<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDING JUNE 30, 1996
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 0-12167
RATIONAL SOFTWARE CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 54-1217099
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2800 SAN TOMAS EXPRESSWAY, SANTA CLARA, CA 95051-0951
(Address of principal executive office) (Zip Code)
408-496-3600
(Registrant's telephone number including area code)
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 / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
COMMON STOCK, PAR VALUE
$.01 PER SHARE 17,268,231
(Class) (Shares outstanding on July 31, 1996)
<PAGE> 2
CONTENTS PAGE
PART I -- FINANCIAL INFORMATION
Item 1 -- Consolidated Financial Statements:
Condensed Consolidated Balance Sheets........................... 3
Condensed Consolidated Statements of Income..................... 5
Condensed Consolidated Statements of Cash Flows................. 6
Notes to Condensed Consolidated Financial Statements............ 7
Item 2 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 9
PART II -- OTHER INFORMATION
Item 6 -- Exhibits and Reports on Form 8-K................................ 15
SIGNATURE ................................................................. 16
<PAGE> 3
RATIONAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
June 30, March 31,
1996 1996
----------- --------
(Unaudited)
<S> <C> <C>
Cash and cash equivalents $ 41,448 $ 43,934
Short-term investments 11,474 8,711
Accounts receivable, net 21,472 23,408
Prepaid expenses and other assets 2,512 2,074
-------- --------
Total current assets 76,906 78,127
Property and equipment, at cost:
Computer, office and manufacturing equipment 24,078 22,779
Office furniture 2,115 2,109
Leasehold improvements 1,227 1,209
-------- --------
27,420 26,097
Accumulated depreciation and amortization (21,533) (20,715)
-------- --------
Property and equipment, net 5,887 5,382
Other assets, net 2,004 2,165
-------- --------
Total assets $ 84,797 $ 85,674
======== ========
</TABLE>
See accompanying notes.
3
<PAGE> 4
RATIONAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
June 30, March 31,
1996 1996
---------- ----------
(Unaudited)
<S> <C> <C>
Accounts payable $ 3,005 $ 2,983
Accrued employee benefits 5,769 8,476
Other accrued expenses 4,548 4,285
Accrued merger and restructuring expenses, current portion 490 575
Deferred revenue 11,557 15,606
Current portion of long-term debt and lease obligations 151 654
--------- ---------
Total current liabilities 25,520 32,579
Accrued rent 706 880
Accrued merger and restructuring expenses, long-term 1,216 1,309
--------- ---------
Total liabilities 27,442 34,768
--------- ---------
Stockholders' equity:
Common stock, $.01 par value, 25,000,000
shares authorized 172 168
Additional paid-in capital 116,474 113,939
Treasury stock (1,340) (1,340)
Accumulated deficit (57,831) (61,995)
Cumulative translation adjustment (120) 134
--------- ---------
Total stockholders' equity 57,355 50,906
--------- ---------
Total liabilities and stockholders' equity $ 84,797 $ 85,674
========= =========
</TABLE>
See accompanying notes.
4
<PAGE> 5
RATIONAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
---------------------
1996 1995
---------------------
<S> <C> <C>
Net product revenue $17,300 $11,454
Consulting and support revenue 10,161 8,303
------- -------
Total revenue 27,461 19,757
Cost of product revenue 1,825 1,250
Cost of consulting and support revenue 5,499 4,763
------- -------
Total cost of revenue 7,324 6,013
------- -------
Gross margin 20,137 13,744
Product research and development expenses 4,495 3,171
Sales and marketing expenses 8,877 7,666
General and administrative expenses 2,399 1,711
------- -------
Operating income 4,366 1,196
Other income, net 533 180
------- -------
Income before income taxes 4,899 1,376
Provision for income taxes 735 110
------- -------
Net income $ 4,164 $ 1,266
======= =======
Net income per common share $ 0.23 $ 0.09
Shares used in computing per share amounts 18,465 14,268
</TABLE>
See accompanying notes.
