the application server market. We thus face the
risks, expenses and difficulties frequently encountered by companies in early
stages of development, particularly companies in the rapidly changing software
industry. These risks include:
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- our substantial dependence for revenue from our PowerTier for C++
product, which was first introduced in 1997 and has achieved only
limited market acceptance;
- our substantial dependence for revenue from our PowerTier for EJB
product, which was first introduced in 1998 and has achieved only
limited market acceptance;
- our need to expand our distribution capability through both a direct
sales organization and third party distributors and systems
integrators;
- our unproven ability to anticipate and respond to technological and
competitive developments in the rapidly changing market for
application servers;
- our unproven ability to compete in a highly competitive market;
- uncertainty as to the growth rate in the electronic commerce market
and, in particular, the business-to-business electronic commerce
market;
- our dependence on Enterprise JavaBeans, commonly known as EJB,
becoming a widely accepted standard in the transactional application
server market; and
- our dependence upon key personnel.
Because We Have A History Of Losses And Negative Cash Flow, We May Never Become
Or Remain Profitable.
Our revenues may not continue to grow and we may not be able to achieve
or maintain profitability in the future. We have incurred net losses each year
since 1996. In particular, we incurred losses of $4.7 million in 1997, $4.1
million in 1998 and $11.3 million in 1999, and $5.6 million in the three months
ended March 31, 2000. As of March 31, 2000, we had an accumulated deficit of
approximately $29.6 million. In addition, while we are unable to predict
accurately our future operating expenses, we currently expect these expenses to
increase, potentially substantially, as we continue to expand our product
development and sales and marketing efforts and assume the increased
administrative duties associated with our public company status. Thus, we will
need to increase our revenues to become profitable. Because our product market
is new and evolving, we cannot accurately predict either the future growth rate,
if any, or the ultimate size of the market for our products.
We Have Financed Our Business Through The Sale Of Stock And Not Through Cash
Generated By Our Operations.
Since inception, we have generally had negative cash flow from
operations. To date, we have financed our business primarily through sales of
common stock and convertible preferred stock and not through cash generated by
our operations. We expect to continue to have negative cash flow from
operations.
We May Need To Raise Additional Capital In The Future.
Although we believe that our current cash, cash equivalents and
short-term investment balances will be sufficient to meet our anticipated
operating cash needs for the next 12 months, we may need to raise additional
funds prior to that time. We face several risks in connection with this possible
need to raise additional capital:
- the issuance of additional securities could result in:
- debt securities with rights senior to the common stock;
- dilution to existing stockholders as a result of issuing additional
equity or convertible debt securities;
- debt securities with restrictive covenants that could restrict our
ability to run our business as desired; or
- securities issued on disadvantageous financial terms.
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- the failure to procure needed funding could result in:
- a reduction in scope in our planned product development or marketing
efforts; or
- an inability to respond to competitive pressures or take advantage
of market opportunities, which could adversely affect our ability to
achieve profitability or positive cash flow.
The Unpredictability Of Our Quarterly Results May Adversely Affect The Price Of
Our Common Stock.
Our operating results have fluctuated significantly in the past and may
fluctuate significantly in the future as a result of a variety of factors, many
of which are outside our control. In particular, the fourth quarter of each year
has in the past tended to account for the greatest percentage of total revenues
for the year, and we have often experienced an absolute decline in revenues from
the fourth quarter to the first quarter of the next year. If our future
quarterly operating results are below the expectations of securities analysts or
investors, the price of our common stock would likely decline. The factors that
may cause fluctuations of our operating results include the following:
- our ability to close relatively large sales on schedule;
- delays or deferrals of customer orders or deployments;
- delays in shipment of scheduled software releases;
- demand for and market acceptance of our PowerTier for C++ and
PowerTier for EJB products;
- the possible loss of sales people;
- introduction of new products or services by us or our competitors;
- annual or quarterly budget cycles of our customers;
- the level of product and price competition in the application server
market;
- our lengthy sales cycle;
- our success in expanding our direct sales force and indirect
distribution channels;
- the mix of direct sales versus indirect distribution channel sales;
- the mix of products and services licensed or sold;
- the mix of domestic and international sales; and
- our success in penetrating international markets and general
economic conditions in these markets.
