<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 2, 1996
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
RATIONAL SOFTWARE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<TABLE>
<S> <C> <C>
DELAWARE 7372 54-1217099
(STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
JURISDICTION OF INCORPORATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
2800 SAN TOMAS EXPRESSWAY
SANTA CLARA, CALIFORNIA 95051-0951
(408) 496-3600
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
PAUL D. LEVY
CHIEF EXECUTIVE OFFICER
2800 SAN TOMAS EXPRESSWAY, SANTA CLARA, CALIFORNIA 95051-0951
(408) 496-3600
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
------------------------
COPIES OF ALL COMMUNICATIONS SHOULD BE SENT TO:
<TABLE>
<S> <C>
FRANCIS S. CURRIE, ESQ. ROBERT J. BRIGHAM, ESQ.
GAIL C. HUSICK, ESQ. COOLEY GODWARD LLP
CRAIG H. FACTOR, ESQ. FIVE PALO ALTO SQUARE
WILSON SONSINI GOODRICH & ROSATI, P.C. 3000 EL CAMINO REAL
650 PAGE MILL ROAD PALO ALTO, CALIFORNIA 94306-2155
PALO ALTO, CALIFORNIA 94304-1050
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
- ------------------
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
- ------------------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
------------------------
CALCULATION OF REGISTRATION FEE FOR SHARES
<TABLE>
<CAPTION>
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PROPOSED MAXIMUM PROPOSED MAXIMUM AGGREGATE AMOUNT OF
TITLE OF EACH CLASS OF SECURITIES AMOUNT TO BE OFFERING PRICE OFFERING REGISTRATION
TO BE REGISTERED REGISTERED(1) PER SHARE(2) PRICE(2) FEE
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<S> <C> <C> <C> <C>
Common Stock, par value $.01 per
share................................ 5,872,725 $31.31 $183,875,020 $55,720
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</TABLE>
(1) Includes 766,007 shares which the Underwriters have the option to purchase
to cover over-allotments, if any. Reflects two-for-one stock split effected
September 10, 1996.
(2) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457(c).
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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<PAGE> 2
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor
may offers to buy be accepted prior to the time the registration statement
becomes effective. This prospectus shall not constitute an offer to sell or
the solicitation of an offer to buy nor shall there be any sale of these
securities in any State in which such offer, solicitation or sale would be
unlawful prior to registration or qualification under the securities laws
of any such State.
SUBJECT TO COMPLETION, DATED OCTOBER 2, 1996
PROSPECTUS
5,106,718 SHARES
LOGO
COMMON STOCK
Of the 5,106,718 shares of Common Stock offered hereby, 4,150,000 shares
are being sold by Rational Software Corporation ("Rational" or the "Company")
and 956,718 shares are being sold by the Selling Stockholders. Such share
numbers reflect a two-for-one stock split effected on September 10, 1996. The
Company will not receive any of the proceeds from the sale of shares by the
Selling Stockholders. See "Principal and Selling Stockholders."
The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol RATL. On October 1, 1996, the last reported sale price of the Common
Stock was $35.50 per share. See "Price Range of Common Stock and Dividend
Policy."
------------------------
THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 6.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
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PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2) PROCEEDS TO
SELLING
STOCKHOLDERS
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<S> <C> <C> <C> <C>
Per Share.............................. $ $ $ $
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Total(3)............................... $ $ $ $
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</TABLE>
(1) See "Underwriting" for indemnification arrangements with the several
Underwriters.
(2) Before deducting expenses payable by the Company estimated at $675,000.
(3) The Company has granted to the Underwriters a 30-day option to purchase up
to additional 766,007 shares of Common Stock solely to cover
over-allotments, if any. If all such shares are purchased, the total Price
to Public, Underwriting Discount and Proceeds to Company will be
$ , $ and $ , respectively. See "Underwriting."
------------------------
The Shares of Common Stock are offered by the several Underwriters subject
to prior sale, receipt and acceptance by them and subject to the right of the
Underwriters to reject any order in whole or in part and certain other
conditions. It is expected that certificates for such shares will be made
available for delivery on or about , 1996, at the office of the
agent of Hambrecht & Quist LLC in New York, New York.
HAMBRECHT & QUIST
GOLDMAN, SACHS & CO.
WESSELS, ARNOLD & HENDERSON
, 1996
<PAGE> 3
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information can be inspected and copied at the public
reference facilities maintained by the Commission at Room 1024, 450 Fifth
Street, N.W., Judiciary Plaza, Washington, D.C. 20549, and at the Commission's
following Regional Offices: Suite 1400, Northwest Atrium Center, 500 West
Madison Street, Chicago, Illinois 60661; and 13th Floor, Seven World Trade
Center, New York, New York 10048. Copies of such material can be obtained at
prescribed rates from the Public Reference Section of the Commission at 450
Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549. The Company's
Common Stock is quoted for trading on the Nasdaq National Market and reports,
proxy statements and other information concerning the Company may also be
inspected at the offices of the National Association of Securities Dealers, 1735
K. Street, N.W., Washington, D.C. 20006.
Additional information regarding the Company and the shares offered hereby
is contained in the Registration Statement on Form S-3 and the exhibits thereto
filed with the Commission under the Securities Act of 1933, as amended (the
"Securities Act"). For further information pertaining to the Company and the
shares, reference is made to the Registration Statement and the exhibits
thereto, which may be inspected without charge at, and copies thereof may be
obtained at prescribed rates from, the office of the Commission at 450 Fifth
Street, N.W., Judiciary Plaza, Washington, D.C. 20549.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1996, as amended, the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1996, and the Company's two Form 8-K's dated October 2,
1996 filed by the Company with the Commission are hereby incorporated by
reference in this Prospectus except as superseded or modified herein. All
documents filed by the Company with the Commission pursuant to Section 13(a),
13(c), 14 or 15(d) of the Exchange Act after the date of this Prospectus and
prior to the termination of the offering of the shares offered hereby shall be
deemed to be incorporated by reference into this Prospectus and to be a part
hereof from the date of filing of such documents. Any statement contained in any
document incorporated or deemed to be incorporated by reference herein shall be
deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement contained herein or in any other subsequently filed
document which also is or is deemed to be incorporated by reference herein
modifies or supersedes such statement. Any such statement so modified or
superseded shall not be deemed, except as modified or superseded, to constitute
a part of this Prospectus. The Company will provide without charge to each
person, including any beneficial owner, to whom this Prospectus is delivered,
upon written or oral request of such person, a copy of any and all of the
documents that have been or may be incorporated by reference herein (other than
exhibits to such documents which are not specifically incorporated by reference
into such documents). Such requests should be directed to the Secretary at the
Company's principal executive offices at 2800 San Tomas Expressway, Santa Clara,
California 95051-0951 (telephone (408) 496-3600).
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET
MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN
ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE
"UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
Rational(R), Rational Rose(R), SoDA(R), Verdix(R), VADS(R), Rational
Summit, Rational Apex, VADScross, Rational Approach and Rational Visual Test are
trademarks of the Company. Microsoft, Windows(R) 95, Windows(R) NT, Visual
Basic(R), Visual C++, Visual J++, Active X, BackOffice and Developer Studio are
trademarks of Microsoft Corporation. This Prospectus also includes trademarks of
companies other than the Company.
2
<PAGE> 4
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the Consolidated Financial Statements and Notes thereto
appearing elsewhere in this Prospectus. The Common Stock offered hereby involves
a high degree of risk. See "Risk Factors."
THE COMPANY
Rational Software Corporation ("Rational" or the "Company") develops,
markets and supports a comprehensive solution for the component-based
development of software systems. The Company's objective is to ensure the
success of customers in developing and managing software systems that are
strategically important to their businesses. Rational provides an integrated
family of tools that spans the critical phases of the software development
process from initial analysis and design through delivery and maintenance. In
addition, the Company provides technical consulting, training and support
services. By supporting controlled iterative development, visual modeling and an
architecture-driven process, Rational's products and services enable customers
to reduce the risk of project failure, improve the quality of the software
systems they develop, increase developer productivity, reduce time-to-market and
increase software reusability.
Software permeates products and processes encountered in almost every
aspect of daily life, in areas as diverse as equity trading systems, inventory
management, telecommunications, military command-and-control systems, office
machinery and medical devices. Software development projects suffer from a high
rate of failure, resulting in project cancellation, substantial cost overruns or
significant delays to market. As organizations increasingly rely on
enterprise-wide information systems and seek competitive advantage through the
use of computer technology, a more effective approach to software development
becomes increasingly important.
Component-based development offers a more effective approach to software
development. It builds on object-oriented programming, in which "objects" are
used as modular building blocks to model real-world processes. Component-based
development raises the level of abstraction and reduces the amount of source
code that must be created in connection with the development of a new software
system, leading to higher levels of re-use and greater return on investment than
previous techniques. The growing interest in and increasing usage of
component-based development is being driven by the growth of the Internet,
company-specific intranets and distributed multi-tier client/server systems, as
well as the widespread adoption of implementation languages such as Visual
Basic, Java, and related technologies such as CORBA and Microsoft's ActiveX.
Major software vendors, including Microsoft Corporation, Oracle Corporation,
Hewlett-Packard Company, Sun Microsystems, Inc. and Netscape Communications
Corp., have begun to use internally, and some have publicly endorsed, component-
based development.
Visual modeling of software components and the relationships among them is
an essential element of using component-based development on a large scale. The
Company believes that its Unified Modeling Language ("UML") has become the de
facto standard language for visual modeling. The UML has been endorsed by
industry leaders Microsoft, Oracle and Hewlett-Packard.
Rational provides products supporting component-based development.
Rational's product lines are Rational Rose, for visual modeling; Rational Apex,
for managing development teams and the components they generate; Rational
Summit, for software change management and process enforcement; and SoDA, for
automated documentation generation. In addition, the Company is adding Visual
Test to its product line for automated software testing on Windows 95 and
Windows NT.
As of September 30, 1996, Rational has sold over 40,000 licenses of its
software products to over 2,500 customers worldwide. The Company's customers
build an extensive range of software including enterprise information systems,
packaged software products and systems used in telecommunications, financial
services, aerospace/defense and transportation. Representative customers include
Andersen Consulting, AT&T, British Telecom, LM Ericsson, Fidelity Investments,
IBM, Lockheed Martin,
3
<PAGE> 5
MetLife, Microsoft, Rockwell-Collins, Smith Barney and Siemens. No single
customer accounted for 10% or more of revenues in fiscal 1996. International
sales represented approximately 36% of the Company's total revenue in fiscal
1996.
The Company was incorporated in Delaware in 1982. The Company's executive
offices are located at 2800 San Tomas Expressway, Santa Clara, California
95051-0951, and its telephone number is (408) 496-3600. On September 10, 1996,
the Company effected a two-for-one stock split of its Common Stock by way of a
stock dividend (the "Stock Split").
RECENT EVENTS
On October 2, 1996, Rational and Microsoft announced the formation of a
business alliance which will consist of Rational's acquisition of Microsoft's
Visual Test product, technology cross-licensing, joint development projects and
joint marketing programs. As part of this arrangement, Rational has agreed to
develop a visual modeling product which includes selected elements of Rational
Rose for distribution in certain Microsoft development tools. Rational's
objective in forming this alliance with Microsoft is to extend the Company's
product line and to increase the use of component-based development by providing
visual modeling capabilities to developers using Microsoft's visual tools. In
addition, Rational believes that its arrangement with Microsoft will expose the
Company's technology to potential customers outside of its historical customer
base.
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company......................... 4,150,000 shares
Common Stock offered by the Selling Stockholders............ 956,718 shares
Common Stock to be outstanding after the offering........... 38,641,973 shares(1)
Use of proceeds............................................. Working capital, general
corporate purposes and
possible acquisitions
Nasdaq National Market symbol............................... RATL
</TABLE>
- ------------------------------
(1) Based on the number of shares outstanding at September 30, 1996. Excludes
4,930,729 shares of Common Stock reserved as of September 30, 1996 for
issuance upon the exercise of outstanding options at a weighted average
exercise price of $9.61 per share. Also excludes 1,994,958 shares reserved
for future grant or issuance under the Company's stock option and stock
purchase plans at September 30, 1996. See Note 9 of Notes to Consolidated
Financial Statements.
4
<PAGE> 6
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
FISCAL YEAR ENDED MARCH 31, JUNE 30,
------------------------------------------------ -----------------
1992 1993 1994 1995 1996 1995 1996
------- ------- -------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA:
Net product revenue............ $38,161 $46,123 $ 41,716 $39,221 $55,899 $11,454 $17,300
Consulting and support
revenue...................... 22,168 24,880 28,627 33,678 35,208 8,303 10,161
Total revenue........ 60,329 71,003 70,343 72,899 91,107 19,757 27,461
Income (loss) from continuing
operations(1)................ (1,065) (2,163) (13,807) 4,678 (4,021) 1,266 4,164
Net income (loss)(2)........... (761) (3,974) (13,982) 4,678 (4,021) 1,266 4,164
Income (loss) from continuing
operations per common
share........................ $ (0.04) $ (0.09) $ (0.57) $ 0.19 $ (0.13) $ 0.04 $ 0.11
Net income (loss) per common
share(2)..................... $ (0.03) $ (0.16) $ (0.57) $ 0.19 $ (0.13) $ 0.04 $ 0.11
Shares used in computing per
share amounts(3)............. 23,820 24,260 24,394 25,212 30,725 28,536 36,930
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1995 1995 1995 1996 1996
-------- --------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Total revenue................................... $ 19,757 $ 21,642 $ 24,004 $ 25,704 $ 27,461
Net income (loss)(4)............................ 1,266 2,094 (11,163) 3,782 4,164
Net income per common share..................... $ 0.04 $ 0.06 $ (0.34) $ 0.12 $ 0.11
Shares used in computing per share amounts(3)... 28,536 33,206 32,466 36,279 36,930
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1996
--------------------------
ACTUAL AS ADJUSTED(5)
------- --------------
(UNAUDITED)
<S> <C> <C>
CONSOLIDATED BALANCE SHEETS DATA:
Cash, cash equivalents and short-term investments................. $52,922 $192,206
Working capital................................................... 51,386 190,670
Total assets...................................................... 84,797 224,081
Long-term obligations............................................. 1,922 1,922
Stockholders' equity.............................................. 57,355 196,639
</TABLE>
- ------------------------------
(1) Amounts for 1993 and 1994 include merger and restructuring costs of
$2,500,000 and $9,922,000, respectively. Amounts for 1995 include expense
reversals of $1,100,000. Amounts for 1996 include $14,500,000 of one-time
charges and operating expenses primarily associated with the Company's
acquisition of Objectory AB and the subsequent restructuring and shaping of
the Company's business, including an $8,700,000 write-off of in-process
research and development costs acquired in connection with the acquisition.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and Note 5 of Notes to Consolidated Financial Statements.
(2) Amounts for 1992, 1993 and 1994 include income (loss) from discontinued
operations of $304,000, ($1,811,000) and ($175,000), respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note 4 of Notes to Consolidated Financial Statements.
(3) Computed on the basis described in Note 1 of Notes to Consolidated Financial
Statements.
(4) Amount for the quarter ended December 31, 1995 includes $14,500,000 of
one-time charges and operating expenses primarily associated with the
Company's acquisition of Objectory AB and the subsequent restructuring and
shaping of the Company's business, including an $8,700,000 write-off of
in-process research and development costs acquired in connection with the
acquisition.
(5) Adjusted to give effect to the receipt of the net proceeds from the sale of
4,150,000 shares of Common Stock offered by the Company hereby, at an
assumed public offering price of $35.50 per share. See "Use of Proceeds."
Except as otherwise noted, all figures presented in this Prospectus have
been restated to reflect the Stock Split. Except as otherwise noted, all
information in this Prospectus assumes no exercise of the Underwriters'
over-allotment option. See "Underwriting."
5
<PAGE> 7
RISK FACTORS
This Prospectus contains forward-looking statements that involve risks and
uncertainties. Actual results could differ materially from those discussed in
the forward-looking statements as a result of certain factors, including those
set forth below and elsewhere in this Prospectus. The following risk factors
should be considered carefully in addition to the other information contained in
this Prospectus before purchasing the Common Stock offered hereby.
Dependence Upon Market Growth and Development of Industry Standards. The
Company's product lines are designed for use in visual modeling of business
processes, in the development of software systems and in the day-to-day
development of software by teams of developers. The Company's future growth and
financial performance will depend in part upon continued growth in the market
for tools supporting component-based development. There can be no assurance that
the market will continue to grow or that the Company will be able to respond
effectively to the evolving requirements of the market. In addition, the
Company's future growth and financial performance may depend upon the
development of industry standards that facilitate the adoption of
component-based development, as well as the Company's ability to play a leading
role in the establishment of those standards. The Company believes that the
Unified Modeling Language developed at Rational has become the de facto standard
language for visual modeling and intends to submit an application to the Object
Management Group ("OMG"), an industry consortium, for inclusion of the UML in
their Object Analysis and Design Facility specification. Competing standards,
including some that support the UML as well as other notations, also are
expected to be submitted to the OMG. The official sanction of a competing
standard by the OMG could have a material adverse effect on Rational's marketing
and sales efforts and, in turn, on revenues and operating results.
The number of software developers using component-based development
technology is relatively small compared to the number of developers using more
traditional software development technology. The adoption of component-based
development technology by software programmers who have traditionally used other
technology requires re-orientation to significantly different programming
methods, and there can be no assurance that the acceptance of component-based
development technology will expand beyond sophisticated programmers who are
early adopters of the technology. Furthermore, there can be no assurance that
potential customers will be willing to make the investment required to retrain
programmers to build software using component-based development technology
rather than traditional programming techniques. Many of the Company's customers
have purchased only small quantities of the Company's tools, and there can be no
assurance that these or new customers will broadly implement component-based
development technology or purchase additional tools.
Expansion of Product Lines. The Company believes that its continued
success will depend in part upon its ability to provide a tightly integrated
line of software application development tools that support software development
for a number of implementation languages. This will require the Company to
enhance its current products and to continue to develop and introduce new
products. The Company also believes its continued success will become
increasingly dependent on its ability to support the Microsoft platform,
including Windows 95 and 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 implementation languages in order
to be successful in its efforts to reach broader markets and to further increase
its market share within its existing market segments. There can be no assurance
that the Company will be able to successfully develop and market such a broad
line of products or that the Company will not encounter unexpected difficulties
and delays in integrating new products with existing product lines.