5
<PAGE> 6
RATIONAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS, UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
------------------------
1996 1995
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 4,164 $ 1,266
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 970 1,558
Compensation expense for stock option grants 36 --
(Increase) decrease in assets:
Accounts receivable 1,936 (1,707)
Prepaids and other, net (438) (154)
Other assets 9 (3)
Increase (decrease) in liabilities:
Accounts payable 22 647
Accrued employee benefits (2,707) (1,514)
Deferred revenue (4,049) (551)
Accrued expenses (165) (1,178)
Accrued merger and restructuring expenses (178) (296)
-------- --------
Net cash used in operating activities (400) (1,932)
Cash flows from investing activities:
Purchase of investments (7,639) (984)
Sale of investments 4,876 980
Capital expenditures (1,323) (710)
-------- --------
Net cash used in investing activities (4,086) (714)
Cash flows from financing activities:
Principal payments under debt and lease obligations (503) (630)
Proceeds from issuance of common stock 2,503 30,783
-------- --------
Net cash provided by financing activities 2,000 30,153
-------- --------
Net increase (decrease) in cash and cash equivalents (2,486) 27,507
Cash and cash equivalents at beginning of period 43,934 9,440
-------- --------
Cash and cash equivalents at end of period $ 41,448 $ 36,947
======== ========
</TABLE>
See accompanying notes.
6
<PAGE> 7
RATIONAL SOFTWARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION -- The consolidated financial information included
herein has been prepared without audit in accordance with the Company's
accounting policies, as described in its latest annual report filed with
the Securities and Exchange Commission on Form 10-K. In the opinion of
management, all adjustments, which consist only of normal recurring
adjustments necessary for a fair presentation of the Company's financial
position, statements of income, and cash flows for the interim periods
presented have been made. As permitted by Form 10-Q, certain information
and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted where such disclosure would substantially
duplicate previous disclosures. Operating results for the three months
ended June 30, 1996 are not necessarily indicative of the results that
may be expected for the year ending March 31, 1997.
2. ACCOUNTS RECEIVABLE -- Accounts receivable were reduced by an allowance
for doubtful accounts of $1,046,000 at June 30, 1996 and $1,042,000 at
March 31, 1996, respectively.
3. NET INCOME PER COMMON SHARE -- Net income per share has been computed by
dividing the net income by the weighted average numbers of common and
dilutive common equivalent shares outstanding during the period. Common
stock equivalents consist of stock options using the treasury stock
method.
4. CONTINGENCY -- On December 1, 1995, a complaint was filed against the
Company relating to the Company's preliminary acquisition negotiations
with the plaintiff, which were subsequently terminated. The plaintiff is
seeking money damages and specific performance of an alleged promise by
the Company to acquire the plaintiff. The Company has denied each and
every remaining allegation in the complaint and intends to defend the
case vigorously. Discovery has begun, and the trial date has been set for
January 1997. The Company believes the resolution of these matters will
not have an adverse impact on its financial condition and results of
operations.
5. SUBSEQUENT EVENT -- On July 23, 1996, the Company's Board of Directors
approved a two-for-one forward stock split of its common stock, to be
effected by means of a stock dividend of one share of common stock for
each one share of common stock outstanding on August 27, 1996, the record
date for the stock split. The stock split is subject to receipt of
stockholder approval of an increase to the Company's authorized common
stock at the Company's annual meeting to be held on August 27, 1996. The
payment date is scheduled for
7
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5. SUBSEQUENT EVENT -- (Continued) September 10, 1996. Shares used in
computing earnings per share have not been adjusted for the split.
8
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ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The statements contained in Management's Discussion and Analysis of Financial
Condition and Results of Operations include "forward looking" information within
the meaning of Sections 27A of the Securities Act of 1993 and 21E of the
Securities and Exchange Act of 1934, as amended, and are subject to the safe
harbor created by those sections. The actual future results of the Company could
differ materially from those projected in the forward looking information. For a
discussion of certain factors that could cause actual results to differ
materially from those projected by the forward looking information see "Factors
That May Affect Future Results".
The Company's revenue is derived from product license fees and charges for
services, including technical consulting, training, and customer support. In
accordance with generally accepted accounting principles, the Company recognizes
software license revenue upon shipment and recognizes customer-support revenue
over the term of the maintenance agreement. Revenue from consulting and training
is recognized when earned. The Company's license agreements generally do not
provide a right of return, and reserves are maintained for potential credit
losses, of which there have been only immaterial amounts incurred to date.
COMPARATIVE ANALYSIS OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30,
1996
Total revenue increased $7,704,000 (39.0%) in the three-month period ended June
30, 1996 from the comparable fiscal 1996 period. Net product revenue increased
by $5,846,000 (51.0%) in the fiscal 1997 period versus the same fiscal 1996
period. The increase is primarily due to continued strength across the Company's
product lines.