We typically receive a substantial portion of our orders in the last two
weeks of each fiscal quarter because our customers often delay purchases of our
products to the end of the quarter to gain price concessions. Because a
substantial portion of our costs are relatively fixed and based on anticipated
revenues, a failure to book an expected order in a given quarter would not be
offset by a corresponding reduction in costs and could adversely affect our
operating results.
Our Sales Cycle Is Long, Unpredictable And Subject To Seasonal Fluctuations, So
It Is Difficult To Forecast Our Revenues.
Any delay in sales of our products or services could cause our quarterly
revenues and operating results to fluctuate. The typical sales cycle of our
products is long and unpredictable and requires both a significant capital
investment decision by our customers and our education of potential customers
regarding the use and benefits of our products. Our sales cycle is generally
between three and nine months. A successful sales cycle typically includes
presentations to both business and technical decision makers, as well as a
limited
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pilot program to establish technical fit. Our products typically are purchased
as part of a significant enhancement to a customer's information technology
system. The implementation of our products involves a significant commitment of
resources by prospective customers. Accordingly, a purchase decision for a
potential customer typically requires the approval of several senior decision
makers. Our sales cycle is affected by the business conditions of each
prospective customer. Due to the relative importance of many of our product
sales, a lost or delayed sale could adversely affect our quarterly operating
results. Our sales cycle is affected by seasonal fluctuations as a result of our
customers' fiscal year budgeting cycles and slow summer purchasing patterns in
Europe.
We Depend On A Relatively Small Number Of Significant Customers, And The Loss Of
One Or More Of These Customers Could Result In A Decrease In Our Revenues.
Historically, we have received a substantial portion of our revenues
from product sales to a limited number of customers. In the three months ended
March 31, 2000, sales of products and services to Cisco accounted for 12% of our
total revenues and sales of products and services to our top five customers
accounted for 44% of our total revenues. In 1999, sales of products and services
to Cisco accounted for 13% of our total revenues, and sales of products and
services to our top five customers accounted for 35% of total revenues. In 1998,
sales of products and services to Cisco accounted for 14% of our total revenues,
sales of products and services to Instinet accounted for 17% of our total
revenues, and sales of products and services to our top five customers accounted
for 55% of total revenues. In 1997, sales of products and services to Lucent
accounted for 11% of our total revenues, and sales of products and services to
our top five customers accounted for 15% of our total revenues. In addition, the
identity of our top five customers has changed from year to year. If we lose a
significant customer, or fail to increase product sales to an existing customer
as planned, we may not be able to replace the lost revenues with sales to other
customers. In addition, because our marketing strategy is to concentrate on
selling products to industry leaders, any loss of a customer could harm our
reputation within the industry and make it harder for us to sell our products to
other companies in that industry. The loss of, or a reduction in sales to, one
or more significant customers would likely result in a decrease in our revenues.
We Depend On The Java Programming Language, The Enterprise JavaBeans Standard
And The Emerging Market For Distributed Object Computing, And If These
Technologies Fail To Gain Acceptance, Our Business Could Suffer.
We are focusing significant marketing efforts on our PowerTier for EJB
application server, which is based on three relatively new technologies, none of
which has been widely adopted by companies. These three technologies are a
distributed object computing architecture, Sun Microsystems' Java programming
language and Enterprise JavaBeans, or EJB. Distributed object computing combines
the use of software modules, or objects, communicating across a computer network
to software applications, such as our PowerTier application server. EJB is the
Java programming standard for use in an application server. In 1998, we launched
our PowerTier for EJB product, which is a transactional application server that
uses Java and conforms to the EJB standard. Sun Microsystems released the EJB
standard in 1998, and thus far EJB has had limited market acceptance. Since our
PowerTier for EJB product depends upon the specialized EJB standard, we face a
limited market compared to competitors who may offer application servers based
on more widely accepted standards, including the Java programming language. We
expect a substantial portion of our future revenues will come from sales of
products based on the EJB standard. Thus, our success depends significantly upon
broad market acceptance of distributed object computing in general, and Java
application servers in particular. If EJB does not become a widespread
programming standard for application servers, our revenues and business could
suffer.