Fluctuations in Operating Results. The Company's 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. The Company
typically 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
6
<PAGE> 8
on orders booked and shipped in that quarter. Because the Company's staffing and
operating expenses are based on anticipated revenue levels, and 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. Historically, the Company has earned
a substantial portion of its revenues in the last weeks of the quarter. To the
extent this trend continues, the failure to achieve such revenues in the last
weeks of any given quarter will have a material adverse effect on the Company's
financial results for that quarter. Although the Company has experienced
increasing revenues in each of the past nine quarters, the Company's sales
compensation structure has historically resulted in revenues for the first
quarter of a fiscal year being lower than revenues for the fourth quarter of the
prior fiscal year. There can be no assurance that similar fluctuations will not
occur again in the future.
The Company's earnings for the quarter ending December 31, 1996 will be
reduced by charges and operating expenses associated with the acquisition of the
Visual Test product, including an expected acquired in-process research and
development charge to operations of between $15 million and $19 million, as well
as increased marketing expenditures related to the promotion of the Visual Test
product. As a result, the Company will incur a significant net loss for the
quarter ending December 31, 1996, and may incur a net loss for fiscal 1997.
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. See "-- Possible
Volatility of Stock Price."
Dependence Upon Revenues From New Products. The Company plans to introduce
new products during fiscal 1997. Delay in the start of shipment of the Company's
new products would have an adverse effect on the Company's revenues, gross
profit and operating income. As a result of the Company's business alliance with
Microsoft, certain of the Company's new product releases are expected to be
tightly integrated with new releases of certain Microsoft products. To the
extent that scheduled Microsoft product releases are delayed, there could be a
material adverse effect on the Company's revenues from new products. 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 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 and to potential cutbacks in defense
spending.
Business Alliance with Microsoft. On October 2, 1996, Rational and
Microsoft announced the formation of a business alliance which will consist of
Rational's acquisition of Microsoft's Visual Test product, technology
cross-licensing, joint development projects and joint marketing programs. While
the Company believes that Microsoft's current strategy in relation to the
enterprise information systems market is based on component-based development,
there can be no assurance that this strategy will continue or that, if it does
continue, Microsoft's emphasis or priorities will not change in the future,
resulting in less attention and fewer resources being devoted to Microsoft's
relationship with Rational. Although certain aspects of the business alliance
are contractual in nature, many important aspects of the relationship depend on
the continued cooperation of the two companies, and there can be no assurance
that the Company and Microsoft will be able to work together successfully over
an extended period of time. In addition, there can be no assurance that
Microsoft will not use the information it gains in its relationship with
Rational to develop or market competing products. See "Business -- Business
Alliance with Microsoft."
Acquisition of the Visual Test Product. The Company acquired the Visual
Test product from Microsoft on October 2, 1996. There can be no assurance that
Rational will be able to successfully incorporate Visual Test into its
integrated family of products, or that it will be able to achieve
7
<PAGE> 9
significant sales of the Visual Test product. Many potential customers for
Visual Test differ from the Company's historical customer base in terms of
component-based software development expertise, purchasing processes, financial
resources and expectations regarding software-engineering tools. There can be no
assurance that the Company will not encounter unanticipated concerns of Visual
Test customers that are different from the concerns of the Company's traditional
customers, or that the Company will have the infrastructure and experience
necessary to adequately respond to the volume and type of such concerns.
Rational has granted Microsoft a non-exclusive, perpetual license to the
Visual Test product source code for the purpose of creating derivative works and
for the purpose of distributing portions of the Visual Test product and
derivative works as part of Microsoft products that do not directly compete with
the Visual Test product in the market for software testing tools. There can be
no assurance that Microsoft will not use such rights to create and distribute
products that compete with Rational in other segments of the component-based
development tools market. Rational has also granted Microsoft the option to
obtain a license to incorporate certain elements of Visual Test technology into
Microsoft development tool products, including Visual Basic, Visual C++ and
Visual J++. Should Microsoft exercise such right, sales of the Visual Test
product by Rational could be materially and adversely impacted.
See "-- Fluctuations in Operating Results," "Business -- Products and
Services -- Visual Test: Software Testing Automation Tools" and "-- Business
Alliance with Microsoft."
Licensing of Rose Technology to Microsoft. Microsoft and Rational have
entered into an agreement providing for the inclusion of a subset of the
Rational Rose visual modeling technology in future versions of Microsoft's
enterprise-oriented visual tools. The Company's objective in entering into this
arrangement is to expose the Company's technology to a broader market than
Rational's historical customer base. The Company expects that changes in the
Company's pricing models and combinations of features within product lines will
be required to appeal to this market, and there can be no assurance that such
changes will achieve market acceptance. Rational does not expect the licensing
of its Rose technology to Microsoft to directly result in a material increase in
product revenue. In addition, there can be no assurance that developers
introduced to the Rose technology incorporated into Microsoft products will
become purchasers of Rational products in the future. Rational has granted
Microsoft the option to obtain a perpetual, non-exclusive right to source code
for certain aspects of Rational's Rose technology after the expiration of the
agreement. While Rational believes that Microsoft's and Rational's strategies
currently are complementary, there can be no assurance that Microsoft will not
use this right to develop and market competing products in the future. See
"Business -- Business Alliance with Microsoft."
Adverse Impact of Promotional Product Versions on Actual Product
Sales. The Company's marketing strategy relies in part on making elements of
its technology available for no charge or at a very low price, either directly
or by incorporating such elements into products offered by the Company's
partners, such as Microsoft. This strategy is designed to expose the Company's
products to a broader market than its historical customer base, and to encourage
potential customers in that market to purchase an upgrade or other higher-priced
product from the Company. There can be no assurance that the Company will be
able to introduce enhancements to its full-price products or versions of its
products with intermediate functionality at a rate necessary to adequately
differentiate them from the promotional versions, particularly in cases where
the Company's partners are distributing versions of the Company's products with
other desirable features.
Management of Growth. The Company is experiencing a period of rapid growth
and aggressive product introductions that have placed, and may continue to
place, a significant strain on its resources, including its personnel. Projects
such as the expansion of the Company's product lines, efforts to address broader
markets and to expand distribution channels, acquisitions of companies or
technologies such as the recent acquisitions of Objectory AB and the Visual Test
product, and strategic relationships such as the recent arrangement with
Microsoft, 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
8
<PAGE> 10
the Company's ability to manage growth successfully, and there can be no
assurance that the Company will be successful in attracting and retaining the
necessary personnel. If Company management is unable to effectively manage
growth, the Company's business, competitive position, results of operations and
financial condition will be materially and adversely affected.
Risks Associated With Recent and Future Acquisitions. During the past two
years the Company has made a number of strategic acquisitions. Acquisitions by
the Company may result in the diversion of management's attention from the
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. To the extent that efforts to integrate
recent and future acquisitions fail, there could be a material adverse effect on
results of operations. Acquisitions by the Company have the potential to result
in dilutive issuances of equity securities, the incurrence of additional debt,
and amortization expenses related to goodwill and other intangible assets. While
there are currently no commitments with respect to any particular future
acquisitions, Company management frequently evaluates the strategic
opportunities available to it and may in the near-term or long-term future
pursue acquisitions of complementary products, technologies or businesses.
Dependence on Strategic Relationships. The Company's development,
marketing and distribution strategies rely increasingly on the Company's ability
to form long-term strategic relationships with major software and hardware
vendors, many of whom are substantially larger than the Company. Divergence in
strategy between the Company and any given partner, or a change in focus by a
given partner, may interfere with the Company's ability to develop, market, sell
or support its products. See "-- Business Alliance with Microsoft."
Rapid Technological Change. The market for software development tools is
characterized by rapid technological advances, changes in customer requirements
and frequent new product introductions and enhancements. The Company must
respond rapidly to developments related to hardware platforms, operating systems
and applicable programming languages. Such developments will require the Company
to make substantial product development investments. Any failure by the Company
to anticipate or respond adequately to technology developments and customer
requirements, or any significant delays in product development or introduction,
could result in a loss of competitiveness or revenue. In addition, there can be
no assurance that new products or product enhancements intended to respond to
technological change or evolving customer requirements will achieve market
acceptance.
Risk of Software Defects. Software products like those sold by the Company
often contain undetected errors, or "bugs," or performance problems. Such
defects are most frequently found during the period immediately following
introduction of new products or enhancements to existing products. Despite
extensive product testing prior to introduction, the Company's products have in
the past contained software errors that were discovered after commercial
introduction. There can be no assurance that errors or performance problems will
not be discovered in the future. Any future software defects discovered after
shipment of the Company's products could result in loss of revenues or delays in
market acceptance, which could have a material adverse effect on the Company's
business, operating results or financial condition.
Competition. The software engineering tools market is extremely
competitive and rapidly changing. The Company believes that the increased level
of competition it observed in fiscal 1996 and the first half of fiscal 1997 will
continue to increase. The Company competes primarily on the bases of corporate
and product reputation, breadth of its integrated product line, product
architecture, functionality and features, product quality, performance,
ease-of-use, quality of support, availability of technical consulting services
and price. The Company faces intense competition for each product within its
product line. Because individual product sales are often the first step in a
broader customer relationship, the Company's success depends in part upon its
ability to successfully compete with numerous competitors at each point within
its product line. Certain of the Company's competitors are more experienced than
the Company in the development of software-engineering tools, databases or
9
<PAGE> 11
software-development products. Some of the Company's competitors have, and new
competitors may have larger technical staffs, more established distribution
channels and greater financial resources than the Company. The Company also
encounters substantial competition from in-house developers of solutions for
large organizations. There can be no assurance that either existing or new
competitors will not develop products that are superior to the Company's
products or that achieve greater market acceptance. The Company's future success
will depend in large part upon its ability to increase its share of its target
markets and to license additional products and product enhancements to existing
customers. There can be no assurance that future competition will not have a
material adverse effect on the Company's results of operations. See
"Business -- Competition."
Dependence on Sales Force and Other Channels of Distribution. The Company
currently distributes its products primarily through field sales personnel
teamed with highly trained technical support personnel. The Company believes
that a high level of technical consulting, training and customer support is
essential to maintaining its competitive position, and 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, the services provided by these
personnel have historically yielded lower margins for the Company than its
product business. To the extent that these services constitute a higher
proportion of total revenues in the future, the Company's margins will be
adversely affected. The Company has also developed other direct and indirect
sales channels, including telesales, the World Wide Web, and partnering with
external service providers and VARs. There can be no assurance that such
channels will be successful in increasing sales of the Company's products or in
reducing the Company's sales costs on a percentage basis.
Dependence on Key Personnel. 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 the highly trained technical personnel that
are integral to its direct sales teams may limit the rate at which the Company
can increase sales. Competition for qualified personnel in the software industry
is intense, and there can be no assurance that the Company will be successful in
attracting and retaining such personnel. See "Business -- Employees" and
"Management -- Directors and Executive Officers."
Risks Associated with International Operations. International sales
accounted for approximately 31%, 34% and 36% of the Company's revenues in fiscal
1994, 1995 and 1996, respectively, and the Company expects that international
sales will continue to account for a significant portion of the Company's
revenues in future periods. In addition, the Company expects that the majority
of Visual Test product sales will come from outside the United States.
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. 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 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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Limited Protection of Intellectual Property and Proprietary Rights. 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
10
<PAGE> 12
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. The
Company licenses its products primarily under "shrink-wrap" licenses (i.e.,
licenses included as part of the product packaging). Shrink-wrap licenses are
not negotiated with or signed by individual licensees, and purport to take
effect upon the opening of the product package. 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. In addition, the laws of some foreign countries do not
protect proprietary rights to the same extent as do the laws of the United
States. There can be no assurance that these protections will be adequate. To
the extent that the Company increases its international activities, it expects
that its exposure to unauthorized copying and use of its products and
proprietary information will increase.
The status of United States patent protection in the software industry is
not well defined and will evolve as the United States Patent and Trademark
Office grants additional patents. Because patent applications in the United
States are not publicly disclosed until the patent is issued, applications may
have been filed which would relate to the Company's products. There can be no
assurance that third parties will not assert infringement claims against the
Company in the future or that such claims will not be successful. The Company
could incur substantial costs in defending itself and its customers against any
such claims. Parties making such claims may be able to obtain injunctive or
other equitable relief that could effectively block the Company's ability to
sell its products in the United States and abroad, and could result in an award
of substantial damages. In the event of a claim of infringement, the Company and
its customers may be required to obtain one or more licenses from third parties.
There can be no assurance that the Company or its customers could obtain
necessary licenses from third parties at a reasonable cost or at all. Defense of
any lawsuit or failure to obtain any such required license would have a material
adverse effect on the Company's results of operations. See
"Business -- Intellectual Property."
Possible Volatility of Stock Price. The market price of the Company's
Common Stock has been, and is likely to continue to be, volatile. Factors such
as new product announcements or changes in product pricing policies by the
Company or its competitors, quarterly fluctuations in the Company's operating
results, announcements of technical innovations, announcements relating to
strategic relationships or acquisitions, changes in earnings estimates by
analysts and general conditions in the component-based software development
market, among other factors, may have a significant impact on the market price
of the Company's Common Stock. Should the Company fail to introduce products on
the schedule expected, the Company's stock price could be adversely affected. In
addition, in recent years the stock market in general, and the shares of
technology companies in particular, have experienced extreme price fluctuations.
This volatility has had a substantial effect on the market prices of securities
issued by many companies for reasons unrelated to the operating performance of
the specific companies. These broad market fluctuations may adversely affect the
market price of the Company's Common Stock. See "-- Fluctuations in Operating
Results" and "-- Dependence Upon Revenues From New Products."
Shares Eligible for Future Sale. Other than approximately 700,000 shares
subject to a lock-up expiring 90 days after effectiveness of the offering made
hereby and certain shares of affiliates subject to volume limitations on resale,
substantially all of the shares of the Company's Common Stock outstanding
following this offering will be freely tradeable. Sales of substantial amounts
of Common Stock in the public market after this offering could adversely affect
the prevailing market price of the Common Stock.
Forward-Looking Statements. This Prospectus contains forward-looking
statements, which may be deemed to include the Company's plans with respect to
product developments and introductions, domestic and international marketing
efforts, and strategic relationships, as well as the Company's expectations
concerning market trends. Actual results and actions taken by the Company could
differ from those projected in any forward-looking statements for a number of
reasons, including those detailed in the other sections of this "Risk Factors"
portion of the Prospectus, or elsewhere in this Prospectus.
11
<PAGE> 13
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 4,150,000 shares of
Common Stock offered by the Company hereby, at an assumed public offering price
of $35.50 per share, are estimated to be $139,283,750 ($165,117,336 if the
Underwriters' over-allotment option is exercised in full), after deducting the
estimated underwriting discounts and commissions and estimated offering expenses
payable by the Company. The Company will not receive any proceeds from the sale
of Common Stock by the Selling Stockholders. See "Principal and Selling
Stockholders."
The proceeds to the Company from the offering will be used for working
capital and general corporate purposes. A portion of the proceeds may also be
used for investment in or acquisition of complementary products, technologies or
businesses. As of the date hereof, the Company has no commitments with respect
to any specific acquisition. The consummation of future acquisitions will be
subject to, among other things, favorable market conditions, the availability of
financing on terms and conditions satisfactory to the Company, and suitable
acquisition candidates. Pending such uses, the net proceeds will be invested in
investment-grade, interest-bearing securities.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol RATL. The following table sets forth for the periods indicated the
high and low sale price for the Common Stock. All prices have been adjusted to
give effect to the Stock Split.
<TABLE>
<CAPTION>
FISCAL YEAR HIGH LOW
- ----------- ------ ------
<C> <S> <C> <C>
1997 2nd Quarter............................................ $36.00 $17.50
1st Quarter............................................ 33.13 19.00
1996
4th Quarter............................................ 20.75 7.94
3rd Quarter............................................ 12.00 6.82
2nd Quarter............................................ 9.32 6.57
1st Quarter............................................ 6.10 5.25
1995
4th Quarter............................................ 6.00 3.57
3rd Quarter............................................ 4.03 2.82
2nd Quarter............................................ 3.94 2.07
1st Quarter............................................ 4.69 2.07
</TABLE>
On October 1, 1996, the last reported sale price for the Company's Common
Stock was $35.50 per share. As of September 30, 1996, there were 792 holders of
record of Common Stock.
The Company has not paid any cash dividends since its inception and does
not anticipate paying cash dividends in the foreseeable future. The Company
currently intends to retain available future earnings to finance the operations
of its business.
12
<PAGE> 14
CAPITALIZATION
The following table sets forth the capitalization of the Company at June
30, 1996, and as adjusted to give effect to the receipt by the Company of the
net proceeds from the sale of 4,150,000 shares of Common Stock offered hereby at
an assumed public offering price of $35.50 per share. The financial data in the
following table should be read in conjunction with the Company's unaudited
Consolidated Financial Statements and Notes thereto at June 30, 1996 contained
in this Prospectus or incorporated by reference herein.
<TABLE>
<CAPTION>
JUNE 30, 1996
---------------------------
ACTUAL AS ADJUSTED(1)
-------- --------------
(IN THOUSANDS)
<S> <C> <C>
Long-term obligations.............................................. $ 1,922 $ 1,922
Stockholders' equity:
Common Stock, $.01 par value, 75,000,000 shares authorized;
34,441,700 shares issued and outstanding; 38,591,700 shares
issued and outstanding as adjusted(2)......................... 344 386
Additional paid-in capital....................................... 116,302 255,544
Treasury stock................................................... (1,340) (1,340)
Accumulated deficit.............................................. (57,831) (57,831)
Cumulative Translation adjustment.................................. (120) (120)
-------- --------
Total stockholders' equity.................................... 57,355 196,639
-------- --------
Total capitalization.......................................... $ 59,277 $198,561
======== ========
</TABLE>
- ------------------------------
(1) Excludes 4,263,674 shares of Common Stock reserved as of June 30, 1996 for
issuance upon the exercise of outstanding options at a weighted average
exercise price of $4.64 per share. Also excludes 619,682 shares reserved for
future grant or issuance at June 30, 1996 under the Company's stock option
and stock purchase plans. See Note 9 of Notes to Consolidated Financial
Statements. At September 30, 1996, 4,930,729 shares of Common Stock were
reserved for issuance upon the exercise of outstanding options at a weighted
average exercise price of $9.61 per share, and 1,994,958 shares were
reserved for future grant or issuance under the Company's stock option and
stock purchase plans.
(2) The number of shares authorized reflects the increase in the number of
shares authorized in August 1996. See Note 11 of Notes to Consolidated
Financial Statements.