Consulting and support revenue increased $1,858,000 (22.4%) in the fiscal 1997
three-month period versus the same fiscal 1996 period. The increase is primarily
attributable to continuing demand for the Company's consulting expertise in
object-oriented software development and business process engineering.
Cost of product revenue, expressed as a percentage of the related revenue, was
10.5% for the three-month period of fiscal 1997 compared to 10.9% for the same
period of fiscal 1996. The decrease in cost as a percentage is primarily due to
lower royalty expense resulting from a decrease in third party product sales.
As a percentage of the related revenue, cost of consulting and support revenue
decreased from 57.4% in fiscal 1996 to 54.1% in fiscal 1997 for the three-month
period. The decrease in cost as a percentage is primarily due to more efficient
9
<PAGE> 10
management of the Company's consulting resources, combined with the impact of an
underlying relatively fixed support cost base being spread over increased
revenues.
The Company's gross margin for the three month period increased to 73.3% in
fiscal 1997 from 69.6% in fiscal 1996 as a result of the shift towards product
sales, which have higher margins than consulting and support revenue.
Product research and development expenses increased $1,324,000 (41.8%) in the
fiscal 1997 three-month period versus the same fiscal 1996 period. This increase
is attributable to the cost of additional personnel and related costs incurred
in maintaining existing products and developing new product releases.
For the three-month period of fiscal 1997, sales and marketing expenses
increased $1,211,000 (15.8%) comparable to the same period of fiscal 1996. The
increased expenses for the fiscal 1997 period reflect the additional personnel,
commissions and related costs required in sales and marketing to expand the
Company's sales channels, penetrate new markets and increase its market share in
core markets.
General and administrative expenses increased $688,000 (40.2%) in the fiscal
1997 three-month period versus the same fiscal 1996 period. The increased
expense for the fiscal 1997 period resulted from increased employee-related
expenses associated with staffing requirements needed to support the Company's
expanding business and increased amortization of goodwill arising from the
Objectory purchase.
Other income, net consists of interest income, interest expense, gains and
losses on foreign currency transactions and miscellaneous items of income and
expense. Other income increased from $180,000 to $533,000 for the quarters ended
June 30, 1995 and 1996, respectively. The quarter ended June 30, 1995 included
only one month's interest earned on cash raised from the secondary public
offering completed in June 1995, versus three months of interest earned for the
quarter ended June 30, 1996.
The provision for income taxes for the first three months of fiscal 1997 and
1996 is based on the estimated annual effective tax rate and includes current
federal, state and foreign income taxes. The effective tax rates for fiscal 1997
and 1996 differ from the federal statutory rate, primarily as a result of the
utilization of net operating loss carryforwards, offset by certain foreign and
state taxes. The higher tax rate in fiscal 1997 is primarily attributable to
higher state taxes due to utilization of remaining state net operating losses in
1996, as well as federal minimum tax.
At March 31, 1996, the Company had net operating loss carryforwards for federal
income tax purposes of approximately $47,400,000 that expire in 1997 through
2011, and other tax carryforwards of approximately $3,100,000 which expire in
years 1996 through 2010. As a result of the sale of common stock in June 1995,
the Company incurred a change in stock ownership as defined under Section 382 of
the Internal Revenue Code of 1986. Accordingly, approximately $34,000,000 of the
Company's
10
<PAGE> 11
net operating loss carryforwards and all of the tax credit carryforwards will be
subject to an annual limitation of approximately $8,700,000 regarding their
utilization against taxable income in future periods. In addition, as a result
of the fiscal 1994 merger with old Rational and provisions in the Internal
Revenue Code, utilization of approximately $4,600,000 of net operating loss
carryforwards are further limited to the future income of the Company.
LIQUIDITY AND CAPITAL RESOURCES AT JUNE 30, 1996
As of June 30, 1996, the Company had cash, cash equivalents and short-term
investments of $52,922,000 and working capital of $51,386,000. Net cash used in
operating activities for the period ending June 30, 1996 was composed primarily
of decreases in accrued employee benefits and deferred revenue offset by a
decrease in accounts receivable and increased net income.
The Company believes that expected cash flow from operations combined with
existing cash and cash equivalents and short-term investments will be sufficient
to meet its cash requirements for the foreseeable future.