If We Do Not Deliver Products That Meet Rapidly Changing Technology Standards
And Customer Demands, We Will Lose Market Share To Our Competitors.
The market for our products and services is characterized by rapid
technological change, dynamic customer demands and frequent new product
introductions and enhancements. Customer requirements for products can change
rapidly as a result of innovation in software applications and hardware
configurations and the emergence or adoption of new industry standards,
including Internet technology standards. We need to increase our research and
development investment to maintain our technological leadership. Our future
success depends on our ability to continue to enhance our current products and
to continue to develop and introduce new products that keep pace with
competitive product introductions and technological developments. For example,
as Sun Microsystems introduces new EJB specifications, we will need to introduce
new versions of PowerTier for EJB designed to support these new specifications
to remain competitive. If we do not bring enhancements and new versions of our
products to market in a timely manner, our market share and revenues could
decrease and our reputation could suffer. If we fail to anticipate or respond
adequately to changes in technology and customer needs, or if there are any
significant delays in product development or introduction, our revenues and
business could suffer.
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Because Our Direct Sales Team Is Currently Our Most Critical Sales Channel, Any
Failure To Build And Train This Team May Result In Lower Revenues.
We must expand our direct sales team to generate increased revenue. In
1998, we hired several new salespeople, replacing most of our preexisting sales
force. In 1999 and 2000, we continued to hire new salespeople. In order to meet
our future sales goals, we will need to hire many more salespeople within the
next two years for both our domestic and international sales efforts. In the
past, newly hired employees have required training and approximately six to nine
months experience to achieve full productivity. Because our entire sales team is
relatively new, they may not meet our sales goals. In addition, our recently
hired employees may not become productive, and we may not be able to hire enough
qualified individuals in the future.
Because Our Future Revenue Goals Are Based On Our Development Of A Strong Sales
Channel Through Systems Integrators And Other Third Parties, Any Failure To
Develop This Channel May Result In Lower Revenues.
To date, we have sold our products primarily through our direct sales
force, but our ability to achieve significant revenue growth in the future will
depend in large part on our success in establishing and leveraging relationships
with systems integrators and other third parties. It may be difficult for us to
establish these relationships, and, even if we establish these relationships, we
will then depend on the systems integrators' and other third parties' sales
efforts. In addition, because these relationships are nonexclusive, systems
integrators may choose to use application servers or other alternative solutions
offered by our competitors, and not our products. If we fail to successfully
build our third-party distribution channels or if our systems integrator and
other third party partners do not perform as expected, our business could be
harmed.
Because Our Products Are Often Incorporated Into Enterprise-Wide System
Deployments, Any Delays In These Projects May Result In Lower Revenues.
Because our products are often incorporated into multi-million dollar
enterprise projects, we depend on the successful and timely completion of these
enormous projects to fully deploy our products and achieve our revenue goals.
These enterprise projects often take many years to complete and can be delayed
by a variety of factors, including general or industry-specific economic
downturns, our customers' budget constraints, other customer-specific delays,
problems with other system components or delays caused by the systems
integrators who may be managing the system deployment. If our customers cannot
successfully implement large-scale deployments, or they determine for any reason
that our products cannot accommodate large-scale deployments or that our
products are not appropriate for widespread use, our business could suffer. In
addition, if a systems integrator fails to complete a project utilizing our
product for a customer in a timely manner, our revenues or business reputation
could suffer.
Because We Compete With Sun Microsystems, Who Controls The EJB Application
Server Standard, We Face The Risk That They May Develop This Standard To Favor
Their Own Products.