13
<PAGE> 15
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated statements of operations data set forth below for
the years ended March 31, 1994, 1995 and 1996, and the consolidated balance
sheets data at March 31, 1995 and 1996 are derived from, and are qualified by
reference to, the Consolidated Financial Statements which were audited by Ernst
& Young LLP and are included elsewhere in this Prospectus. The consolidated
statements of operations data for the three months ended June 30, 1995 and 1996,
and the consolidated balance sheets data at June 30, 1996, are derived from
unaudited financial statements included elsewhere in this Prospectus and
include, in the opinion of management, all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of the financial
position and results of operations of the Company for such periods. The
consolidated statements of operations data for the years ended March 31, 1992
and 1993 and the consolidated balance sheets data at March 31, 1992, 1993 and
1994 are derived from the Company's audited consolidated financial statements
not included in this Prospectus. The results for the year ended March 31, 1996
and the three-month period ended June 30, 1996 are not necessarily indicative of
the results to be expected for the entire year ending March 31, 1997 or any
future period. The information presented below should be read in conjunction
with the Company's Consolidated Financial Statements, Notes thereto and
discussions thereof included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
FISCAL YEAR ENDED MARCH 31, JUNE 30,
---------------------------------------------------- ------------------
1992 1993 1994 1995 1996 1995 1996
------- ------- -------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net product revenue................................... $38,161 $46,123 $ 41,716 $39,221 $55,899 $11,454 $17,300
Consulting and support revenue........................ 22,168 24,880 28,627 33,678 35,208 8,303 10,161
------- ------- -------- ------- ------- ------- -------
Total revenue..................................... 60,329 71,003 70,343 72,899 91,107 19,757 27,461
------- ------- -------- ------- ------- ------- -------
Cost of product revenue............................... 10,057 10,268 11,862 6,955 7,196 1,250 1,825
Cost of consulting and support revenue................ 10,807 11,291 13,494 18,095 19,336 4,763 5,499
------- ------- -------- ------- ------- ------- -------
Total cost of revenue............................. 20,864 21,559 25,356 25,050 26,532 6,013 7,324
------- ------- -------- ------- ------- ------- -------
Gross profit...................................... 39,465 49,444 44,987 47,849 64,575 13,744 20,137
Operating expenses:
Research and development.............................. 17,834 18,986 20,221 12,187 15,939 3,171 4,495
Sales and marketing................................... 17,564 21,652 21,338 25,100 35,000 7,666 8,877
General and administrative............................ 5,597 7,510 7,194 6,995 9,511 1,711 2,399
Charges for acquired in-process research and
development......................................... -- -- -- -- 8,700 -- --
Merger and restructuring costs........................ -- 2,500 9,922 (1,100) -- -- --
------- ------- -------- ------- ------- ------- -------
Total operating expenses.......................... 40,995 50,648 58,675 43,182 69,150 12,548 15,771
Income (loss) from continuing operations.......... (1,530) (1,204) (13,688) 4,667 (4,575) 1,196 4,366
Other income, net..................................... 981 545 285 417 1,582 180 533
------- ------- -------- ------- ------- ------- -------
Income (loss) from continuing operations before
provision for income taxes...................... (549) (659) (13,403) 5,084 (2,993) 1,376 4,899
Provision for income taxes............................ 516 1,504 404 406 1,028 110 735
------- ------- -------- ------- ------- ------- -------
Income (loss) from continuing operations.......... (1,065) (2,163) (13,807) 4,678 (4,021) 1,266 4,164
Discontinued operations:
Income (loss) from discontinued operations........ 304 (1,515) -- -- -- -- --
Loss on disposal.................................. -- (296) (175) -- -- -- --
------- ------- -------- ------- ------- ------- -------
Net income (loss)..................................... $ (761) $(3,974) $(13,982) $ 4,678 $(4,021) $ 1,266 $ 4,164
======= ======= ======== ======= ======= ======= =======
Income (loss) from continuing operations per common
share............................................... $ (0.04) $ (0.09) $ (0.57) $ 0.19 $ (0.13) $ 0.04 $ 0.11
Net income (loss) per common share.................... $ (0.03) $ (0.16) $ (0.57) $ 0.19 $ (0.13) $ 0.04 $ 0.11
Shares used in computing per share amounts............ 23,820 24,260 24,394 25,212 30,725 28,536 36,930
</TABLE>
<TABLE>
<CAPTION>
MARCH 31,
-----------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- ------- ------- JUNE 30, 1996
(IN THOUSANDS) -------------
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEETS DATA:
Cash, cash equivalents and short-term investments............... $21,904 $14,945 $13,687 $10,476 $52,645 $ 52,922
Working capital................................................. 22,438 22,921 4,972 7,742 45,548 51,386
Total assets.................................................... 53,727 50,836 39,343 38,000 85,674 84,797
Long-term obligations........................................... 5,392 5,683 7,809 3,675 2,189 1,922
Stockholders' equity............................................ 28,489 27,045 6,487 12,084 50,906 57,355
</TABLE>
The amounts presented above have been restated to reflect the Stock Split.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
14
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The statements contained in Management's Discussion and Analysis of
Financial Condition and Results of Operations include "forward-looking"
information within the meaning of Section 27A of the Securities Act of 1933 and
21E of the Securities 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.
Some factors that could cause future actual results to differ materially from
the Company's recent results or those projected in the forward-looking
information are discussed elsewhere in this Prospectus. See "Risk Factors." The
Company assumes no obligation to update the forward-looking information or such
factors.
OVERVIEW
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.
On October 2, 1996, the Company and Microsoft announced the formation of a
business alliance that will consist of Rational's acquisition of Microsoft's
Visual Test product, technology cross-licensing, joint development projects and
joint marketing programs. The purchase price of the Visual Test product
consisted of a single $23 million cash payment, which will be accounted for
using the purchase method. The Company's earnings for the quarter ending
December 31, 1996 will be reduced by charges and operating expenses associated
with the acquisition of the Visual Test product, including an expected acquired
in-process research and development charge to operations of between $15 million
and $19 million, as well as increased marketing expenditures related to the
promotion of the Visual Test product. As a result, the Company will incur a
significant net loss for the quarter ending December 31, 1996, and may incur a
net loss for fiscal 1997. Amounts attributed to other purchased intangible
assets will be amortized to operations over their estimated useful lives, which
in most cases are two to four years. The Company does not expect the
cross-licensing arrangements to directly result in a material increase in
product revenue. See "Risk Factors -- Business Alliance with Microsoft,"
"-- Acquisition of the Visual Test Product," "-- Licensing of Rose Technology to
Microsoft," and "Business -- Business Alliance with Microsoft."
During October 1995, the Company signed a definitive agreement to purchase
all the outstanding stock of Objectory AB, a Swedish software development
company, in exchange for 1,496,718 shares of common stock. The acquisition was
accounted for using the purchase method and, accordingly, the operating results
of Objectory AB are included in the consolidated results of the Company from the
date of acquisition. In addition, in the third quarter of fiscal 1996, the
Company incurred approximately $14.5 million of one-time charges and operating
expenses primarily associated with the Company's acquisition of Objectory AB and
the subsequent restructuring and shaping of the Company's business, including an
$8.7 million write-off of in-process research and development costs acquired in
connection with the Objectory AB acquisition. See Note 3 of Notes to
Consolidated Financial Statements.
On March 31, 1994, the Company, a publicly traded corporation formerly
known as Verdix Corporation, completed the merger with Rational, a privately
held corporation, and changed its name to Rational Software Corporation. The
transaction was accounted for as a pooling-of-interests business combination and
involved the issuance of approximately 14.3 million additional shares of common
stock. Merger-related expenses of $9.9 million were recorded in fiscal 1994 as a
result of the closing of facilities, severance costs, administrative costs and
the write-off of capitalized software costs related to overlapping product
lines. Fiscal 1995 results reflected expense reductions of $1.1 million relating
to
15
<PAGE> 17
the reversal of fiscal 1994 rent accrual adjustments associated with the closing
of facilities. The remaining facilities accrual is $1,706,000 at June 30, 1996.
See Notes 3 and 5 of Notes to Consolidated Financial Statements.
International sales accounted for 31%, 34% and 36% of the Company's
revenues in fiscal 1994, 1995 and 1996, respectively, and the Company expects
that international sales will continue to account for a significant portion of
the Company's revenues in future periods. See "Risk Factors -- Risks Associated
with International Operations."
In recent periods, the Company's revenues from consulting and support have
grown at a slower rate than revenues from product sales, contributing to
increasing gross margins. There can be no assurance that this trend will
continue in future periods. See "Risk Factors -- Dependence Upon Revenues From
New Products."
Although the Company has experienced increasing revenues in each of the
past nine quarters, the Company's sales compensation structure has historically
contributed to revenues for the first quarter of a fiscal year being lower than
revenues for the fourth quarter of the prior fiscal year. There can be no
assurance that the Company will continue to experience increasing revenues or
that similar fluctuations will not occur again in the future. See "Risk
Factors -- Fluctuations in Operating Results" and "-- Dependence Upon Revenues
From New Products."
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
total revenue represented by certain line items from the Company's Consolidated
Statements of Operations:
<TABLE>
<CAPTION>
THREE MONTHS
FISCAL YEAR ENDED
ENDED MARCH 31, JUNE 30,
---------------------- -------------
1994 1995 1996 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net product revenue....................................... 59 % 54 % 61 % 58 % 63 %
Consulting and support revenue............................ 41 46 39 42 37
--- --- --- --- ---
Total revenue........................................... 100 100 100 100 100
Cost of product revenue................................... 17 9 8 6 7
Cost of consulting and support revenue.................... 19 25 21 24 20
--- --- --- --- ---
Total cost of revenue................................... 36 34 29 30 27
--- --- --- --- ---
Gross profit............................................ 64 66 71 70 73
Operating expenses:
Research and development.................................. 29 17 17 16 16
Sales and marketing....................................... 30 34 38 39 32
General and administrative................................ 10 10 11 9 9
Charges for acquired in-process research and
development............................................. -- -- 10 -- --
Merger and restructuring costs............................ 14 (1 ) -- -- --
--- --- --- --- ---
Total operating expenses................................ 83 60 76 64 57
--- --- --- --- ---
Income (loss) from continuing operations................ (19 ) 6 (5 ) 6 16
Other income, net(1)...................................... -- 1 2 1 2
--- --- --- --- ---
Income (loss) before provision for income taxes......... (19 ) 7 (3 ) 7 18
Provision for income taxes.............................. 1 1 1 1 3
--- --- --- --- ---
Net income (loss)......................................... (20 )% 6 % (4 )% 6 % 15 %
=== === === === ===
</TABLE>
- ------------------------------
(1) Amount for 1994 includes a loss from discontinued operations of $175,000.
See Note 4 of Notes to Consolidated Financial Statements.
16
<PAGE> 18
THREE MONTHS ENDED JUNE 30, 1996 AND 1995
Revenue
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 Revenue; Gross Margin
Cost of product revenue. Cost of product revenue consists principally of
materials, packaging and freight, and amortization of capitalized software costs
and royalties. 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.
Cost of consulting and support revenue. Cost of consulting and support
revenue consists principally of personnel costs for training, consulting and
customer support. 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 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.
Operating Expenses
Research and development. 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.
Sales and marketing. 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. General and administrative expenses consist of
personnel costs for administration, finance, information systems, human
resources and general management, as well as legal and accounting expenses.
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
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
17
<PAGE> 19
offering completed in June 1995, versus three months of interest earned for the
quarter ended June 30, 1996.
Income Taxes
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 the impact of the federal minimum tax.
FISCAL YEARS ENDED MARCH 31, 1996, 1995 AND 1994
Revenue
Total revenue increased 25% in fiscal 1996 and 4% in fiscal 1995 after a 1%
decrease in fiscal 1994.
Net product revenue. Net product revenue increased 43% in fiscal 1996
compared to decreases of 6% and 10% in fiscal 1995 and 1994, respectively. The
increase in net product revenue in fiscal 1996 was due to continued strong
customer acceptance of the Company's visual modeling tools (the Rational Rose
family) and the introduction of new versions of the Company's Rational Apex
product for C/C++ application construction. The Company's visual modeling tools
revenue grew in excess of 100% during fiscal 1996 from the prior year. The
decline in net product revenue in fiscal 1995 and 1994 was due principally to
the transition from software products designed for proprietary hardware to
software products designed for open systems and to the elimination of
overlapping product lines following the March 1994 merger. In fiscal 1996 and
fiscal 1995 the Company received no revenue from hardware sales compared to $3.5
million for fiscal 1994. Assuming the elimination of hardware sales from fiscal
1994, net product sales increased 3% in fiscal 1995 compared to fiscal 1994.
Declines in fiscal 1995 net product revenue were partially offset by increases
in the Rational Rose product line.
Consulting and support revenue. Consulting and support revenue increased
5%, 18% and 15% in fiscal 1996, 1995 and 1994, respectively. These increases
reflected higher demand for the Company's consulting expertise in object
modeling and advanced software-development practices, and, to a lesser extent,
increased training and customer-support revenues. In fiscal 1996, the decline in
year-over-year growth from fiscal 1995 was due primarily to the Company's
decision to forgo certain consulting revenue opportunities with existing
customers in favor of presales investment with new customers.
International sales. During fiscal 1996, 1995 and 1994, international
revenues from product sales and related consulting and customer support were
$33.2 million, $24.8 million, and $21.5 million, representing 36%, 34% and 31%
of total revenues, respectively. The growth in international sales in each of
the last three years was due principally to increased sales and marketing
activities in international markets. The Company's international sales are
priced in foreign currencies. The Company has attempted to limit its exposure to
fluctuations in foreign currencies from time to time by utilizing a hedging
strategy for existing receivables denominated in foreign currencies. At March
31, 1996, the Company had no forward exchange contracts. The Company's results
of operations during fiscal 1996 and 1995 were favorably impacted by changes in
foreign exchange rates. The impact of using actual exchange rates throughout the
year compared to exchange rates at the beginning of the year was to increase
income from operations by approximately $100,000 and $500,000 in fiscal 1996 and
1995, respectively.
Cost of Revenue
Cost of product revenue. Cost of product revenue increased 3% in fiscal
1996 after decreasing 41% in fiscal 1995 and increasing 16% in fiscal 1994.
These costs represented 13%, 18%, and 28% of total product revenue in fiscal
1996, 1995 and 1994, respectively. In fiscal 1996, the decrease in product cost
18
<PAGE> 20
as a percentage of product revenue was due mainly to lower royalty expense
resulting from a decrease in third party product sales. In fiscal 1995, the
decline in cost as a percentage of product revenues was due mainly to the
discontinuance of proprietary hardware sales, which resulted in lower material
cost, and to a lesser extent, to the change in the product mix to higher-margin
products and the elimination of overlapping product lines.
Cost of consulting and support revenue. Cost of consulting and support
increased 7%, 34% and 19% in fiscal 1996, 1995 and 1994, respectively. These
costs represented 55%, 54% and 47% of consulting and support revenue in fiscal
1996, 1995 and 1994, respectively. These increases were the result of additional
personnel and personnel-related expenses needed to perform professional services
in object modeling, advanced software-development practices, and business
process engineering. The increases as a percentage of consulting and support
revenue resulted from an increase in consulting services compared to support
services because of the cost of providing consulting services compared to the
costs of providing customer-support services.
Operating Expenses
Research and development. Total expenditures for research and development
increased 31% in fiscal 1996 after decreasing 40% in fiscal 1995. Total
expenditures for research and development increased 6% in fiscal 1994. Research
and development costs represented 17%, 17% and 29% of total revenue in fiscal
1996, 1995 and 1994, respectively. The increase in fiscal 1996 was due primarily
to expenses incurred following the October 1995 acquisition of Objectory AB. The
decrease in fiscal 1995 was the result of personnel reductions implemented as
part of the 1994 merger and the elimination of redundant development efforts.
The increase in fiscal 1994 was due primarily to increased staffing and support
required to expand and enhance the Company's product line.
The Company did not capitalize any software-development costs in fiscal
1996 and 1995 because eligible costs were not material. The Company capitalized
software-development costs of $1.9 million in fiscal 1994. Those costs have
since been amortized to cost of product sales. The Company expects that the
amount of software-development costs capitalized in future periods will be
immaterial to the Company's results of operations and financial position because
the time period and the engineering effort required between demonstration of a
product's economic and technological feasibility and the date of product release
has been very short.
Sales and marketing. Sales and marketing expenses increased 39% in fiscal
1996 and 18% in fiscal 1995 after decreasing 2% in fiscal 1994. These expenses
represented 38%, 34% and 30% of total revenue in fiscal 1996, 1995 and 1994,
respectively. The fiscal 1996 increase in sales and marketing expenses reflect
the additional personnel, commissions and related costs required in sales and
marketing to expand the Company's sales channels, to penetrate new markets, and
to increase its market share in core markets. Fiscal 1996 also included expenses
associated with Objectory AB since the acquisition in October 1995. The increase
in fiscal 1995 was primarily due to expansion of the Company's worldwide sales
and marketing infrastructure to support greater direct sales, both in major
accounts and geographic territories, expansion of the Company's telesales
channel and penetration of new markets such telecommunications, banking and
financial services, and transportation.
General and administrative. General and administrative expenses increased
36% in fiscal 1996 after decreasing 3% and 4% in fiscal 1995 and 1994,
respectively. General and administrative expenses represented 11%, 10% and 10%
of total revenue in fiscal 1996, 1995 and 1994, respectively. The increase in
general and administrative expenses in fiscal 1996 is due primarily to expenses
associated with Objectory AB since the acquisition in October 1995, to
amortization of goodwill and other purchased intangibles resulting from the
Objectory acquisition, and to an increase in the reserve for doubtful
19
<PAGE> 21
accounts. The decrease in general and administrative expenses in absolute
dollars in fiscal 1995 and 1994 is primarily attributable to economies of scale
and increased efficiencies in the Company's administrative operations following
the March 1994 merger of Verdix and old Rational.
Charges for acquired in-process research and development. In connection
with the acquisition of Objectory AB, acquired in-process research and
development of $8.7 million was charged to operations during the Company's third
fiscal quarter. In-process research and development represents the present value
of the estimated cash flow expected to be generated by Objectory AB related
technology which at the acquisition date has not yet reached the point of
technological feasibility and does not have an alternative future use.
Merger and restructuring costs. Merger-related expenses of $9.9 million
were recorded in fiscal 1994 as a result of the closing of facilities, severance
costs, administrative costs, and the write-off of capitalized software costs
related to overlapping product lines. The actions related to severance,
administrative and capitalized software costs are complete. During fiscal 1995
the Company recorded expense reductions of $1.1 million relating to the reversal
of the rent accrual associated with the closing of facilities. The accrual was
reduced as a result of greater-than-anticipated recoveries through subleases of
certain facilities reserved at the time of the merger. The remaining facilities
accrual is $1.7 million as of March 31, 1996.