FACTORS THAT MAY AFFECT FUTURE RESULTS
There are a number of factors that could affect the Company's future operating
results. The Company's product lines are designed for use in object modeling of
business processes, business objects, and software systems and in the day-to-day
development of software by teams of developers. The Company's financial
performance will depend in part upon continued growth in the object-oriented
technology market and the development of industry standards that the Company's
products address.
The software-engineering tools market is highly competitive and rapidly
changing. The Company believes that the increased level of competition it has
observed in fiscal 1996 will continue to increase. New competition is expected
to continue to enter the market. Competitors may be experienced either in the
development of software-engineering tools or in database and
software-development products. Competitors may have larger technical staffs,
more established distribution channels, and more financial resources than the
Company.
The Company believes that its continued success will depend in part on its
ability to provide an integrated line of software application development tools
that support software development for a number of application construction
technologies, including the enhancement of current products and development and
introduction of new products. The Company also believes its continued success
will become increasingly dependent on its ability to support the Microsoft
platform, including Windows NT. The Company believes that it will be
particularly important to successfully develop and market a broader line of
products for C++, Visual Basic, Java, and other application
11
<PAGE> 12
construction technologies in order to be successful in its efforts to reach
broader markets and to further increase the value of its share in the
aerospace/defense market segment. There is no assurance that the Company's
efforts will be successful.
The Company is experiencing a period of aggressive product introductions that
has placed, and may continue to place, a significant strain on its resources,
including its personnel. Projects such as the expansion of the Company's C++
product line, additional product development and product introductions, or
acquisitions of other technologies or companies, such as the recent acquisition
of Objectory AB, when added to the day-to-day activities of the Company, will
place a further strain on the Company's resources and personnel. The Company
believes that the hiring and retaining of qualified individuals at all levels in
the Company is essential to the Company's ability to manage growth successfully.
Historically, the Company has operated with little backlog because software
products are generally shipped as orders are received. As a result, revenue in
any quarter is substantially dependent on orders booked and shipped in that
quarter.
Revenue is difficult to forecast due to the fact that the Company's sales cycle,
from initial evaluation to purchase, varies substantially from customer to
customer. Because the Company's staffing and operating expenses are based on
anticipated revenue levels and because a high percentage of the Company's costs
are fixed, small variations in the timing of the recognition of specific
revenues could cause significant variations in operating results from quarter to
quarter.
The Company's planned revenues for the remainder of fiscal 1997 include sales of
new products that are scheduled to ship for the first time during fiscal 1997.
Delay in the start of shipment of the Company's new products would have an
adverse effect on the Company's gross profit and operating income. The Company
attempts to make adequate allowances in its new product release schedules for
both internal and beta-site testing of product performance. Because of the
complexity of the Company's products, however, the release of new products may
be postponed should test results indicate the need for substantial redesign and
retesting or should the Company elect to add product enhancements in response to
beta customer feedback. The Company's sales remain sensitive to its existing and
prospective customers' budgeting practices, to the continuing Department of
Defense support of the Ada programming language, and to potential cutbacks in
defense spending in response to economic conditions.
The growth in revenues and operating income (exclusive of nonrecurring operating
and merger-related expenses) experienced by the Company in recent quarters is
not necessarily indicative of future results and period-to-period comparisons of
its financial results should not be relied upon as an indication of future
performance. Fluctuations in operating results may also result in volatility in
the price of the Company's common stock.
12
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The Company currently distributes its products primarily through field sales
personnel teamed with highly trained technical consulting and support personnel.
The Company believes that a high level of technical consulting, training, and
customer support is essential to maintaining its competitive position, and it
has found that the ability to deliver a high level of technical consulting,
training, and customer support is an important selling point with respect to its
products. While complementary to the Company's products, services have
historically yielded lower margins for the Company than its products business.
To the extent that services constitute a higher proportion of total revenues in
the future, the Company's margins will be adversely affected.
Future acquisitions by the Company may result in the diversion of management's
attention from day-to-day operations of the Company's business and may include
numerous other risks, including difficulties in the integration of the
operations, products, and personnel of the acquired companies. Although there
are currently no commitments with respect to any particular acquisition, Company
management frequently evaluates the strategic opportunities available to it and
may in the near-term or long-term future pursue acquisitions of products,
technologies, or businesses.