Our success depends on achieving widespread market acceptance of our
PowerTier for EJB application server. Because Sun Microsystems controls the EJB
standard, we need to maintain a good working relationship with Sun Microsystems
to develop future versions of PowerTier for EJB, as well as additional products
using EJB, that will gain market acceptance. In March 1998, we entered into a
license agreement with Sun Microsystems, pursuant to which we granted Sun
Microsystems rights to manufacture and sell, by itself and not jointly with
others, products under a number of our patents and Sun Microsystems granted us
rights to manufacture and sell, by ourselves and not jointly with others,
products under a number of Sun Microsystems' patents. As a result, Sun
Microsystems may develop and sell some competing products that would, in the
absence of this license agreement, infringe our patents. Because Sun
Microsystems controls the EJB standard, it could develop the EJB standard in a
more proprietary way to favor a product offered by its subsidiary, iPlanet, or a
third party, which could make it much harder for us to compete in the EJB
application server market.
Microsoft Has Established A Competing Application Server Standard, Which Could
Diminish The Market Potential For Our Products If It Gains Widespread
Acceptance.
Microsoft has established a competing standard for distributed
computing, COM, which includes an application server product. If this standard
gains widespread market acceptance over the EJB or CORBA standards, on which our
products are based, our business would suffer. Because of Microsoft's resources
and commanding position with respect to other markets and technologies,
Microsoft's entry into the application server market may cause our potential
customers to delay purchasing decisions. We expect that Microsoft's presence in
the application server market will increase competitive pressure in this market.
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We Face Significant Competition From Companies With Greater Resources Than We
Have And May Face Additional Competition In The Future.
The market for our products is intensely competitive, subject to rapid
change and significantly affected by new product introductions and other market
activities of industry participants. We believe that the principal competitive
factors in our market are:
- performance, including scalability, integrity and availability;
- ability to provide a complete software platform;
- flexibility;
- use of standards-based technology;
- ease of integration with customers' existing enterprise systems;
- ease and speed of implementation;
- quality of support and service;
- security;
- company reputation; and
- price.
Our competitors include both publicly and privately-held enterprises,
including BEA Systems (WebLogic), Secant Technologies, IBM (WebSphere), Inprise,
Iona Technologies, Oracle (OAS) and i-Planet (Sun Microsystems). Many customers
may not be willing to purchase our PowerTier platform because they have already
invested heavily in databases and other enterprise software components offered
by these competing companies. Many of these competitors have preexisting
customer relationships, longer operating histories, greater financial,
technical, marketing and other resources, greater name recognition and larger
installed bases of customers than we do. In addition, some competitors offer
products that are less complex than our PowerTier products and require less
customization to implement with potential customers' existing systems. Thus,
potential customers engaged in simpler business-to-business e-commerce
transactions may prefer these "plug-and-play" products to our more complex
offerings. Moreover, there are other very large and established companies,
including Microsoft, who offer alternative solutions and are thus indirect
competitors. Further, dozens of companies, such as Allaire, have announced their
intention to support EJB and may compete against us in the future. These
competitors and potential competitors may be able to respond more quickly to new
or emerging technologies and changes in customer requirements, or to devote
greater resources to the development, promotion and sale of their products than
we can. In addition, in the PowerTier for C++ market, many potential customers
build their own custom application servers, so we effectively compete against
our potential customers' internal information technology departments.
If The Market For Business-To-Business Electronic Commerce Over The Internet
Does Not Develop As We Currently Envision, Our Business Model Could Fail And Our
Revenues Could Decline.
Our performance and future success will depend on the growth and
widespread adoption of the market for business-to-business electronic commerce
over the Internet. If business-to-business electronic commerce does not develop
in the manner currently envisioned, our business could be harmed. Moreover,
critical issues concerning the commercial use of the Internet, including
security, cost, accessibility and quality of network service, remain unresolved
and may negatively affect the growth of the Internet as a platform for
conducting business-to-business electronic commerce. In addition, the Internet
could lose its viability due to delays in the development or adoption of new
standards and protocols to handle increased activity or due to increased
government regulation and taxation of Internet commerce.
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Our Failure To Manage Growth Could Impair Our Business.