Other Income, Net
Other income has fluctuated as a result of operating results, the amount of
cash available for investment in interest-bearing accounts, and the extent of
foreign currency transactions. Other income, net, increased $1.2 million to $1.6
million in fiscal 1996 from $0.4 million in fiscal 1995. The increase is due
primarily to interest earned on cash generated from the Company's public
offering, which was completed in June 1995.
Income Taxes
The provision for income taxes consists primarily of foreign income taxes
as well as federal and state minimum taxes. The effective tax rate for 1996
differs from the federal statutory income tax rate due primarily to the impact
of non-tax deductible charges for acquired in-process research and development,
utilization of net operating loss carryforwards, and foreign and state taxes. As
of March 31, 1996, the Company had net operating loss carryforwards for federal
income tax purposes of approximately $47.4 million that expire in 1997 through
2011. In addition, the Company had approximately $3.1 million of tax credit
carryforwards which expire in years 1997 through 2010 if not utilized. As a
result of the common stock sale in June 1995, the Company incurred a change in
ownership as defined under Section 382 of the Internal Revenue Code of 1986.
Accordingly, approximately $34 million of the Company's net operating loss
carryforwards and all of the tax credit carryforwards will be subject to an
annual limitation of approximately $8.7 million regarding their utilization
against taxable income in future periods. In addition, as a result of the merger
with old Rational and provisions in the Internal Revenue Code, utilization of
approximately $4.6 million of net operating loss carryforwards are further
limited to the future income of the Company. Based on the Company's earnings
history, a valuation allowance for deferred tax assets of approximately $25.0
million is required to reduce the Company's net deferred tax assets to the
amount realizable. See Note 8 of Notes to Consolidated Financial Statements.
20
<PAGE> 22
QUARTERLY RESULTS
The following table sets forth consolidated statements of operations data
for each of the nine quarters in the period ended June 30, 1996, and the
percentage of the Company's net revenues represented by each item of the
respective quarter. This information has been derived from unaudited
consolidated financial statements that, in the opinion of management, reflect
all adjustments (consisting only of normal recurring accruals) necessary to
fairly present this information when read in conjunction with the Consolidated
Financial Statements and Notes thereto appearing elsewhere in this Prospectus.
The results of operations for any quarter are not necessarily indicative of the
results to be expected for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR 31, JUNE 30,
1994 1994 1994 1995 1995 1995 1995 1996 1996
-------- --------- -------- -------- -------- --------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net product revenue.......... $ 8,915 $ 9,429 $ 9,983 $10,894 $11,454 $13,815 $ 14,905 $15,725 $17,300
Consulting and support
revenue.................... 8,068 8,299 8,622 8,689 8,303 7,827 9,099 9,979 10,161
------- ------- ------- ------- ------- ------- ------- ------- -------
Total revenue............ 16,983 17,728 18,605 19,583 19,757 21,642 24,004 25,704 27,461
Cost of product revenue...... 1,435 1,304 1,741 2,475 1,250 1,879 1,952 2,115 1,825
Cost of consulting and
support revenue............ 4,337 4,597 4,506 4,655 4,763 4,165 4,860 5,548 5,499
------- ------- ------- ------- ------- ------- ------- ------- -------
Total cost of revenue.... 5,772 5,901 6,247 7,130 6,013 6,044 6,812 7,663 7,324
------- ------- ------- ------- ------- ------- ------- ------- -------
Gross profit............. 11,211 11,827 12,358 12,453 13,744 15,598 17,192 18,041 20,137
Operating expenses:
Research and development..... 3,086 3,191 2,876 3,034 3,171 3,285 5,374 4,109 4,495
Sales and marketing.......... 5,986 6,060 6,558 6,496 7,666 8,417 10,906 8,011 8,877
General and administrative... 1,711 1,915 1,828 1,541 1,711 2,066 3,446 2,288 2,399
Charges for acquired
in-process research and
development................ -- -- -- -- -- -- 8,700 -- --
Merger and restructuring
costs...................... -- (590) (510 ) -- -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses............... 10,783 10,576 10,752 11,071 12,548 13,768 28,426 14,408 15,771
------- ------- ------- ------- ------- ------- ------- ------- -------
Income (Loss) from
operations............. 428 1,251 1,606 1,382 1,196 1,830 (11,234) 3,633 4,366
Other income, net............ 18 76 99 224 180 446 291 665 533
------- ------- ------- ------- ------- ------- ------- ------- -------
Income (Loss) before
provision for income
taxes.................. 446 1,327 1,705 1,606 1,376 2,276 (10,943) 4,298 4,899
Provision for income
taxes.................. 31 106 141 128 110 182 220 516 735
------- ------- ------- ------- ------- ------- ------- ------- -------
Net income (Loss)............ $ 415 $ 1,221 $ 1,564 $ 1,478 $ 1,266 $ 2,094 $(11,163) $ 3,782 $ 4,164
======= ======= ======= ======= ======= ======= ======= ======= =======
Net income (Loss) per common
share...................... $ 0.02 $ 0.05 $ 0.06 $ 0.06 $ 0.04 $ 0.06 $ (0.34) $ 0.12 $ 0.11
Shares used in computing
per share amounts.......... 24,814 24,814 25,336 25,884 28,536 33,206 32,466 36,042 36,930
</TABLE>
<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUE
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net product revenue.......... 52 % 53% 54 % 56 % 58 % 64% 62% 61 % 63 %
Consulting and support
revenue.................... 48 47 47 44 42 36 38 39 37
-------- --------- -------- -------- -------- --------- -------- -------- --------
Total revenue............ 100 100 100 100 100 100 100 100 100
Cost of product revenue...... 8 7 9 12 6 9 8 8 7
Cost of consulting and
support revenue............ 26 26 24 24 24 19 20 22 20
-------- --------- -------- -------- -------- --------- -------- -------- --------
Total cost of revenue.... 34 33 34 36 30 28 28 30 27
-------- --------- -------- -------- -------- --------- -------- -------- --------
Gross profit............. 66 67 66 64 70 72 72 70 73
Operating expenses:
Research and development..... 18 18 15 16 16 15 22 16 16
Sales and marketing.......... 35 34 35 33 39 39 45 31 32
General and administrative... 10 11 10 8 9 10 14 9 9
Charges for acquired
in-process research and
development................ -- -- -- -- -- -- 36 -- --
Merger and restructuring
costs...................... -- (3) (3 ) -- -- -- -- -- --
-------- --------- -------- -------- -------- --------- -------- -------- --------
Total operating
expenses............... 63 60 58 57 64 64 118 56 57
-------- --------- -------- -------- -------- --------- -------- -------- --------
Income (Loss) from
operations............. 3 7 9 7 6 8 (47) 14 16
Other income, net............ -- -- 1 1 1 2 1 3 2
-------- --------- -------- -------- -------- --------- -------- -------- --------
Income (Loss) before
provision for income
taxes.................. 3 7 9 8 7 11 (46) 17 18
Provision for income
taxes.................. -- 1 1 1 1 1 1 2 3
-------- --------- -------- -------- -------- --------- -------- -------- --------
Net income (Loss)............ 2 % 7% 8 % 7 % 6 % 10% (47)% 15 % 15 %
======== ======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
21
<PAGE> 23
LIQUIDITY AND CAPITAL RESOURCES
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. This is due
primarily to a public offering of the Company's common stock in June 1995, with
net proceeds of $29.9 million after deducting underwriting discounts,
commissions, and expenses.
Operating activities generated cash of $13.6 million in fiscal 1996 and
generated cash of $1.7 million in fiscal 1995. Net cash generated by operating
activities during fiscal 1996 was composed primarily of a net loss plus an
increase in trade accounts receivable, offset by noncash adjustments consisting
of the write-off of acquired in-process research and development, depreciation
and amortization, and an increase in deferred revenue. Net cash generated by
operating activities during fiscal 1995 was due primarily to net income along
with depreciation and amortization offset by increases in accounts receivable
and decreases in accrued expenses and merger-related costs. Net cash used in
operating activities for the three-month 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's investing activities have consisted primarily of the purchase
and sale of short-term investments in commercial paper and expenditures for
fixed assets, which totaled $2.8 million for fiscal 1996 and $3.2 million for
fiscal 1995. The Company has no significant capital commitments and currently
anticipates that additions to property and equipment for the next fiscal year
will be comparable to recent past years.
Financing activities generated cash of $31.1 million in fiscal 1996, of
which $29.9 million was generated by the public offering of the Company's Common
Stock in June 1995 and $3.8 million was generated from the issuance of Common
Stock upon the exercise of stock options and pursuant to the Company's employee
stock purchase plan, offset by $2.6 million used to decrease long-term
obligations and capital lease obligations. In fiscal 1995, financing activities
used cash of $1.5 million, including $2.5 million used to decrease long-term
debt and capital lease obligations offset in part by $0.6 million of proceeds
from the issuance of Common Stock upon the exercise of stock options.
The Company believes that the net proceeds from the sale of Common Stock
offered by this Prospectus, together with cash flow from operations and existing
cash balances, will be sufficient to meet its cash requirements for the
foreseeable future.
22
<PAGE> 24
BUSINESS
Rational Software Corporation ("Rational" or the "Company") develops,
markets and supports a comprehensive solution for the component-based
development of software systems. The Company's objective is to ensure the
success of customers in developing and managing software systems that are
strategically important to their businesses. Rational provides an integrated
family of tools that spans the critical phases of the software development
process from initial analysis and design through delivery and maintenance. In
addition, the Company provides technical consulting, training and support
services. By supporting controlled iterative development, visual modeling and an
architecture-driven process, Rational's products and services enable customers
to reduce the risk of project failure, improve the quality of the software
systems they develop, increase developer productivity, reduce time-to-market and
increase software reusability.
INDUSTRY BACKGROUND
Traditional software development techniques have not kept pace with
advances in computer processor technology, with the development of new platforms
such as the Internet or company-specific intranets, or with the general demand
for distributed software systems such as multi-tiered client/server
applications. Software, therefore, has increasingly become the constraint on
performance, quality, and time-to-market for many organizations. The ability to
quickly and cost-effectively create complex software applications that perform
as desired and that are easy to maintain and reuse in related applications and
products can be a critical competitive differentiator. As the number and
complexity of software applications continues to expand, it is becoming
increasingly important for businesses to migrate to a more effective approach to
software development.
The Growth of Software Systems
Software permeates products and processes encountered in almost every
aspect of daily life. Many companies base their businesses on enterprise-wide
information systems which are increasingly built as distributed systems
exploiting a company-specific intranet or the Internet. Software is at the core
of business applications ranging from equity-trading systems to inventory
management. The telecommunications business is highly dependent on software in
areas as diverse as call routing, switching, rate setting and billing. Software
is the central element of command-and-control systems in submarines and military
aircraft. Software governs the operation of machines from ordinary office
copiers and cellular phones to life-saving medical devices. As organizations
seek competitive advantage by exploiting the ongoing improvements in
microprocessor technology and the emergence of new computing platforms, software
is becoming more pervasive and more sophisticated. The success of businesses
around the world depends increasingly on their ability to construct and modify
software systems that match their changing business needs.
The Challenge of Developing Software Systems
As demand for software applications continues to grow, managers and
technical personnel face increasing difficulty controlling the complexity of
software, coordinating ever-expanding teams of developers, supporting
development and deployment on multiple hardware platforms and operating systems,
and delivering systems that meet the needs of the users on time and on budget.
Software development projects across a wide range of industries and application
types suffer from a high rate of failure, resulting in project cancellation,
substantial cost overruns or significant delays to market. An enormous amount of
time and energy is wasted by organizations building software systems that fail
or fall short of user expectations.
23
<PAGE> 25
As software development becomes more complex, traditional methods are
becoming increasingly inadequate to respond to the following challenges faced by
many developers:
Addressing hard-to-define and constantly changing customer
requirements. When a software system is first specified, the specification
is often incomplete, ambiguous, or contradictory and evolves while the
system is being built.
Coordinating teams of developers. Team members, who often are
geographically distributed, must work in parallel on different elements of
an overall system without interfering with one another's work. As the size
of the development team increases, difficulties in communication and
coordination among team members typically increase at an even greater rate.
Reusing software on a large scale. The ability to reuse software
components on a large scale to enhance existing products and build
additional products offers organizations the opportunity to further
leverage their investments in software development and decrease the cost
and time-to-market of new products.
Adhering to stringent reliability and certification
standards. Customers often require that software systems meet stringent
performance and reliability specifications. In addition, software
developers are often required to formalize, document and improve their
software development processes in order to gain market entry to industries
regulated by the Federal Aviation Administration, the Department of
Defense, the Food and Drug Administration or other certifying bodies that
review the software components of regulated products.
Developing and deploying new software in combination with existing
software on multiple platforms and operating systems. Software developers
creating different elements of the same project often work on different
hardware platforms and operating systems, such as in the development of
client/server systems. Furthermore, purchasers of software developed for
one platform or operating system often require the ability to deploy the
software on new platforms or operating systems. In addition, developers are
often required to incorporate elements of existing software systems into
new projects.
Organizations have tried, often without success, to address these
challenges with a variety of development products and processes. Typical
approaches have included structured analysis and design, the use of numerous
stand-alone tools from various vendors to address various aspects of
programming, the use of CASE (Computer-Aided Software Engineering) tools to
automate portions of the software development process, and numerous management
approaches such as design review and code "walk-throughs." However, none of
these solutions offered a fully integrated approach. For example, traditional
CASE tools required users to adopt methods that were difficult to use and that
did not track the typical software development process.
Many large organizations have responded to the absence of a satisfactory
commercial solution by attempting to create ad hoc software development tools
and processes in-house. However, because such organizations typically are not in
the primary business of creating software development tools, such in-house
efforts frequently are hampered by a lack of understanding of the complexity
involved, a lack of relevant expertise within the organization, and limits on
the amount of resources available for efforts that will benefit only a single
product line or organization.
Commercial and in-house efforts often are further hampered by their
reliance on traditional sequential development methods. In applying these
methods, the analysis, design, coding, unit testing, software integration and
delivery phases of a software development project take place sequentially. The
end product is not delivered until the very end of the process, often months or
years later. Traditional sequential methods are poorly suited to responding to
specifications that evolve during the development process. They also involve a
high degree of risk that flaws in the system will not be discovered until the
end of the development process, requiring significant, and often unplanned,
time, effort and expense to produce a working product.
24
<PAGE> 26
The Emergence of Component-Based Development
Component-based development is a way of constructing software systems by
combining and integrating pre-engineered and pre-tested software components.
Component-based development has emerged as a powerful technique to simplify the
construction of software systems and to improve their quality. Software
components can be designed, developed, and tested once, and then combined
multiple times by other users to create new software systems in a manner
analogous to combining hardware integrated circuits to create a new electronic
device. By increasing software re-use, this approach reduces the amount of
source code that must be created in connection with the development of a new
software system, helping to reduce risk, time-to-market and cost, as well as to
improve the quality of the resulting software.
Rudimentary forms of software components have been used for several
decades, starting with the use of subroutines in the first programming
languages. The increasing adoption of object-oriented development during the
1990s has fostered a higher level of software component use. In object-oriented
programming, "objects" are used as building-blocks to model real-world
processes. Each object is a collection of data and code that performs operations
on that data. Details of how the object is implemented are "encapsulated," or
hidden, from all but the developer of the object, thus enabling the developer or
team responsible for the object to modify it without impacting the work of other
developers. Reducing or eliminating unnecessary interdependencies among objects
enables the efficient reuse of objects on a modular basis.
Component-based development builds on the foundation provided by
object-oriented programming, using components with more functionality to provide
a higher level of abstraction with greater capability. Often, a complete program
will serve as a component in a larger system. By raising the level of
abstraction and re-use of components, component-based development offers higher
leverage and return on investment than previous techniques.
The growing interest in and increasing usage of component-based development
are driven by several major industry trends that emphasize the development of
separate but complete programs that work together as part of a larger system.
These include the growth of the Internet, company-specific intranets, and
distributed multi-tier client/server systems. Component-based development is
also driven by the widespread adoption of implementation languages such as
Visual Basic, Java, and related technologies such as CORBA and Microsoft's
ActiveX, each of which provides mechanisms necessary for distributed components
to work together.
Major software vendors including Microsoft, Oracle, Hewlett-Packard, Sun
Microsystems and Netscape Communications have begun to use internally, and some
have publicly endorsed, component-based development. For example, Java applets
are separate, self-contained, pre-existing programs (components) that can be
automatically downloaded from an Internet site and run on a user's system. In
addition, the Company believes that Microsoft's strategy for supporting
customers that are building enterprise information systems is based on
component-based development. Much of Microsoft's technology infrastructure is
aimed at providing ways of allowing complete programs to serve as software
components that can be integrated with other components.
THE RATIONAL APPROACH(TM)
Rational provides extensive support for component-based development through
each of the major phases of the software development lifecycle. The Rational
Approach consists of three elements: a flexible software development process, a
set of integrated products and technical consulting services. This approach
enables customers to reduce the risk of failure, improve the quality of the
software products they develop, increase developer productivity, reduce
time-to-market and increase software reusability.
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The first element of the Rational Approach, a flexible software development
process, includes several software development concepts:
Controlled iterative development: Reducing risk, cost and
time-to-market. Rational's tools support controlled iterative development,
which the Company believes is more economical and predictable than
traditional sequential development, significantly reducing the risk and
cost of delivering software. In controlled iterative development, the
objectives for a software system are specified and used to drive the
creation of a series of partial but increasingly functional systems. Risk
is reduced because each iteration provides an opportunity for developers to
identify problems in system functionality, performance and user interface,
and to obtain user and customer feedback. The need for unplanned,
unbudgeted fixes can be significantly reduced or eliminated. Controlled
iterative development also provides a significant time-to-market advantage.
Because working iterations are available over much of the project
lifecycle, developers have the option of shipping a high-quality system
even before full functionality is implemented, if necessary to take
advantage of a market window, and to add functionality as new iterations
are completed.
Visual modeling: Managing complexity. Visual modeling is a technique
in which software components and the relationships among them are described
graphically. The model captures information about business processes or
software requirements, and the software components and architectures
necessary to implement them. The model raises the level of abstraction from
source code to a visual programming approach, which the Company believes is
more intuitive than non-graphical approaches for most software developers.
Visual modeling is an essential element of using component-based
development on a large scale.