The Company is dependent upon the efforts and abilities of a number of key
management, sales, product development, support, and technical personnel. The
success of the Company depends to a large extent upon its ability to retain and
continue to attract key employees. The rate at which the Company can attract and
retain highly trained technical personnel that are integral to its direct sales
teams may limit the rate at which the Company can increase sales.
International sales currently account for approximately one third of the
Company's revenues, and the Company expects that international sales will
continue to account for a significant portion of revenues in future periods.
International sales are subject to inherent risks, including unexpected changes
in regulatory requirements and tariffs, difficulties in staffing and managing
foreign operations, longer payment cycles, greater difficulty in accounts
receivable collection, potentially adverse tax consequences, price controls or
other restrictions on foreign currency, and difficulties in obtaining export and
import licenses. Any material adverse effect on the Company's international
business would be likely to materially and adversely affect the Company's
business, operating results, and financial condition as a whole. The Company's
international sales are generally denominated in foreign currencies. The Company
attempts to limit its exposure to fluctuations in foreign currencies from time
to time by utilizing a hedging strategy. Gains and losses on the conversion of
foreign payments into U.S. dollars may contribute to fluctuations in the
Company's results of operations. Although the Company has not experienced any
material adverse impact to date from the fluctuations in foreign currencies,
there can be no assurance that the Company will not experience a material
adverse impact on its financial condition and results of operations from
fluctuations in foreign currencies in the future.
13
<PAGE> 14
The Company regards its software as proprietary and attempts to protect it with
a combination of copyright, trademark and trade secret laws, employee and
third-party nondisclosure agreements, and other methods of protection. Despite
these precautions, it may be possible for unauthorized third parties to copy
certain portions of the Company's products or reverse engineer or obtain and use
information the Company regards as proprietary. The Company's software products
are generally licensed to end users on a "right to use" basis pursuant to a
perpetual license. Certain license provisions protecting against unauthorized
use, copying, transfer, and disclosure of the licensed program may be
unenforceable under the laws of certain jurisdictions and foreign countries.
Substantially all of the Company's common stock outstanding is freely tradable.
Sales of substantial amounts of common stock in the public market could
adversely affect the prevailing market price of the common stock.
14
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PART II -- OTHER INFORMATION
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 11.1: Statement of Computation of Net Income per Common Share
(b) Exhibit 27: Financial Data Schedule
(c) Reports on Form 8-K: None.
15
<PAGE> 16
SIGNATURE
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.
RATIONAL SOFTWARE CORPORATION
by: s/s Robert T. Bond
----------------------------------------
Robert T. Bond
Senior Vice President
Chief Operating Officer,
Chief Financial Officer and Secretary
August 14, 1996
16
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Exhibit 11.1
Statement of Computation of Net Income Per Common Share
<TABLE>
<CAPTION>
(In thousands, except per share Three Months Ended
amounts ) June 30,
----------------------------
1996 1995
------- -------
<S> <C> <C>
Primary:
Weighted average
shares outstanding 16,907 13,300
Dilutive stock options 1,558 968
------- -------
Total 18,465 14,268
======= =======
Fully diluted:
Weighted average
shares outstanding 16,907 13,300
Dilutive stock options 1,559 1,096
======= =======
Total 18,466 14,396
======= =======
Net income $ 4,164 $ 1,266
Income per common share
Primary: $ .23 $ .09
Fully diluted: $ .23 $ .09
</TABLE>
17
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-START> APR-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 41448
<SECURITIES> 11474
<RECEIVABLES> 22518
<ALLOWANCES> 1046
<INVENTORY> 0
<CURRENT-ASSETS> 76906
<PP&E> 27420
<DEPRECIATION> 21533
<TOTAL-ASSETS> 84797
<CURRENT-LIABILITIES> 25520
<BONDS> 151
0
0
<COMMON> 115306
<OTHER-SE> (57951)
<TOTAL-LIABILITY-AND-EQUITY> 84797
<SALES> 17300
<TOTAL-REVENUES> 27461
<CGS> 1825
<TOTAL-COSTS> 7324
<OTHER-EXPENSES> 15771
<LOSS-PROVISION> (4)
<INTEREST-EXPENSE> (640)
<INCOME-PRETAX> 4899
<INCOME-TAX> 735
<INCOME-CONTINUING> 4164
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4164
<EPS-PRIMARY> .23
<EPS-DILUTED> .23
</TABLE>