Achieving our planned revenue growth and other financial objectives will
place significant demands on our management and other resources. We anticipate
increasing our headcount significantly over the next two years. Our ability to
manage this growth effectively will require us to continue to develop and
improve our operational, financial and other internal systems and controls, as
well as our business development capabilities, and to train, motivate and manage
our employees. If we are unable to manage our growth effectively, we may not be
able to retain key personnel and the quality of our services and products may
suffer.
Our Business Could Suffer If We Cannot Attract And Retain The Services Of Key
Employees.
Our future success depends on the ability of our management to operate
effectively, both individually and as a group. We are substantially dependent
upon the continued service of our existing executive personnel, especially
Christopher T. Keene, our Chief Executive Officer and Chairman of the Board. We
do not have a key person life insurance policy covering Mr. Keene or any other
officer or key employee. Our success will depend in large part upon our ability
to attract and retain highly-skilled employees, particularly sales personnel and
software engineers. There is significant competition for skilled employees,
especially for people who have experience in both the software and Internet
industries. If we are not successful in attracting and retaining these skilled
employees, our sales and product development efforts would suffer. In addition,
if one or more of our key employees resigns to join a competitor or to form a
competing company, the loss of that employee and any resulting loss of existing
or potential customers to a competitor could harm our business. If we lose any
key personnel, we may not be able to prevent the unauthorized disclosure or use
of our technical knowledge or other trade secrets by those former employees.
Our Software Products May Contain Defects Or Errors, And Shipments Of Our
Software May Be Delayed.
Complex software products often contain errors or defects, particularly
when first introduced or when new versions or enhancements are released. Our
products have in the past contained and may in the future contain errors and
defects, which may be serious or difficult to correct and which may cause delays
in subsequent product releases. Delays in shipment of scheduled software
releases or serious defects or errors could result in lost revenues or a delay
in market acceptance, which could have a material adverse effect on our revenues
and reputation.
We May Be Sued By Our Customers For Product Liability Claims As A Result Of
Failures In Their Critical Business Systems.
Because our customers use our products for important business
applications, errors, defects or other performance problems could result in
financial or other damages to our customers. They could pursue claims for
damages, which, if successful, could result in our having to make substantial
payments. Although our purchase agreements typically contain provisions designed
to limit our exposure to product liability claims, existing or future laws or
unfavorable judicial decisions could negate these limitation of liability
provisions. A product liability claim brought against us, even if meritless,
would likely be time consuming and costly for us to litigate or settle.
A Portion Of Our Revenues Is Derived From International Sales, Which Could
Decline As A Result Of Legal, Business And Economic Risks Specific To
International Operations.
Our future success will depend, in part, on our successful development
of international markets for our products. Approximately 33% of our revenues
came from sales of products and services outside of the United States in the
three months ended March 31, 2000. Approximately 28% of our revenues came from
sales of products and services outside the United States during 1999, and
approximately 29% of our revenues came from sales of products and services
outside the United States during 1998. We expect international revenues to
continue to represent a significant portion of our total revenues. To date,
almost all of our international revenues have resulted from our direct sales
efforts. In international markets, however, we expect that we will depend more
heavily on third party distributors to sell our products in the future. The
success of our international strategy will depend on our ability to develop and
maintain productive relationships with these third parties. The failure to
develop key international markets for our products could cause a reduction in
our revenues. Additional risks related to our international expansion and
operation include:
- difficulties of staffing and managing foreign operations;
- our dependence on the sales efforts of our third party distributors;
- longer payment cycles typically associated with international sales;
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- tariffs and other trade barriers;
- failure to comply with a wide variety of complex foreign laws and
changing regulations;
- exposure to political instability and economic downturns;
- failure to localize our products for foreign markets;
- restrictions on the export of technologies;
- potentially adverse tax consequences;
- reduced protection of intellectual property rights in some
countries; and
- currency fluctuations.
We sell products outside the United States in U.S. dollars. We do not
currently engage in any hedging transactions to reduce our exposure to currency
fluctuations as a result of our foreign operations. We are not currently ISO
9000 compliant, nor are we attempting to meet all foreign technical standards
that may apply to our products. Our failure to develop our international sales
channel as planned could cause a decline in our revenues.