Architectural approach: Enhancing quality and reuse. Rational's tools
help software developers build applications that have a sound architecture,
thereby maintaining the flexibility to make modifications or add new
modules. This, in turn, can increase reusability and thereby decrease
time-to-market for future products. Software architecture refers to the
basic structure and foundation of a software program. Designing a robust
architecture early in the development process, verifying the soundness of
the architecture with early development iterations, and enforcing the
integrity of the architecture over the lifetime of the project produce an
architecture that is adaptable in the face of changes driven by customer
feedback or changing business conditions. A well-designed architecture also
allows the developer to identify and package reusable software components.
Unless consistently enforced, system architecture can begin to break down
as the original architecture is violated or circumvented, either by
accident or in response to development time pressures.
The second element of the Rational Approach is a comprehensive set of
integrated software-development products that automate the activities of
software managers, designers and developers throughout the software lifecycle.
Rational's products include Rational Rose, Visual Test, Rational Apex, Rational
Summit and SoDA. Rational's products support visual modeling of the basic
business processes and objects necessary for implementing enterprise-wide
information systems and developing software components. Rational's products
further support the definition of software architecture, coding, testing,
debugging, software change management, software process enforcement and
documentation of components and entire software systems.
The third element of the Rational Approach is to provide customers with
technical consulting, training and support services. These services help
customers apply the elements of the flexible software development process and
use Rational's tools effectively. Rational's services are designed to minimize
customers' risks and maximize their ability to achieve their business
objectives.
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RATIONAL'S BUSINESS STRATEGY
Rational's strategy is to ensure the success of its customers in developing
and managing software systems that are strategically important to their
businesses. Key components of the Company's strategy are to:
Maintain technology leadership. The Company offers a comprehensive
family of software products that enable component-based development
throughout the critical phases of the software development process. The
Company has pioneered the tight integration of individual tools to support
controlled iterative development and an architecture-driven process
throughout the software development lifecycle. The Company plans to
continue enhancing its products and integrating additional tools that
strengthen and extend the Company's support for component-based
development.
Support the major platforms and implementation languages. Rational's
strategy is to offer products that support component-based development on
the major UNIX platforms, Windows 95, and Windows NT. The Company believes
that in order to reach a wide market for its products it is important to
support the major implementation languages used for software development.
The Company currently supports Visual Basic, C++ and PowerBuilder, and has
announced plans to introduce products, currently in beta testing, that
support Java and Forte. The Company plans to adapt and extend its
technology to support additional implementation languages as they become
widely used.
Leverage the business alliance with Microsoft. On October 2, 1996,
the Company and Microsoft announced the formation of a business alliance
that will consist of four major elements: technology cross-licensing, joint
development, joint marketing and Rational's acquisition of Microsoft's
Visual Test product. Rational believes that the strategies of the two
companies in relation to the enterprise information systems market are
complementary, and the parties have announced that the alliance is intended
to allow Microsoft to focus on development environments like Visual Basic,
Visual C++ and Visual J++ and Rational to focus on lifecycle tools for
analysis and design, testing, documentation and change management. The
Company believes that this alliance will facilitate the integration of its
products with Microsoft's technology, leading to products that are more
appealing to software developers using Windows 95 and Windows NT. Further,
the Company believes that its alliance with Microsoft will enable the
introduction of the Company's products to software developers using
Microsoft's products. See "Business -- Business Alliance with Microsoft."
Drive the industry standard for visual modeling. The Company believes
that its Unified Modeling Language has become the de facto standard
language for visual modeling of business processes and for the development
of software systems. Rational, Microsoft, Oracle and Hewlett-Packard have
announced plans to submit a joint proposal for inclusion of the UML in the
OMG's Object Analysis and Design Facility specification. Rational believes
that the existence of an official standard will help accelerate the rate of
adoption of object technology by reducing the uncertainty and confusion
that stem from a lack of standards. The Company believes that it is
well-positioned as the developer of the UML standard and as a market leader
in visual modeling tools. See "Risk Factors -- Dependence Upon Market
Growth and Development of Industry Standards."
Build comprehensive distribution capabilities. Rational intends to
continue leveraging its worldwide presence to provide tools to customers
whose businesses depend on developing and maintaining software systems. The
Company's direct sales force, supported by highly-skilled technical
personnel in the field, allows the Company to work closely with its
customers to help ensure their success. In fiscal 1996, the Company
established new sales channels, including telesales, service providers and
VARs, which it intends to expand. In addition, Rational plans to make
extensive use of the Internet for marketing, selling and customer support,
with the objective of reaching a larger potential market while reducing
selling costs.
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The discussion of the Company's strategy above contains forward-looking
statements that are based upon the Company's current intentions and that involve
risks and uncertainties. Actual results and future actions taken by the Company
could differ materially from those discussed in the forward-looking statements
as a result of certain factors, some of which are beyond the Company's control
and are dependent upon future market developments. See "Risk
Factors -- Dependence Upon Market Growth and Development of Industry Standards,"
"-- Expansion of Product Lines," "-- Business Alliance with Microsoft," and
"-- Dependence on Sales Force and Other Channels of Distribution," as well as
the other risks set forth in "Risk Factors" and elsewhere in this Prospectus.
PRODUCTS AND SERVICES
Rational supports component-based development with an extensive family of
software products covering critical phases of the software development
lifecycle, from initial analysis of requirements through detailed design,
coding, testing, debugging and maintenance. Rational's products support
individual designers and developers, development teams and project managers. The
major components of Rational's product line are Rational Rose, for visual
modeling; Rational Apex, for managing development teams and the components they
generate; Rational Summit, for software change management and process
enforcement; and SoDA, for automated documentation generation. These tools work
together to support controlled iterative development, visual modeling and an
architecture-driven process in a consistent manner. In addition, the Company is
adding Visual Test to its product line for automated software testing on Windows
95 and Windows NT.
Rational Rose: Visual Modeling Tools
Rational Rose is a software-engineering tool that allows users to develop,
verify and document the analysis and design model of their software graphically.
Rational Rose keeps the analysis and design model consistent through the entire
software lifecycle, making controlled iterative development feasible. The first
Rational Rose product was shipped in 1992. Rational Rose is used in the
construction of enterprise information systems, packaged software products,
systems integration activities, and for the construction of technical systems in
industries such as telecommunications, medical instruments, transportation and
aerospace. Over 20,000 licenses of Rational Rose family products have been sold
worldwide. Rational Rose has been the recipient of industry product-excellence
awards.
The Company's Rational Rose product line supports major platforms,
including UNIX, Windows 95 and Windows NT, and implementation languages,
including C++, Visual Basic and Power Builder, that are widely used today. The
Company has also announced plans to introduce Rose/Java and Rose/Forte, which
are currently in beta testing. Rational Rose generally supports round-trip
engineering, in which the user can go from graphical design to generation of
source code, modify the resulting source code, reverse engineer the new source
code to generate a graphical depiction of the system as it exists after being
modified, and merge any changes made in the source code back into the model or
vice versa. By keeping the graphical analysis and design model consistent with
the source code, Rational Rose supports controlled iterative development over
the lifetime of the project. The Company believes that Rational Rose is unique
in its ability to support an unlimited number of "round-trips" with no loss of
information.
Rational Apex: Integrated Development Environment Tools
Rational Apex is a software-engineering environment for control of software
projects. It effectively controls large-scale development efforts, helping
customers improve time-to-market while reducing risk and cost. It also makes
large-scale software reuse possible by directly managing software architecture,
significantly improving the efficiency of the overall software development
process. The product was first shipped in 1993, replacing the Company's
first-generation programming environment, and over 7,500 licenses have been sold
to date. Rational Apex runs on UNIX platforms and is available in versions that
support the C/C++ and Ada programming languages. The Company has announced
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that the next release of its Apex C/C++ product will provide architectural
control and build/release management for Java.
Rational Apex gives users architectural control, a way of expressing and
enforcing automatically the overall architecture of a software system throughout
the lifetime of the project, allowing users to replace manual mechanisms of
expressing and enforcing a software system's architecture. The product provides
a construct that enforces the boundaries of the architecture automatically. It
detects, reports and eliminates violations of the architecture, preventing the
decay or degradation of the architecture that can occur over the lifetime of a
project.
Rational Apex also provides extensive support for day-to-day configuration
management and version control. It supports parallel development within and
among development teams. It generates an audit trail of changes to the software,
capturing the specifics of every change made over the course of the project. The
building and releasing of each iteration of a software system is automated,
thereby providing the team and project management support that is essential for
controlled iterative development.
The Apex family also includes the VADS line of Ada compilers, debuggers,
and related tools for the development of highly-reliable, high-performance
embedded systems. VADS was first shipped in 1984 and over 7,000 licenses have
been shipped to date. The VADS family runs on major UNIX platforms, and the VADS
cross-compiler product family supports major embedded system targets including
the PowerPC, Motorola 680x0 and Intel architecture.
Rational Summit: Software Change-Management Tools
Rational Summit is an integrated software change-management tool that helps
manage the overall software change process, including change identification,
change policy enforcement, and measurement and management of software
development progress. Rational Summit allows users to group a number of related
software changes into a task, which can then be explicitly managed. These
changes may collectively be necessary, for example, to fix a software bug or to
add a requested feature. Rational Summit can be customized and configured to
meet specific change-management needs of organizations.
Rational Summit is available on major UNIX platforms. Rational Summit was
first shipped in May 1996 and approximately 750 licenses have been sold. Summit
supports integration with the leading desktop project-management tools, such as
Microsoft Project and Microsoft Excel.
SoDA: Software Document Authorization Tools
SoDA allows users to generate documentation automatically and incrementally
using graphical and textual information taken from many external sources. SoDA
also can be tailored to a variety of documentation formats and can be used on
projects regardless of the implementation language. SoDA is available on UNIX,
Windows 95 and Windows NT. SoDA was first shipped in June 1994, and over 1,500
licenses have been sold to date.
Visual Test: Software Testing Automation Tools
Visual Test, an automated, language-independent, software testing tool, is
designed to increase developers' and testers' productivity by rapidly creating
tests for applications of virtually any size and created in any implementation
language by capturing those tests for later re-use. These capabilities enhance
the ability of organizations to deploy applications for the Windows 95 and
Windows NT operating systems. Visual Test includes a Scenario Recorder used to
create test cases interactively, and may be used to test individual software
components or entire systems, including "stress tests" of large client/server
applications. Visual Test supports testing of the latest technologies, such as
ActiveX Controls, which helps developers to ensure the quality of their
applications while realizing the
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productivity benefits of component software. Visual Test is integrated with
Microsoft Developer Studio, a desktop development environment.
Visual Test was first shipped by Microsoft in 1992. Microsoft has announced
the shipment of over 75,000 licenses since the product's introduction. Rational
acquired Visual Test on October 2, 1996 from Microsoft.
Technical Consulting and Customer Support Services
The Company views its technical consulting services as an important part of
its strategy of offering a complete, integrated solution for customers who are
developing complex software systems, as well as a way to promote higher-margin
product sales. The Company approaches the delivery of its technical consulting
services as a partnership with its customers. Customers often request the
Company's guidance to help them improve their approach to software development,
to realize the benefits of the Rational Approach and to efficiently use the
Company's tools.
Rational's services include consulting and training that enable customers
to adopt advanced software processes and to use component-based development
effectively. Consulting services range from helping customers implement
large-scale software reuse, to working with customers to develop the right
architecture for their software systems, to helping a customer's development
team work through the first few iterations of the controlled iterative
development process. The Company also offers several standard consulting
packages and training courses that assist customers in the implementation of
controlled iterative development and the use of component-based development.
The Company complements its products and professional services with an
experienced team that allows it to maintain strong relationships with its
customers and further promote its products and services. The Company provides
telephone, electronic mail and fax-based customer support through the Company's
Customer Support Services organization. Members of the Company's software
support team typically have several years experience in areas such as software
engineering, software testing, or tool development.
BUSINESS ALLIANCE WITH MICROSOFT
On October 2, 1996, Rational and Microsoft announced the formation of a
business alliance which will consist of Rational's acquisition of Microsoft's
Visual Test product, technology cross-licensing, joint development projects and
joint marketing programs. See "Risk Factors -- Business Alliance with
Microsoft," "-- Acquisition of the Visual Test Product," "-- Licensing of Rose
Technology to Microsoft," and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview."
In connection with this alliance, Rational acquired from Microsoft the
Visual Test product, a leading software quality automation tool. Microsoft has
announced the shipment of over 75,000 licenses since the product's introduction
in 1992. Rational intends to release new versions of the Visual Test product
that extend its support for component-based development and Internet
applications. Microsoft has retained rights to continue using Visual Test in its
own software development, and the companies have agreed to work together to
specify and develop new product features and updated releases to exploit new
releases of Microsoft's operating system and tools products. Rational has also
granted Microsoft the option to obtain a license to incorporate certain elements
of Visual Test technology in Microsoft's development tool products, including
Visual Basic, Visual C++ and Visual J++. See "Business -- Products and
Services -- Visual Test: Software Testing Automation Tools."
The cross-licensing element of the alliance includes a license to Rational
to develop and distribute, as part of Rational's products, Microsoft's Developer
Studio, an integrated development environment for Windows 95 and Windows NT.
Rational plans to integrate its visual modeling tools into Developer Studio. In
addition, Rational has licensed the rights to the future Microsoft repository,
and Rational plans to integrate its products with Visual Source Safe,
Microsoft's version control system, introducing capabilities for change
management and process automation.
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Rational has entered into an agreement to develop a visual modeling
product, including certain elements of Rational Rose, for distribution in
certain Microsoft development tools which run on Windows 95 and Windows NT.
Rational will be obligated to provide timely product updates to maintain
compatibility with changes in Microsoft operating systems. Following expiration
of the agreement, Microsoft will have the option to obtain a perpetual,
non-exclusive right to source code for the product, including certain aspects of
Rational's Rose technology.
Rational's objective in acquiring the Visual Test product and partnering
with Microsoft is to extend the Company's product line and to increase the use
of component-based development by providing visual modeling capabilities to
developers using Microsoft's visual tools. In addition, Rational believes that
its arrangement with Microsoft will expose the Company's technology to potential
customers outside of its historical customer base. The Company expects that
changes in its pricing models and combinations of features within product lines
will be required to encourage these potential customers to purchase Rational
products.
Joint development efforts include Rational developers and testers working
with Microsoft personnel on site at Microsoft in Redmond, Washington, to
integrate Rational's products with the Microsoft infrastructure, including DCOM,
ActiveX, BackOffice and the Microsoft visual tool products. The joint
development efforts also include testing of Rational products in Microsoft's
Usability Labs.
Plans for joint marketing activities include use of the Internet and the
World Wide Web, co-sponsored seminars, joint press conferences, direct mail
campaigns and other promotional activities.
PRODUCT DEVELOPMENT
Rational believes that its success will depend largely upon its ability to
enhance existing products and develop new products that meet the needs of a
rapidly evolving marketplace and increasingly sophisticated and demanding
customers. The Company intends to extend and strengthen its lifecycle support
for component-based development by expanding its product offerings, introducing
new products, and offering higher levels of integration among its products.
Rational uses its own software processes and tools extensively in its own
software development activities. While the Company has primarily developed
products internally, it may, based on timing and cost considerations, acquire
technologies or products from third parties.
The Company's research and development staff, including product
development, product support and technical writing personnel consists of 133
employees as of June 30, 1996. Rational's total research and development
expenses were approximately $20.2 million, $12.2 million and $15.9 million in
fiscal years 1994, 1995, and 1996, respectively.
CUSTOMERS AND APPLICATIONS
Over 40,000 licenses of Rational's software products, exclusive of Visual
Test, have been sold to over 2,500 customers worldwide. No single customer
accounted for 10% or more of revenues in fiscal 1996. The Company's
comprehensive solution of software development tools and professional services
is used by major organizations in many industry segments to design, build and
maintain complex software systems.
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The following customers were among the Company's largest customers in
fiscal 1996 in the areas listed:
ENTERPRISE INFORMATION SYSTEMS
AT&T
Daimler-Benz
Dow Chemical
Eastman Kodak
Knight-Ridder
MCI
NBC
NTT
Nynex
Osaka Gas Information Systems
Reuters
WorldCom
Xerox
TELECOMMUNICATIONS
Alcatel
Bell Sygma Telecom
British Telecom
Broadband Technologies
Deutsche Telekom
LM Ericsson
Mitel Corporation
Nortel
Qualcomm
Siemens
INDEPENDENT SOFTWARE VENDORS AND SYSTEMS INTEGRATORS
Andersen Consulting
Attachmate
CSC
EDS
IBM
Microsoft
Perot Systems
FINANCIAL SERVICES
Bankers Trust Company
Barclays Bank
Chase Manhattan Bank
CNA Insurance
Deutsche Bank
Fidelity Investments
London Stock Exchange
Merrill Lynch
MetLife
Morgan Guaranty
Nomura International
Prudential Insurance
Smith Barney
Standard Life Assurance
Union Bank of Switzerland
USF&G
Zurich Cantonal Bank
AEROSPACE/DEFENSE
Boeing
Hughes
Lockheed Martin
Raytheon Company
Texas Instruments
TRW
TRANSPORTATION
British Airways
GEC-Alsthom
Honeywell
Hughes Air Traffic Systems
Rockwell-Collins
SALES AND MARKETING
Rational primarily employs a direct selling approach which couples sales of
its integrated software tools with high-value technical consulting services. The
Company has established a major-account direct sales and technical consulting
organization in the United States, Canada, Europe, and in the Asia/Pacific/Latin
America region. Rational's major-account direct sales and technical consulting
organization is based on a team-selling model organized around an Account
Representative and an average of three Software Engineering Specialists. The
Company's Software Engineering Specialists provide pre- and post-sales support,
and are the primary delivery mechanism for the Company's high-value technical
consulting services. Rational believes that its major-account sales and
technical consulting organization is a powerful asset, giving the Company the
resources to form lasting
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relationships with its major customers. See "Risk Factors -- Dependence on Sales
Force and Other Channels of Distribution."
The Company's major-account direct sales and technical consulting
organization is focused on large customers that directly depend on their
capability to develop software. The Company believes that additional
opportunities exist which may be pursued by the Company's direct sales force in
partnership with external service providers and VARs. The Company also believes
that it can exploit additional revenue opportunities by developing channels such
as telesales and the use of the World Wide Web for direct marketing, sales and
customer support. The Company believes that the development of these additional
channels will allow it to reach a broader base of customers and maintain direct
contact with them at a lower cost than direct sales efforts.