If We Do Not Protect Our Intellectual Property Rights, Our Competitive Position
May Be Impaired.
Our success may depend on our ability to protect our proprietary rights
to the technologies used in our products, and yet the measures we are taking to
protect these rights may not be adequate. If we are not adequately protected,
our competitors could use the intellectual property that we have developed to
enhance their products, which could harm our business. We rely on patent
protection, as well as a combination of copyright, trade secret and trademark
laws, and nondisclosure and other contractual restrictions to protect our
proprietary technology, but these legal means afford only limited protection.
Unauthorized parties may attempt to copy aspects of our products or to obtain
and use information that we regard as proprietary. In addition, the laws of some
foreign countries may not protect our intellectual property rights to the same
extent as do the laws of the United States. We have commenced patent
infringement actions against two competitors -- See "Part II, Other Information,
Item 1, Legal Proceedings." Further litigation may be necessary to enforce our
intellectual property rights, which could result in substantial costs and
diversion of management attention and resources.
We May Be Sued For Patent Infringement.
The software industry is characterized by the existence of a large
number of patents and frequent litigation based on allegations of patent
infringement and the violation of other intellectual property rights. As the
number of competitors in the application server market grows and the
functionality of products in different market segments overlaps, the possibility
of an intellectual property claim against us increases. For example, we may
inadvertently infringe a patent of which we are unaware. In addition, because
patent applications can take many years to issue, there may be a patent
application now pending of which we are unaware, which will cause us to be
infringing when it is issued in the future. To address these patent infringement
or other intellectual property claims, we may have to enter into royalty or
licensing agreements on disadvantageous commercial terms. Alternatively, we may
be unable to obtain a necessary license. A successful claim against us, and our
failure to license the infringed or similar technology, would harm our business.
In addition, any infringement or other intellectual property claims, with or
without merit, which are brought against us could be time consuming and
expensive to litigate or settle and could divert management attention from
administering our core business.
Future Sales Of Our Common Stock May Depress Our Stock Price.
If our current stockholders sell substantial amounts of common stock,
including shares issued upon the exercise of outstanding options and warrants,
in the public market, the market price of our common stock could fall. In
addition, these sales of common stock could impede our ability to raise funds at
an advantageous price through the sale of securities. As of March 31, 2000,
we had 19.5 million shares of common stock outstanding. Beginning in December
1999, approximately 14.4 million shares of restricted common stock held by our
stockholders became eligible for sale in the public market. Approximately 7
million of these restricted shares are subject to volume and other restrictions
under Rule 144.
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Our Stock Price Has Been, And May Continue To Be, Volatile.
Our common stock has only been available in the public market since June
24, 1999. An active public market for our common stock may not completely
develop or be sustained in the future. To date, the market price of our common
stock has been highly volatile and may rise or fall in the future as a result of
many factors, such as:
- variations in our quarterly results;
- announcements of technological innovations by us or our competitors;
- introductions of new products by us or our competitors;
- acquisitions or strategic alliances by us or our competitors;
- hiring or departure of key personnel;
- the gain or loss of a significant customer or order;
- changes in estimates of our financial performance or changes in
recommendations by securities analysts;
- market conditions in the software industry and in our customers'
industries; and
- adoption of new accounting standards affecting the software
industry.
The stock market in general has experienced extreme price and volume
fluctuations, which could adversely affect the market price of our stock. In
particular, the market prices of the common stock of many companies in the
software and Internet industries have experienced this volatility, which has
often been unrelated to these companies' operating performance. In the past,
securities class action litigation has often been brought against a company
after a period of volatility in the market price of its stock. We may in the
future be a target of similar litigation. Securities litigation could result in
substantial costs and divert management's attention and resources, which could
harm our business.
Our Executive Officers And Directors Own A Large Percentage Of Our Voting Stock
And Could Exert Significant Influence Over Matters Requiring Stockholder
Approval.
As of March 31, 2000, executive officers and directors, and entities
affiliated with them, own approximately 45% of our outstanding common stock.
Accordingly, these stockholders may, as a practical matter, continue to control
the election of a majority of the directors and the determination of all
corporate actions. This concentration of voting control could have the effect of
delaying or preventing a merger or other change in control, even if it would
benefit our other stockholders.
The Antitakeover Provisions In Our Charter Documents And Under Delaware Law
Could Discourage A Takeover.
Provisions in our certificate of incorporation, bylaws and Delaware law
may discourage, delay or prevent a merger or other change in control that a
stockholder may consider favorable. These provisions may also discourage proxy
contests or make it more difficult for stockholders to take corporate action.
These provisions include the following:
- establishing a classified board in which only a portion of the total
board members will be elected at each annual meeting;
- authorizing the board to issue preferred stock;
- prohibiting cumulative voting in the election of directors;
- limiting the persons who may call special meetings of stockholders;
- prohibiting stockholder action by written consent; and
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<PAGE> 22
- establishing advance notice requirements for nominations for
election of the board of directors or for proposing matters that can
be acted on by stockholders at stockholder meetings.
We May Engage In Future Acquisitions That Could Disrupt Our Business And Dilute
Our Stockholders.
As part of our business strategy, we expect to review acquisition
prospects that we believe would be advantageous to the development of our
business. For example, we have recently acquired object request broker
technology and servlet engine technology. While we have no current agreements or
negotiations underway with respect to any major acquisitions, we may make
acquisitions of businesses, products or technologies in the future. If we make
any acquisitions, we could take any or all of the following actions, any of
which could materially and adversely affect our financial results and the price
of our common stock:
- issue equity securities that would dilute existing stockholders'
percentage ownership;
- incur substantial debt;
- assume contingent liabilities; or
- take substantial charges in connection with the amortization of
goodwill and other intangible assets.
Acquisitions also entail numerous risks, including:
- difficulties in assimilating acquired operations, products and
personnel with our pre-existing business;
- unanticipated costs;
- diversion of management's attention from other business concerns;
- adverse effects on existing business relationships with suppliers
and customers;
- risks of entering markets in which we have limited or no prior
experience; and
- potential loss of key employees from either our preexisting business
or the acquired organization.
We may not be able to successfully integrate any businesses, products,
technologies or personnel that we might acquire in the future, and our failure
to do so could harm our business.
We Have Not Designated Any Specific Use For The Net Proceeds Of The Company's
Initial Public Offering Of Common Stock, And Thus May Use The Remaining Net
Proceeds To Fund Operating Losses, For Acquisitions Or For Other Corporate
Purposes.
We have not designated any specific use for the net proceeds of our
initial public offering of common stock. As a result, our management and board
of directors has broad discretion in spending the remaining net proceeds of that
offering. We currently expect to use the remaining net proceeds primarily for
working capital and general corporate purposes, funding product development and
expanding our sales and marketing organization. In addition, we may use a
portion of the remaining net proceeds for further development of our product
lines through acquisitions of products, technologies and businesses.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Sensitivity. Our operating results are sensitive to
changes in the general level of U.S. interest rates, particularly because most
of our cash equivalents are invested in short-term debt instruments. If market
interest rates were to change immediately and uniformly by ten percent from
levels at March 31, 2000, the fair value of our cash equivalents and short-term
investments would change by approximately $150,000.
Foreign Currency Fluctuations. We have not had any significant
transactions in foreign currencies, nor did we have any significant balances
that are due or payable in foreign currencies at March 31, 2000. Therefore, a
hypothetical ten percent change in foreign
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<PAGE> 23
currency rates would have an insignificant impact on our financial position or
results of operations. We do not hedge any of our foreign currency exposure.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On December 6, 1999, the Company filed a patent infringement action in
the United States District Court for the Northern District of California against
The Object People Inc. and The Object People (U.S.) Inc. (collectively, "TOP"),
Persistence Software, Inc. v The Object People Inc., et al., Case No. C 99-5182
MMC (N.D. Cal.). On December 14, 1999, the Company filed a similar action
against Secant Technologies, Inc. ("Secant"), Persistence Software, Inc. v.