The Company's North American sales, marketing and professional service
organization consists of 322 individuals, operating out of corporate
headquarters in Santa Clara, California, field offices in other locations
throughout North America, the United Kingdom, France, Germany, Sweden,
Australia, Taiwan, India, South Korea and Brazil. The Company's direct
international operations are staffed almost exclusively by local personnel. The
Company also has distributors and resellers in North America and additional
distributors in Spain, Italy, Israel, Singapore, Korea, China, Japan and South
Africa.
The Company has established a partnership with Osaka Gas Information
Systems Research Institute ("OGIS-RI"), a subsidiary of Osaka Gas and a provider
of object-oriented programming expertise in the Japanese market. OGIS-RI has
localized certain of Rational's tools, including the Windows and UNIX versions
of Rational Rose/C++, for the Japanese market, along with training materials on
software process and object technology. OGIS-RI currently markets, sells and
offers an extensive range of technical consulting and training services to
support the Rational Rose product line in Japan.
In support of its sales efforts, the Company's marketing department
conducts comprehensive programs which include maintenance of an extensive home
page on the World Wide Web, an electronic subscription service for news
announcements about the Company, print advertising, direct mail, public
relations, trade shows and ongoing customer communications programs. The Company
also keeps its customers informed of advances in the field through a customer
newsletter, technical papers and other mailings.
PRODUCT PRICING
The Company's software licenses are normally perpetual, fully-paid-up
floating licenses. The floating license limits the number of simultaneous users
in a network instead of being associated with a specific user or computer. The
Company also offers other kinds of licenses, such as node-locked licenses that
limit a software license to a single computer and project licenses that provide
selected Company tools to all the developers working on a specific project.
The bulk of the Company's net product revenue in fiscal 1996 was derived
from sales of its Rose and Apex product families. Elements of the Rose family
range in price from $495 for a single-user PC version of Rational Rose, to
$2,400 for Rational Rose/Visual Basic on a PC, to $8,400 for a floating license
of Rational Rose/C++ on a UNIX workstation. Elements of the Apex family range in
price from $7,500 for an Apex C++ license on UNIX to $22,000 for an Apex Ada
license on UNIX. The Company's products are often sold in multiple quantities to
teams of software developers working together in a client/server environment.
The Company offers standard discounts based on dollar volume in a single
purchase order.
The Company also offers a support program which entitles a licensee to
receive all enhancements and upgrades to the licensed product that are published
in the succeeding twelve month period, as well as certain other support
services. Annual fees for support generally range from 15% to 20% of the
software license fee.
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Rational's packaged training courses are offered in the form of
open-enrollment public courses and in-house courses at customer facilities, and
range from $1,750 per person for a typical four-day course, between $3,000 to
$12,500 for in-house courses depending on the length of the course and the
maximum number of students in the class. Rational's packaged consulting services
range from approximately $50,000 to several hundred thousand dollars. Currently,
custom consulting is priced on a time-and-materials basis, although the Company
plans to bill more of its custom consulting on a project-by-project basis in the
future. Discounts are offered for engagements of 1,000, 2,000 and 6,000 hours of
consulting in a calendar year.
COMPETITION
The marketplace for software engineering tools is intensely competitive.
Given the breadth of the Company's product lines, each product faces competition
from one or more sources. See "Risk Factors -- Competition."
Rational faces competition from software development tools and processes
developed internally by customers, including ad hoc integrations of numerous
stand-alone development tools. The Company believes that its solution is
superior to such in-house efforts, which are frequently hampered by a lack of
understanding of the complexity involved in software development, a lack of
relevant expertise within the organization, limits on the amount of resources
made available for efforts that will benefit only a single product line or
organization and a reliance on traditional sequential development methods.
The Company faces competition from Intersolv, Inc., Platinum Technology,
Inc., Select Software Tools plc and numerous privately held tool suppliers
offering traditional CASE tools that compete with the Rational Rose approach to
visual modeling and component-based development. Rational's Visual Test product
line faces competition from SQA, Inc., Mercury Interactive Corporation, Segue
Software, Inc. and several private companies offering testing automation tools.
Rational Apex for C/C++ faces competition from major UNIX platform vendors such
as Sun Microsystems Inc., Hewlett-Packard Company and Digital Equipment
Corporation, which have C/C++ compilers and debuggers and in some cases
programming environments for their platforms. In addition, numerous privately
held companies offer compilers, debuggers and programming environments which
compete with Rational Apex. The Rational Summit product line faces competition
from Pure Atria Corporation and other suppliers offering change management
systems. Rational's Apex Ada and VADS product lines face competition from
Thomson Software Products, Green Hills Software, Inc. and a large number of
other suppliers offering Ada products for native and embedded systems.
The Company believes that the major competitive factors in its markets are
corporate and product reputation, breadth of coverage by an integrated product
line, product architecture, functionality and features, product quality,
performance, ease of use, quality of support, availability of technical
consulting services and price. Rational believes that its combination of an
integrated family of products supporting component-based development throughout
the software development lifecycle and its emphasis on controlled iterative
development, visual modeling and an architecture-driven process, coupled with
its extensive major-account direct sales and technical consulting organization
and the supporting channels such as VARs, telesales and the World Wide Web, are
effective selling tools.
The Company believes that the increased level of competition it observed in
fiscal 1996 will continue to increase. Because individual product sales are
often the first step in a broader customer relationship, the Company's success
depends in part upon its ability to successfully compete with numerous
competitors at each point within its product line. Certain of the Company's
competitors are more experienced than the Company in the development of
software-engineering tools, databases or software-development products. The
Company encounters substantial competition from in-house software tools
developers for large organizations. Some of the Company's competitors have, and
new competitors may have, larger technical staffs, more established distribution
channels and greater financial resources than the Company. There can be no
assurance that either existing or new competitors will not develop products that
are superior to the Company's products or that achieve greater market
acceptance. The Company's future success will depend in large part upon its
ability to
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increase its share of its target markets and to license additional products and
product enhancements to existing customers. There can be no assurance that
future competition will not have a material adverse effect on the Company's
results of operations.
INTELLECTUAL PROPERTY
Rational regards its software as proprietary and attempts to protect it
under a combination of copyright, trademark and trade secret laws, employee and
third-party non-disclosure 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 to reverse engineer or obtain and
use information the Company regards as proprietary. While Rational's competitive
position may be affected by its ability to protect its proprietary information,
the Company believes that trademark and copyright protections are less
significant to the Company's success than other factors, such as trade secret
protection, the knowledge, ability and experience of the Company's personnel,
name recognition and ongoing product development and support.
Rational's software products are generally licensed to end users on a
"right to use" basis pursuant to a perpetual license. The Company licenses its
products primarily under "shrink wrap" licenses (i.e., licenses included as part
of the product packaging). Shrink wrap licenses are not negotiated with or
signed by individual licensees and purport to take effect upon the opening of
the product package. Certain provisions of such licenses, including provisions
protecting against unauthorized use, copying, transfer and disclosure of the
licensed program, may be unenforceable under the laws of certain jurisdictions.
In addition, the laws of some foreign countries do not protect Rational's
proprietary rights to the same extent as do the laws of the United States.
As the number of software products in the industry increases and the
functionality of these products further overlaps, Rational believes that
software programs will increasingly become subject to infringement claims. There
can be no assurance that third parties will not assert infringement claims
against the Company in the future with respect to current or future products.
Any such assertion could require the Company to enter into royalty arrangements
or result in costly litigation. See "Risk Factors -- Limited Protection of
Intellectual Property and Proprietary Rights."
EMPLOYEES
As of June 30, 1996, the Company employed 538 full-time personnel,
including 133 in product development, 322 in sales, marketing and technical
consulting and 83 in finance and administration. The Company's employees are not
represented by any collective bargaining organization, and the Company has never
experienced a work stoppage. The Company believes its success will depend in
part on its continued ability to attract and retain highly qualified personnel
in a competitive market for experienced and talented software engineers and
sales and marketing personnel. See "Risk Factors -- Dependence on Key
Personnel."
FACILITIES
Rational's headquarters are located in a leased facility, located in Santa
Clara, California, consisting of approximately 94,000 square feet of office
space occupied under a lease expiring in January 2001, with a renewal option for
an additional five years. The Company also leases approximately 16,300 square
feet of office space in Aloha, Oregon under a lease expiring on January 1, 1999,
and approximately 22,900 square feet of office space in McLean, Virginia under a
lease expiring in February 2001. Rational leases additional facilities and
offices, including locations in Alabama, California, Connecticut, Florida,
Maryland, Massachusetts, New York, Ohio, Pennsylvania, Virginia, Washington,
Wisconsin, London, Melbourne, Munich, Paris, Sao Paolo, Seoul, Stockholm, Taipei
and Canada. Rational believes that its existing facilities and offices, together
with additional space available to it, are adequate to meet its requirements for
the foreseeable future.
35
<PAGE> 37
LEGAL PROCEEDINGS
On December 1, 1995, Interactive Development Environments ("IDE") filed an
action against the Company in the San Francisco County Superior Court seeking
monetary damages in excess of $3 million and other relief for the Company's
alleged breach of an alleged contract, misrepresentation and related claims
based on the Company's preliminary, non-binding merger discussions in 1995 with
IDE. In March 1996, the Court sustained the Company's demurrer to IDE's claim
for specific performance of the alleged contract between the parties. Trial on
IDE's remaining claims is set for January 1997, although IDE has indicated its
desire to postpone the trial in order to seek to amend its complaint. The
Company believes IDE's complaints are without merit, although there can be no
assurance that the Company will be successful in defending the action. There are
no other material pending legal proceedings to which the Company is a party or
to which any of the Company's property is the subject.
36
<PAGE> 38
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------- --- -----------------------------------------------------------
<S> <C> <C>
Paul D. Levy............. 41 Chairman of the Board and Chief Executive Officer
Michael T. Devlin........ 41 President and Director
Robert T. Bond........... 53 Senior Vice President, Chief Operating Officer, Chief
Financial Officer, and Secretary
David H. Bernstein....... 44 Senior Vice President and General Manager, Products
John R. Lovitt........... 51 Senior Vice President, North American Field Operations
Stephen F. Zeigler....... 45 Senior Vice President and General Manager, UNIX Application
Construction Products
Timothy A. Brennan....... 41 Vice President, Finance and Administration
Kevin J. Haar............ 39 Vice President, Major Accounts, North American Field
Operations
Ivar Jacobson............ 57 Vice President, Business Engineering
Joseph N. Marasco........ 51 Vice President and General Manager, Windows Application
Construction Products
Gregory L. Meyers........ 40 Vice President and General Manager, Object Modeling
Products
Richard P. Reitman....... 44 Vice President, Process and Project Management Products
Gerard J. Rudisin........ 42 Vice President, Corporate Marketing
James S. Campbell........ 69 Director
Daniel H. Case III(2).... 39 Director
Leslie G. Denend(1)...... 55 Director
John E. Montague(2)...... 42 Director
Allison R. 52 Director
Schleicher(1)..........
</TABLE>
- ------------------------------
(1) Member of Compensation Committee
(2) Member of Audit Committee
Paul D. Levy co-founded Rational in 1981. He is currently Chairman of the
Board and Chief Executive Officer. Prior to September 1996, Mr. Levy served as
President and Chief Executive Officer of the Company. Mr. Levy received a B.S.
degree in economics from the United States Air Force Academy and an M.S. degree
in engineering-economic systems from Stanford University. Mr. Levy is a director
of Peerless Systems Corporation. Mr. Levy is the son-in-law of Mr. Campbell.
Michael T. Devlin co-founded Rational in 1981. He is currently President
and a director. Prior to September 1996, Mr. Devlin served as Chairman of the
Board of the Company. Mr. Devlin received a B.S. degree in computer science from
the United States Air Force Academy and an M.S. degree in computer science from
Stanford University.
Robert T. Bond joined Rational in 1983 as Vice President of Marketing. In
1990, he was named Senior Vice President and General Manager of International
Field Operations. In April, 1996 he was named Senior Vice President, Chief
Operating Officer, Chief Financial Officer and Secretary of the Company. Mr.
Bond has a B.S. degree in engineering from Case Institute of Technology.
David H. Bernstein joined Rational in 1982 as Vice President, Product
Development. Mr. Bernstein was named Vice President and General Manager, Object
Technology Products, and Senior Vice President and General Manager, Object
Technology Products in 1994 and 1995, respectively. In May 1996, Mr. Bernstein
was named Senior Vice President and General Manager, Products. Mr. Bernstein
received a B.S. degree in electrical engineering from the Massachusetts
Institute of Technology.
37
<PAGE> 39
John R. Lovitt joined Rational as a Regional Manager responsible for sales
and marketing in 1986. In 1990, he was promoted to Vice President, and
subsequently Senior Vice President, North American Field Operations, where he is
responsible for field marketing and technical services in North America. Mr.
Lovitt received a B.S. degree in aeronautical engineering from Wichita State and
an M.S. degree in computer science from the University of Missouri.
Stephen F. Zeigler joined the Company in 1983 as an Engineering Manager.
Mr. Zeigler was named Vice President, Ada Products and Senior Vice President,
Ada Products in 1987 and 1994, respectively. Since April 1996, Mr. Ziegler has
served as Senior Vice President and General Manager, UNIX Application
Construction Products. He received his B.A. in Math, Physics, and Chemistry from
Illinois College, his M.S. in Computer Science from Indiana University and his
doctorate in Computer Science from the University of Wisconsin.
Timothy A. Brennan is Vice President, Finance and Administration. He joined
Rational as Corporate Controller in 1994. From 1987 to 1994, Mr. Brennan held
various financial management and controllership positions with The ASK Group,
Inc. Mr. Brennan received a B.S.C. in accounting from Santa Clara University. He
is a certified public accountant in the State of California.
Kevin J. Haar is Vice President, Major Accounts, North American Field
Operations. He joined Rational in 1986 as an account representative in the field
sales force. Since then, he has held a number of positions, most recently
District Manager and Eastern Regional Manager. Mr. Haar received a B.S. in
electrical engineering and an M.B.A. from Washington University in St. Louis.
Ivar Jacobson joined Rational as Vice President, Business Engineering in
1995, when the Company acquired Objectory AB. Prior to joining the Company, Mr.
Jacobson served as President of Objectory AB from 1990 to 1991, and as Vice
President of Objectory AB from 1991 to 1995. Mr. Jacobson received an M.S. in
Electrical Engineering from Chalmers Institute of Technology, Gothenberg and his
doctorate in Computer Systems from the Royal Institute of Technology in
Stockholm.
Joseph N. Marasco is Vice President and General Manager, Windows
Application Construction Products. He joined Rational in 1986 as a product
manager. He has since held various positions in the Company, including Director
of Product Marketing, Director of Consulting Services and Director of
Engineering for the Apex product line. He has an M.S. degree in physics from
State University of New York at Stony Brook and a Ph.D. in physics from the
University of Geneva, Switzerland.
Gregory L. Meyers joined Rational as Director of Rose Development in 1995,
when the Company acquired Palladio Software Corporation. In April 1996, Mr.
Meyers was named Vice President and General Manager, Object Modeling Products.
Prior to joining Rational, Mr. Meyers served as Project Manager at General
Electric Medical Systems from 1990 to 1992, and as Chief Architect, Software
Tools at Palladio Software Corporation from 1992 to 1995. Mr. Meyers received
his B.S. in Engineering from the University of Iowa.
Richard P. Reitman joined the Company in 1982. From 1991 to 1993, he served
as Product Architect, and from 1993 until 1996 he served as Chief Product
Architect of the Company. Mr. Reitman now serves as Vice President, Process and
Project Management Products. Mr. Reitman received a B.A. in Mathematics from
State University of New York, New Paltz, New York, an M.S. in Computer Science
and his doctorate in Computer Science from Cornell University. Since March 1996,
Mr. Reitman has also been Chairman and Secretary of Reitman Corp. Medical
Regulatory Consulting, a business consulting firm unaffiliated with the Company.
Gerard J. Rudisin joined Rational in 1991 as Director of Marketing for
Rational's Ada products. In 1993 he was named Vice President, Corporate
Marketing. Mr. Rudisin received a B.S. degree in electrical engineering from the
Massachusetts Institute of Technology and an M.S. degree in computer science
from University of California, Los Angeles.
James S. Campbell has been a director of the Company since 1990. Since
1987, he has been the Managing Director of Management Partners International
Corporation, a management and consulting
38
<PAGE> 40
firm specializing in technology companies. He serves on the national board of
directors of United We Stand America, Inc. and is a Director of Applied Voice
Technology, Inc. Mr. Campbell is the father-in-law of Mr. Levy.
Daniel H. Case III has been a director of Rational since 1993. Since 1994,
he has been President and Chief Executive Officer of Hambrecht & Quist Group, an
investment banking firm. From 1992 to 1994 he served as President and Co-Chief
Executive Officer of Hambrecht & Quist Group. Previously he held various
positions with Hambrecht & Quist Group. He is a director of Hambrecht & Quist
Group and Electronics Arts, Inc.
Leslie G. Denend has been a director of the Company since 1993. Since 1993,
he has been the President and Chief Executive Officer of Network General
Corporation, a supplier of local and wide area computer network communications
management systems. From 1990 to 1992, he was President of Vitalink
Communications. He is a director of Network General Corporation, McAfee
Corporation and Proxim, Inc.
John E. Montague has been a director of the Company since 1994. Since March
15, 1995, he has been Vice President, Financial Strategies at Lockheed Martin
Corporation. Previously, he was Vice President, Corporate Development and
Investor Relations at Martin Marietta Corporation. From 1988 to 1991, he was
Director, Corporate Development at Martin Marietta Corporation.
Allison R. Schleicher has been a director of the Company since 1990. Since
1967, he has been with IBM Corporation in various executive and management
positions. Most recently in 1994, he was appointed Vice President, Finance of
IBM Credit Corporation.
39
<PAGE> 41
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth the beneficial ownership of Common Stock of
the Company as of September 30, 1996 and as adjusted to reflect the sale of the
shares offered by this Prospectus (assuming no exercise of the Underwriter's
over-allotment option), by (i) all persons known to the Company to be the
beneficial owners of more than 5% of the Company's Common Stock, (ii) the
Company's Chief Executive Officer and the four most highly compensated executive
officers other than the Chief Executive Officer, (iii) each Selling Stockholder,
(iv) each of the Company's directors and (v) all directors and executive
officers as a group. The information on beneficial ownership in the table and
the footnotes below is based upon the Company's records, Schedule 13D and 13G
filings and information supplied to the Company by the listed person or entity.