Secant Technologies, Inc., Case No. C 00-20210 SW (N.D. Cal.). A motion is
pending to consolidate the two actions into one lawsuit. The Company alleges in
both cases that TOP and Secant's software products infringe three of the
Company's patents, and TOP and Secant have contributed to the infringement of,
and induced the infringement of, the Company's patents by third parties (i.e.,
their respective customers). The three patents owned by the Company that are at
issue in these actions are U.S. Patent No. 5,499,371, No. 5,615,362, and No.
5,706,506. The Company also has asserted claims against TOP and Secant for
unfair business practices under California Business and Professions Code
Sections 17200 et seq. ("Section 17200").
On December 22, 1999, TOP filed its Answer to the Company's Complaint
and asserted counterclaims for declaratory relief that the Company's patents are
invalid and unenforceable, as well as counterclaims that allege that the
Company's filing of the lawsuit itself constitutes a violation of the Lanham Act
and unfair business practices under Section 17200. On January 31, 2000, Secant
filed its Answer to the Company's Complaint and asserted only counterclaims for
declaratory relief that the Company's patents are invalid and unenforceable.
Both suits are in the early stages, and discovery has not been
completed. While management believes that the Company's claims are valid, that
the counterclaims asserted by TOP and Secant are without merit, and that any
potential liability that the Company might incur to TOP or Secant is immaterial
as the only counterclaims alleging damages are TOP's claims under the Lanham Act
and Section 17200, it is not possible at this time to determine the ultimate
outcome of these actions.
Except as described above, the Company is not currently subject to any
material legal proceedings, though it may from time to time become a party to
various legal proceedings that arise in the ordinary course of business.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(c) Sales of Unregistered Securities
The Company made the following unregistered sales of Common Stock in the
quarter ended March 31, 2000:
<TABLE>
<CAPTION>
Persons or Class
of Persons to
Name of Whom the
Amount of Underwriter or Consideration Securities Were
Transaction Date Securities Sold Placement Agent Received Sold
---------------- --------------- --------------- ------------- -----------------
<S> <C> <C> <C> <C>
03/02/00 140,000 Shares None (1) 10BaseJ, Inc.
</TABLE>
(1) On March 2, 2000, the Company issued 140,000 shares of Common
Stock to 10BaseJ, Inc. in exchange for substantially all of the
assets of 10BaseJ, Inc. This issuance was deemed to be exempt
from the registration requirements the Securities Act of 1933, as
amended, in reliance on Section 4(2) of the Securities Act as a
transaction by an issuer not involving a public offering. These
securities have not been registered for resale.
23
<PAGE> 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS:
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K:
None.
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<PAGE> 25
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.
PERSISTENCE SOFTWARE, INC.
By: /s/ CHRISTINE RUSSELL
---------------------------------------
CHRISTINE RUSSELL
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND
ACCOUNTING OFFICER)
Date: May 15, 2000
25
<PAGE> 26
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
26
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AND CONDENSED CONSOLIDATED STATEMENT OF
OPERATIONS INCLUDED IN THE COMPANY'S FORM 10-Q AS OF AND FOR THE THREE MONTH
PERIOD ENDED MARCH 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-30-2000
<CASH> 19,529
<SECURITIES> 5,819
<RECEIVABLES> 6,337
<ALLOWANCES> 657
<INVENTORY> 0
<CURRENT-ASSETS> 31,875
<PP&E> 3,644
<DEPRECIATION> 2,401
<TOTAL-ASSETS> 37,795
<CURRENT-LIABILITIES> 7,876
<BONDS> 307
0
0
<COMMON> 59,256
<OTHER-SE> (29,644)
<TOTAL-LIABILITY-AND-EQUITY> 37,795
<SALES> 2,881
<TOTAL-REVENUES> 4,210
<CGS> 50
<TOTAL-COSTS> 765
<OTHER-EXPENSES> 9,374
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 367
<INCOME-PRETAX> (5,562)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,562)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,562)
<EPS-BASIC> (0.29)
<EPS-DILUTED> (0.29)
</TABLE>