The following table has been prepared in accordance with Rule 13d-3 of the
Securities Exchange Act of 1934 and discloses all securities beneficially owned
by the named persons as of September 30, 1996, plus all securities which such
persons have a right to acquire through the exercise of options or other rights
within 60 days of September 30, 1996. Certain individuals in the table below
have the right to acquire additional shares after such 60-day period, as
indicated in the footnotes to the table.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO THE OWNED AFTER THE
OFFERING OFFERING
DIRECTORS, OFFICERS, 5% STOCKHOLDERS --------------------- ---------------------
AND SELLING STOCKHOLDERS NUMBER PERCENT NUMBER PERCENT
- --------------------------------------------------- --------- ------- --------- -------
<S> <C> <C> <C> <C>
Putnam Investments................................. 6,790,644 19.7% 6,790,644 17.6%
FMR Corp........................................... 2,359,000 6.8% 2,359,000 6.1%
The Kaufmann Fund, Inc............................. 1,960,000 5.7% 1,960,000 5.1%
AIM Management Group............................... 1,947,000 5.6% 1,947,000 5.0%
Ivar Jacobson...................................... 920,044 2.7% 507,500 1.3%
Ericsson Inc.(1)................................... 544,174 1.6% -- *
Paul D. Levy(2).................................... -- * -- *
Michael T. Devlin(3)............................... -- * -- *
Robert T. Bond(4).................................. 114,970 * 114,970 *
David H. Bernstein(5).............................. 56,666 * 56,666 *
Kevin J. Haar(6)................................... 56,632 * 56,632 *
Daniel H. Case III(7).............................. 36,329 * 36,329 *
Leslie G. Denend(8)................................ 29,164 * 29,164 *
Allison R. Schleicher(9)........................... 21,498 * 21,498 *
James S. Campbell(10).............................. 15,248 * 15,248 *
John E. Montague(11)............................... 600 * 600 *
All current directors and current executive
officers
as a group (18 persons)(12)...................... 1,707,989 4.9% 1,295,445 3.3%
</TABLE>
- ------------------------------
* Less than one percent.
(1) Ericsson Inc. is a subsidiary of LM Ericsson, which originally acquired
these shares in connection with the Company's acquisition of Objectory AB.
(2) Mr. Levy holds options for the purchase of 475,000 shares of the Company's
Common Stock, which vest at various times following the 60-day period
commencing on September 30, 1996. The Board of Directors of the Company has
agreed to grant Mr. Levy an additional option for the purchase of 200,000
shares of Common Stock on January 1, 1997, which will vest over a four-year
period and will have an exercise price equal to the fair market value of
the Company's Common Stock on the date of grant.
(3) Mr. Devlin holds options for the purchase of 475,000 shares of the
Company's Common Stock, which vest at various times following the 60-day
period commencing on September 30, 1996. The Board of Directors of the
Company has agreed to grant Mr. Devlin an additional option for the
purchase of 200,000 shares of Common Stock on January 1, 1997, which will
vest over a four-year
40
<PAGE> 42
period and will have an exercise price equal to the fair market value of
the Company's Common Stock on the date of grant.
(4) Includes 94,498 shares purchasable by Mr. Bond within 60 days of September
30, 1996, upon exercise of outstanding stock options. Mr. Bond holds
additional options for the purchase of 210,834 shares of the Company's
Common Stock, which vest at various times following such 60-day period.
(5) Includes 26,666 shares purchasable by Mr. Bernstein within 60 days of
September 30, 1996, upon exercise of outstanding stock options. Mr.
Bernstein holds additional options for the purchase of 143,334 shares of
the Company's Common Stock, which vest at various times following such
60-day period.
(6) Includes 52,998 shares purchasable by Mr. Haar within 60 days of September
30, 1996, upon exercise of outstanding stock options. Mr. Haar holds
additional options for the purchase of 76,334 shares of the Company's
Common Stock, which vest at various times following such 60-day period.
(7) Includes 32,498 shares purchasable by Mr. Case within 60 days of September
30, 1996, upon exercise of outstanding stock options. Mr. Case holds
additional options for the purchase of 37,834 shares of the Company's
Common Stock, which vest at various times following such 60-day period.
(8) Includes 29,164 shares purchasable by Mr. Denend within 60-days of
September 30, 1996, upon exercise of outstanding stock options. Mr. Denend
holds additional options for the purchase of 51,168 shares of the Company's
Common Stock, which vest at various times following such 60-day period.
(9) Includes 21,498 shares purchasable by Mr. Schleicher within 60 days of
September 30, 1996, upon exercise of outstanding stock options. Mr.
Schleicher holds additional options for the purchase of 62,834 shares of
the Company's Common Stock, which vest at various times following such
60-day period.
(10) Includes 14,582 shares purchasable by Mr. Campbell within 60 days of
September 30, 1996, upon exercise of outstanding stock options. Mr.
Campbell holds additional options for the purchase of 50,334 shares of the
Company's Common Stock, which vest at various times following such 60-day
period.
(11) Mr. Montague holds options for the purchase of 68,000 shares of the
Company's Common Stock, which vest at various times following the 60-day
period commencing on September 30, 1996.
(12) Includes 599,213 shares purchasable within 60 days of September 30, 1996,
upon exercise of outstanding stock options. Such persons also hold
additional options for the purchase of an aggregate of 2,126,707 shares of
the Company's Common Stock, which vest at various times following such
60-day period.
41
<PAGE> 43
DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 75,000,000 shares of
Common Stock.
COMMON STOCK
The holders of Common Stock are entitled to one vote per share on all
matters submitted to a vote of stockholders. Holders of Common Stock also are
entitled to receive ratably such dividends are may be declared by the Board of
Directors out of funds legally available therefor. See "Price Range of Common
Stock and Dividend Policy." In the event of liquidation, dissolution or winding
up of the Company, holders of Common Stock are entitled to share ratably in all
assets remaining after payment of liabilities. Holders of Common Stock have no
preemptive, subscription, redemption or conversion rights. All outstanding
shares of Common Stock are, and the shares of Common Stock offered hereby will
be, when issued against the consideration set forth in this Prospectus, fully
paid and nonassessable.
REGISTRATION RIGHTS
Ivar Jacobson has been granted certain demand and "piggyback" registration
rights with respect to shares of the Company's Common Stock pursuant to an
agreement between UseCase Engineering S.A. and the Company. Mr. Jacobson has
agreed to a lock-up expiring 90 days following effectiveness of the offering
made hereby with respect to the portion of his holdings not being offered
hereby. The exercise by Mr. Jacobson of his registration rights or other sale of
his holdings following the expiration of such 90-day period could have an
adverse impact on the market for shares of the Company's Common Stock.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Company's Common Stock is
ChaseMellon Shareholder Services of California.
42
<PAGE> 44
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below, through their Representatives, Hambrecht & Quist LLC,
Goldman, Sachs & Co. and Wessels, Arnold & Henderson, L.L.C., have severally
agreed to purchase from the Company and the Selling Stockholders the following
respective number of shares of Common Stock.
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
------------------------------------------------------------------ ---------
<S> <C>
Hambrecht & Quist LLC.............................................
Goldman, Sachs & Co...............................................
Wessels, Arnold & Henderson, L.L.C................................
---------
5,106,718
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent, including the absence
of any material adverse change in the Company's business and the receipt of
certain certificates, opinions and letters from the Company, its counsel and
independent auditors. The nature of the Underwriters' obligation is such that
they are committed to purchase all shares of Common Stock offered hereby if any
of such shares are purchased.
The Underwriters propose to offer the shares of Common Stock directly to
the public at the offering price set forth on the cover of this Prospectus and
to certain dealers at such price less a concession not in excess of $
per share. The Underwriters may allow, and such dealers may reallow, a
concession not in excess of $ per share to certain other dealers. After
the public offering of the shares, the offering price and other selling terms
may be changed by the Underwriters.
The Company has granted to the Underwriters an option, exercisable no later
than 30 days after the date of this Prospectus, to purchase up to additional
766,007 shares of Common Stock at the public offering price, less the
underwriting discount, set forth on the cover page of this Prospectus. To the
extent that the Underwriters exercise this option, each of the Underwriters will
have a firm commitment to purchase approximately the same percentage thereof
which the number of shares of Common Stock to be purchased by it shown in the
above table bears to the total number of shares of Common Stock offered hereby.
The Company will be obligated, pursuant to the option, to sell such shares to
the Underwriters to the extent the option is exercised. The Underwriters may
exercise such option only to cover over-allotments made in connection with the
sale of shares of Common Stock offered hereby.
The offering of the shares is made for delivery when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The Underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and to contribute to payments the Underwriters may be required
to make in respect thereof.
The Company and its executive officers and directors and the Selling
Stockholders have agreed that they will not, without the prior written consent
of Hambrecht & Quist LLC, offer, sell or otherwise dispose of any shares of
Common Stock, options or warrants to acquire shares of Common Stock or
securities exchangeable for or convertible into shares of Common Stock owned by
them during the 90-day period following the date of this Prospectus, except that
the Company may issue shares upon the exercise of options granted prior to the
date hereof, may grant additional options under its stock option plans, and may
issue shares pursuant to the Company's stock purchase plan.
43
<PAGE> 45
In general, the rules of the Commission will prohibit the Underwriters from
making a market in the Company's Common Stock during the "cooling off" period
immediately preceding the commencement of sales in the offering. The Commission
has, however, adopted exemptions from these rules that permit passive market
making under certain conditions. These rules permit an underwriter to continue
to make a market subject to the conditions, among others, that its bid not
exceed the highest bid by a market maker not connected with the offering and
that its net purchases on any one trading day not exceed prescribed limits.
Pursuant to these exemptions, certain Underwriters, selling group members (if
any) or their respective affiliates intend to engage in passive market making in
the Company's Common Stock during the cooling off period.
Daniel H. Case III, a director and stockholder of the Company, is the
President and Chief Executive Officer and a shareholder of Hambrecht & Quist
Group, the parent entity of Hambrecht & Quist LLC. Mr. Case, together with
affiliates and venture funds associated with Hambrecht & Quist Group, owns less
than 1% of the outstanding shares of the Company's Common Stock. Mr. Case may be
deemed to have voting or investment power with respect to certain of the shares
held by Hambrecht & Quist Group affiliates.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company and the Selling Stockholders by Wilson Sonsini Goodrich & Rosati,
Professional Corporation, Palo Alto, California. Certain legal matters will be
passed upon for the Underwriters by Cooley Godward LLP, Palo Alto, California.
EXPERTS
The consolidated financial statements of Rational Software Corporation at
March 31, 1995 and 1996, and for each of the three years in the period ending
March 31, 1996, appearing in this Prospectus and Registration Statement have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
reports thereon appearing elsewhere herein and are included in reliance upon
such reports, given upon the authority of such firm as experts in accounting and
auditing.
44
<PAGE> 46
RATIONAL SOFTWARE CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors..................................... F-2
Consolidated Statements of Operations................................................. F-3
Consolidated Balance Sheets........................................................... F-4
Consolidated Statements of Stockholders' Equity....................................... F-5
Consolidated Statements of Cash Flows................................................. F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE> 47
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Rational Software Corporation
We have audited the accompanying consolidated balance sheets of Rational
Software Corporation as of March 31, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended March 31, 1996. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Rational Software Corporation at March 31, 1996 and 1995, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended March 31, 1996, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
San Jose, California
April 22, 1996
F-2
<PAGE> 48
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
FISCAL YEARS ENDED MARCH 31, ENDED JUNE 30,
-------------------------------- -------------------
1994 1995 1996 1995 1996
-------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net product revenue..................... $ 41,716 $39,221 $55,899 $11,454 $17,300
Consulting and support revenue.......... 28,627 33,678 35,208 8,303 10,161
-------- ------- ------- ------- -------
Total revenue*..................... 70,343 72,899 91,107 19,757 27,461
-------- ------- ------- ------- -------
Cost of product revenue................. 11,862 6,955 7,196 1,250 1,825
Cost of consulting and support
revenue............................... 13,494 18,095 19,336 4,763 5,499
-------- ------- ------- ------- -------
Total cost of revenue.............. 25,356 25,050 26,532 6,013 7,324
-------- ------- ------- ------- -------
Gross profit............................ 44,987 47,849 64,575 13,744 20,137
Operating expenses:
Research and development.............. 20,221 12,187 15,939 3,171 4,495
Sales and marketing................... 21,338 25,100 35,000 7,666 8,877
General and administrative............ 7,194 6,995 9,511 1,711 2,399
Charges for acquired in-process
research and development........... -- -- 8,700 -- --
Merger and restructuring costs........ 9,922 (1,100) -- -- --
-------- ------- ------- ------- -------
Total operating expenses........... 58,675 43,182 69,150 12,548 15,771
-------- ------- ------- ------- -------
Income (loss) from continuing
operations............................ (13,688) 4,667 (4,575) 1,196 4,366
Other income, net....................... 285 417 1,582 180 533
-------- ------- ------- ------- -------
Income (loss) from continuing operations
before provision for income taxes..... (13,403) 5,084 (2,993) 1,376 4,899
Provision for income taxes.............. 404 406 1,028 110 735
-------- ------- ------- ------- -------
Income (loss) from continuing
operations............................ (13,807) 4,678 (4,021) 1,266 4,164
Discontinued operations:
Loss from the disposal of the secure-
products business.................. (175) -- -- -- --
-------- ------- ------- ------- -------
Net income (loss)..................... $(13,982) $ 4,678 $(4,021) $ 1,266 $ 4,164
======== ======= ======= ======= =======
Income (loss) from continuing operations
per common share...................... $(.57) $.19 $(.13) $.04 $.11
Net income (loss) per common share...... (.57) .19 (.13) .04 .11
Shares used in computing per share
amounts............................... 24,394 25,212 30,725 28,536 36,930
*Revenue from related parties........... $8,852 $3,324 $4,000 $291 $--
</TABLE>
See Notes to Consolidated Financial Statements.
F-3
<PAGE> 49
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30,
1996
MARCH 31, MARCH 31, -----------
1995 1996
--------- --------- (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents................................. $ 9,440 $ 43,934 $ 41,448
Short-term investments.................................... 1,036 8,711 11,474
Accounts receivable, net of allowance for doubtful
accounts of $478, $1,042 and $1,046 at March 31, 1995,
1996 and June 30, 1996, respectively:
Trade receivables......................................... 18,204 23,408 21,472
Trade receivables from related parties.................... 537 -- --
Prepaid expenses and other assets......................... 766 2,074 2,512
-------- -------- --------
Total current assets............................ 29,983 78,127 76,906
Property and equipment, at cost:
Computer, office and manufacturing equipment............ 25,467 22,779 24,078
Office furniture........................................ 2,725 2,109 2,115
Leasehold improvements.................................. 1,264 1,209 1,227
-------- -------- --------
29,456 26,097 27,420
Accumulated depreciation and amortization............... (23,339) (20,715) (21,533)
-------- -------- --------
Property and equipment, net.......................... 6,117 5,382 5,887
Other assets.............................................. 1,900 2,165 2,004
-------- -------- --------
Total assets.................................... $ 38,000 $ 85,674 $ 84,797
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable.......................................... $ 2,331 $ 2,983 $ 3,005
Accrued employee benefits................................. 5,619 8,476 5,769
Accrued royalties......................................... 1,665 799 517
Other accrued expenses.................................... 1,824 3,486 4,031
Accrued merger and restructuring expenses................. 449 575 490
Deferred revenue.......................................... 7,781 15,606 11,557
Current portion of long-term debt and lease obligations:
Related parties......................................... 2,163 -- --
Other................................................... 409 654 151
-------- -------- --------
Total current liabilities....................... 22,241 32,579 25,520
Accrued rent.............................................. 1,260 880 706
Long-term accrued merger and restructuring expenses....... 1,764 1,309 1,216
Long-term debt and lease obligations, less current
portion:
Related parties......................................... 488 -- --
Other................................................... 163 -- --
-------- -------- --------
Total liabilities............................... 25,916 34,768 27,442
Commitments and contingencies
Stockholders' equity:
Common Stock, $.01 par value, 75,000 shares authorized
(see Note 11), issued and outstanding 25,050, 33,623
and 34,442 shares as of March 31, 1995 and 1996 and
June 30, 1996, respectively.......................... 251 336 344
Additional paid-in capital................................ 71,147 113,771 116,302
Treasury stock............................................ (1,340) (1,340) (1,340)
Accumulated deficit....................................... (57,974) (61,995) (57,831)
Cumulative translation adjustment......................... -- 134 (120)
-------- -------- --------
Total stockholders' equity...................... 12,084 50,906 57,355
-------- -------- --------
Total liabilities and stockholders' equity...... $ 38,000 $ 85,674 $ 84,797
======== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE> 50
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL CUMULATIVE TOTAL
--------------- PAID-IN TREASURY ACCUMULATED TRANSLATION STOCKHOLDERS'
SHARES AMOUNTS CAPITAL STOCK DEFICIT ADJUSTMENT EQUITY
------ ------ ---------- -------- ----------- ---------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1993.......... 24,592 $246 $ 69,756 $ -- $ (42,957) $-- $ 27,045
Exercise of common stock options... 138 1 339 -- -- -- 340
Repurchase of stock................ (2) -- (2) -- -- -- (2)
Recovery of pooling shares......... (38) -- -- -- -- -- --
Purchase of treasury shares........ -- -- -- (1,394) -- -- (1,394)
Net loss........................... -- -- -- -- (13,982) -- (13,982)
Net transactions of old Rational
eliminated during period from
December 26, 1993 to March 31,
1994............................. 68 1 192 -- (5,713) -- (5,520)
------ --- ------- ------ ------- ---- --------
Balance at March 31, 1994.......... 24,764 248 70,285 (1,394) (62,652) -- 6,487
Exercise of common stock options... 220 2 636 -- -- -- 638
Issuance of common stock........... 66 1 226 -- -- -- 227
Issuance of treasury stock......... -- -- -- 54 -- -- 54
Net income......................... -- -- -- -- 4,678 -- 4,678
------ --- ------- ------ ------- ---- --------
Balance at March 31, 1995.......... 25,050 251 71,147 (1,340) (57,974) -- 12,084
Issuance of common stock, net of
expenses of $852................. 5,759 57 29,888 -- -- -- 29,945
Issuance of common stock for the
acquisition of Objectory AB...... 1,497 15 8,754 -- -- -- 8,769
Exercise of common stock options... 1,167 12 3,305 -- -- -- 3,317
Issuance of common stock under
Employee Stock Purchase Plan..... 150 1 448 -- -- -- 449
Compensation expense for stock
option grants.................... -- -- 229 -- -- -- 229
Cumulative translation
adjustment....................... -- -- -- -- -- 134 134
Net loss........................... -- -- -- -- (4,021) -- (4,021)
------ --- ------- ------ ------- ---- --------
Balance at March 31, 1996.......... 33,623 336 113,771 (1,340) (61,995) 134 50,906
Exercise of common stock options
(unaudited)...................... 450 4 1,295 -- -- -- 1,299
Issuance of common stock under
Employee Stock Purchase Plan
(unaudited)...................... 369 4 1,200 -- -- -- 1,204
Compensation expense for stock
option grants (unaudited)........ -- -- 36 -- -- -- 36
Cumulative translation adjustment
(unaudited)...................... -- -- -- -- -- (254) (254)
Net income (unaudited)............. -- -- -- -- 4,164 -- 4,164
------ --- ------- ------ ------- ---- --------
Balance at June 30, 1996
(unaudited)...................... 34,442 $344 $116,302 $ (1,340) $ (57,831) $ (120) $ 57,355
====== === ======= ====== ======= ==== ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE> 51
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL YEARS ENDED THREE MONTHS
MARCH 31, ENDED JUNE 30,
----------------------------- -----------------
1994 1995 1996 1995 1996
-------- ------- -------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)..................................... $(13,982) $ 4,678 $ (4,021) $ 1,266 $ 4,164
Adjustments to reconcile net income to net cash
provided by operating activities:
Charges for acquired in-process research and
development...................................... -- -- 8,700 -- --
Depreciation and amortization....................... 10,056 4,980 4,577 1,558 970
Compensation expense for stock option grants........ -- -- 229 -- 36
Deferred income taxes............................... 478 -- -- -- --
Loss from the disposal of discontinued operations... 175 -- -- -- --
Loss on disposal of property and equipment, net of
accumulated depreciation......................... 306 -- -- -- --
Other............................................... 40 -- -- -- --
Sale of discontinued operations..................... 778 -- -- -- --
(Increase) decrease in assets:
Accounts receivable................................. 4,427 (3,738) (2,830) (1,707) 1,936
Prepaid expenses and other assets................... 1,447 385 (520) (157) (429)
Net assets of discontinued operations............... (688) -- -- -- --
Increase (decrease) in liabilities:
Accounts payable.................................... (29) 915 (1,640) 647 22
Other accrued expenses.............................. 4,204 (2,135) 1,570 (2692) (2872)
Accrued merger and restructuring expenses........... 6,275 (4,062) (329) (296) (178)
Deferred revenue.................................... 1,323 678 7,825 (551) (4,049)
Net decrease in cash and cash equivalents of old
Rational for the period from December 26, 1993 to
March 31, 1994...................................... (4,722) -- -- -- --
-------- ------- -------- ------- -------
Total adjustments........................... 24,070 (2,977) 17,582 (3,198) (4,564)
-------- ------- -------- ------- -------
Net cash provided by (used in) operating
activities....................................... 10,088 1,701 13,561 (1,932) (400)
INVESTING ACTIVITIES:
Purchase of short-term investments.................... (6,891) (2,369) (11,124) (984) (7,639)
Maturities and sales of short-term investments........ 10,024 7,581 3,449 980 4876
Cash acquired from purchase of subsidiary............. -- -- 279 -- --
Additions to computer software costs.................. (1,931) (154) -- -- --
Purchase of property and equipment.................... (5,280) (3,222) (2,812) (710) (1,323)
-------- ------- -------- ------- -------
Net cash provided by (used in) investing
activities..................................... (4,078) 1,836 (10,208) (714) (4,086)
FINANCING ACTIVITIES:
Principal payments under long-term debt and capital
leases.............................................. (1,345) (2,455) (2,569) (630) (503)
Proceeds from the issuance of common stock............ 529 865 33,710 30,783 2,503
Repayment of notes payable............................ (1,687) -- -- -- --
Issuance (purchase) of treasury stock................. (1,394) 54 -- -- --
Other................................................. (238) -- -- -- --
-------- ------- -------- ------- -------
Net cash provided by (used in) financing activities... (4,135) (1,536) 31,141 30,153 2,000
-------- ------- -------- ------- -------
Net increase in cash and cash equivalents........ 1,875 2,001 34,494 27,507 (2,486)
Cash and cash equivalents at the beginning of the
year................................................ 5,564 7,439 9,440 9,440 43,934
-------- ------- -------- ------- -------
Cash and cash equivalents at the end of the year...... $ 7,439 $ 9,440 $ 43,934 $36,947 $41,448
======== ======= ======== ======= =======
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE> 52
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1996
(INFORMATION AT JUNE 30, 1996 AND FOR THE THREE MONTHS ENDED
JUNE 30, 1996 AND 1995 IS UNAUDITED)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization and basis of presentation. Rational Software Corporation (the
Company) was incorporated under the laws of Delaware on July 28, 1982. The
Company develops, markets and supports a comprehensive solution for developing
and managing software systems that improve software development and maintenance
productivity. The Company changed its name from Verdix Corporation on March 31,
1994.
In October 1995, the Company acquired Objectory AB of Stockholm. Sweden, a
provider of business and systems-engineering solutions based on object
technology. The transaction was recorded using the purchase method. In March
1994, the Company merged with Rational (old Rational), a provider of software
products, technical consulting, and support services for software developers.
The merger was accounted for as a pooling of interests, and accordingly, the
Company's consolidated financial statements have been restated, for all periods
prior to the merger, to include the results of operations, financial position,
and cash flows from old Rational.
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All intercompany transactions and
balances have been eliminated.
Interim financial information. The consolidated financial statements for
the three months ended June 30, 1995 and 1996 are unaudited but include all
adjustments (consisting of normal recurring entries) which the Company considers
necessary for fair presentation. Operating results for the three months ended
June 30, 1996 are not necessarily indicative of the results that may be expected
for any future periods.
Use of estimates. The preparation of the financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Revenue recognition. The Company recognizes revenue and related costs from
the sale of its software products and systems upon shipment. Revenue from
software royalties, whether they are advance payments that are nonrefundable or
minimum royalty guarantees payable over a fixed period, is recorded when the
earnings process is complete and collection is considered probable. Revenue from
consulting services is recognized when earned. Customer support revenue is
deferred and recognized on a straight-line basis over the period covered by the
customer-support agreement. Contract revenue, which generally is special or
custom engineering development under milestone payments, is recognized in
conformity with Accounting Research Bulletin No. 45, "Long-Term Construction
Type Contracts," using the relevant guidance in SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts."
Software capitalization. Computer software development costs are
capitalized after the economic and technological feasibility of a new product is
established. Capitalized costs are amortized on a product basis over the
estimated economic life of a general-release product, which generally does not
exceed three years. The annual amortization is the greater of the amount
computed using the straight-line method or the amount computed using the ratio
of current revenue to the total of current and anticipated future revenues.
Capitalized software-development costs are also written down periodically to net
realizable value based on an analysis of anticipated future revenues. Research
and
F-7
<PAGE> 53
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
development costs prior to the establishment of the economic and technological
feasibility of a product are expensed as incurred.
Capitalized software development costs are included in other assets in the
consolidated balance sheets. The unamortized balance of capitalized
software-development costs as of March 31, 1996 and 1995, is $0 and $329,000,
respectively. For the years ended March 31, 1996, 1995, and 1994, software
amortization was $329,000, $472,000, and $5,287,000, respectively. The 1994
amortization included $1,879,000 of previously capitalized software costs
related to duplicate product lines as a result of the merger.
Translation of foreign currencies. Accounts denominated in foreign
currencies have been translated in accordance with Statement of Financial
Accounting Standards No. 52. The functional currency for the Company's
international sales operations is the U.S. dollar, with the exception of the
Swedish subsidiary whose functional currency is the local currency. Gains and
losses resulting from the remeasurement of the sales operations' foreign
currency financial statements into U.S. dollars are included in other income.
Gains and losses resulting from foreign currency translation of the Swedish
subsidiary are accumulated as a separate component of stockholders' equity.
Other income. During the year ended March 31, 1996, other income consisted
primarily of interest earned on the Company's excess cash balances and
marketable securities and interest expense. It also included gains and losses on
foreign currency transactions. During the years ended March 31, 1995 and 1994,
other income consisted primarily of gains and losses on foreign currency
transactions, net of interest income.
Net income (loss) per share. Net loss per share is computed using the
weighted average number of common shares outstanding during the period. Net
income per share is computed using the weighted average number of common and
dilutive common equivalent shares outstanding during the period. Common stock
equivalents consist of stock options using the treasury stock method.
Cash, cash equivalents and short-term investments. Cash equivalents are
highly liquid investments with original maturity dates of three months or less
at the date of acquisition. Investments with maturity dates between three and
twelve months are considered to be short-term investments.
All of the Company's cash equivalents and short term investments are
classified as available-for-sale under the provisions of Statement of Financial
Accounting Standards No. 115 (FAS 115), "Accounting for Certain Investments in
Debt and Equity Securities." Amortized cost approximates estimated fair value
based on quoted market prices at March 31, 1995 and 1996, and June 30, 1996.
Under FAS 115, management classifies investments as trading,
available-for-sale, or held-to-maturity at the time of purchase and periodically
reevaluates such designation. Debt securities are classified as held-to-maturity
when the Company has the positive intent and ability to hold the securities to
maturity. Held-to-maturity securities are stated at amortized cost with
corresponding premiums or discounts amortized over the life of the investment to
interest income. Debt securities not classified as held-to-maturity are
classified as available-for-sale and reported at fair market value. Unrecognized
gains or losses on available-for-sale securities are included in equity, net of
tax, until their disposition. Realized gains and losses and declines in value
judged to be other than temporary on available-for-sale securities are included
in interest income. The cost of securities sold is based on the specific
identification method.
F-8
<PAGE> 54
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Available-for-sale securities and cash consist of the following (in
thousands):
<TABLE>
<CAPTION>
MARCH 31,
---------------- JUNE 30,
1995 1996 1996
------ ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Cash and cash equivalents:
Money market funds..................................... $5,019 $35,470 $39,014
Cash................................................... 4,421 4,994 2,434
Commercial paper....................................... -- 3,470 --
------ ------- -------
Total............................................... $9,440 $43,934 $41,448
====== ======= =======
Short-term investments:
U.S. government........................................ $ -- $ 4,745 4,745
Commercial paper....................................... -- 3,908 6,671
Municipal obligations.................................. 980 -- --
Certificates of deposit................................ 56 58 58
------ ------- -------
Total............................................... $1,036 $ 8,711 $11,474
====== ======= =======
</TABLE>
Realized gains or losses on sales of available-for-sale securities were
immaterial for the years ended March 31, 1995 and 1996. There were no unrealized
holding gains or losses on such securities at March 31, 1995 and 1996, and June
30, 1996.
Statements of cash flows. The Company paid, net of amounts capitalized,
interest of $172,000, $97,000, $103,000, $13,000 and $4,000 during fiscal years
1994, 1995 and 1996, and the three months ended June 30, 1995 and 1996,
respectively. The Company paid income taxes of $1,152,000, $199,000, $355,000,
$11,000 and $26,000 during fiscal years 1994, 1995 and 1996, and the three
months ended June 30, 1995 and 1996, respectively. The Company also had capital
lease additions of $715,000, and $119,000 during fiscal years 1994 and 1995,
respectively. In addition, the Company received income tax refunds of $523,000
and $123,000 in fiscal year 1995 and 1996, respectively. In fiscal 1996, the
Company issued $8,770,000 of Common Stock for the purchase of Objectory AB.
Fair value of financial instruments. The carrying amounts reported in the
balance sheet for cash and cash equivalents and short-term investments
approximate fair value. The fair value of short-term investments is based on
quoted market prices.
The carrying amount of the Company's long-term debt approximates fair
value. The fair value of the Company's long-term debt is estimated using
discounted cash-flow analyses, based on the Company's current incremental
borrowing rate for similar types of borrowing arrangements.
Concentrations of credit risk. Financial instruments that potentially
subject the Company to concentrations of credit risk consist primarily of cash
equivalents and accounts receivable. The Company's investment policy limits its
exposure to concentrations of credit risk for cash equivalents. The Company
sells its products primarily to major corporations, including systems
integrators, that serve a wide variety of U.S. and foreign markets. Collateral
or deposits generally are not required from customers who demonstrate a positive
credit record and sound financial condition. The concentrations of credit risk
are considered limited for trade receivables.
Property and equipment. The Company's property and equipment are recorded
at cost, which is generally depreciated over a three- to five-year period using
the straight-line method. The cost of furniture and equipment under capital
leases is recorded at the lower of the present value of the minimum lease
payments or the fair value of the asset and is amortized over the shorter of the
term of
F-9
<PAGE> 55
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the related lease or the estimated useful life of the asset. Leasehold
improvements are depreciated over the remaining life of the lease.
Advertising costs. The Company expenses advertising costs as incurred.
Advertising costs totaled $889,000, $1,372,000 and $1,012,000 for the years
ended March 31, 1994, 1995 and 1996, respectively.
Reclassifications. Certain prior year amounts have been reclassified to
conform with current year presentation.
Recent pronouncements. In October 1995, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 123 (FAS 123),
"Accounting for Stock-Based Compensation," which established a fair-value-based
method of accounting for stock-based compensation plans and requires additional
disclosures for those companies who elect not to adopt the new method of
accounting. The Company will be required to adopt FAS 123 in fiscal 1997. The
Company's intention is to continue to account for employee stock awards in
accordance with APB Opinion No. 25 and to adopt the disclosure only alternative
described in FAS 123.
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121 (FAS 121), "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which
requires the Company to review for impairment of long-lived assets certain
identifiable intangibles and goodwill related to those assets whenever events or
changes in circumstances indicate that the carrying amount of an asset might not
be recoverable. In certain situations, an impairment loss would be recognized.
FAS 121 will become effective for the Company's year ending March 31, 1997. The
Company has studied the implications of FAS 121 and, based on its initial
evaluation, does not expect its adoption to have a material impact on the
Company's financial condition or results of operations.
Common Stock. On August 27, 1996, the Company's Board of Directors and
Stockholders approved a two-for-one stock split payable in the form of a stock
dividend to stockholders of record as of September 10, 1996. All shares and per
share information have been adjusted to reflect this change.
2. RISKS DUE TO CONCENTRATIONS.
International 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 the
Company's revenues in future periods. Any material adverse effect on the
Company's international business would have a material adverse effect on the
Company's financial statements. Also, the Company's international sales are
generally denominated in foreign currencies. Losses on the conversion of
foreign-denominated receivables into U.S. dollars may have a material adverse
effect on the Company's financial statements.
3. MERGERS AND ACQUISITIONS.
Objectory. During October, 1995 the Company signed a definitive agreement
to purchase all the outstanding stock of Objectory AB, a Swedish
software-development company, in exchange for 1,496,718 shares of common stock.
The acquisition was accounted for using the purchase method, and, accordingly,
the operating results of Objectory AB are included in the consolidated results
of the Company from the date of acquisition. The consolidated balance sheets
include the assets and liabilities of Objectory AB at March 31, 1996.
F-10
<PAGE> 56
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The total purchase price was allocated as follows (in thousands):
<TABLE>
<S> <C>
Property and equipment..................................................... $ 188
Intangible assets.......................................................... 1,216
Severance and facility closure accruals.................................... (312)
Net liabilities assumed.................................................... (1,022)
In-process research and development........................................ 8,700
-------
$ 8,770
=======
</TABLE>
Intangible assets include assembled workforce and customer base. The
estimated average useful life of these assets is three years. Accumulated
amortization of intangible assets totaled $281,000 at March 31, 1996. In-process
research and development represents the present value of the estimated cash flow
expected to be generated by the Objectory AB related technology, which at the
acquisition date had not yet reached the point of technological feasibility and
does not have an alternative future use. Therefore, in accordance with generally
accepted accounting principles, the in-process research and development was
written off and charged to operations during the quarter ended December 31,
1995.
The following pro forma combined results of operations for the year ended
March 31, 1996 are presented as if the acquisition had occurred at the beginning
of the period. The charges associated with in-process research and development
have not been reflected in the following pro forma summary as they are
nonrecurring.
<TABLE>
<CAPTION>
MARCH 31,
-------------------
1995 1996
------- -------
(UNAUDITED, IN
THOUSANDS EXCEPT
PER SHARE DATA)
<S> <C> <C>
Net revenues..................................................... $80,112 $95,763
Net income....................................................... $ 3,011 $ 3,401
Net loss per share............................................... $ (.10) $ (.12)
</TABLE>
The pro forma results of operations are not necessarily indicative of the
actual results of operations that would have been obtained had the acquisition
occurred at the beginning of the years presented, nor are they intended to be a
projection of future results.
Old Rational. On March 31, 1994, the Company merged with old Rational and
acquired all of the common stock of old Rational in exchange for 14,349,572
shares of the Company's common stock. Old Rational developed, marketed and
provided software products, technical consulting, and support services for
software developers. The merger was accounted for as a pooling-of-interests,
and, accordingly, the Company's Consolidated Financial Statements and Notes to
Consolidated Financial Statements have been restated to include the results of
old Rational for all periods presented.
Separate results of operations for the periods prior to the merger are as
follows:
<TABLE>
<CAPTION>
MERGER-RELATED
THE COMPANY OLD RATIONAL EXPENSES COMBINED
----------- ------------ -------------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Year ended March 31, 1994
(Old Rational as of December
25, 1993)
Net revenue.................... $20,963 $ 49,380 $ -- $70,343
Net income (loss).............. $(4,780) $ 720 $ (9,922) $(13,982)
</TABLE>
F-11
<PAGE> 57
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Consolidated Financial Statements for all prior periods include results
of the Company's operations and balance sheets data on a March 31 fiscal year
basis and old Rational's results on a December 25, 1993 basis. Old Rational's
separate results for fiscal 1993 have not been restated to conform to the twelve
months ended March 31, 1994. Old Rational's separate results of operations for
the three months ended March 31, 1994, are not reflected in the Consolidated
Statements of Operations. Unaudited revenue and net loss of old Rational for the
three months ended March 31, 1994 were $7,799,000 and ($5,713,000),
respectively.
4. DISCONTINUED OPERATIONS.
On March 26, 1993, the Board of Directors approved the disposition of the
operations of the secure-products business. This business was sold in January
1994 for $778,000 cash and a note for $215,000, which has been paid in full. The
total loss from the disposal of the secure-products business was $662,000, of
which $175,000 was recognized in fiscal 1994, with the balance accrued for in
prior years. There were no revenues from discontinued operations during fiscal
1994.
5. RESTRUCTURING OF OPERATIONS.
As part of the business combination with old Rational the Company incurred
substantial merger and restructuring costs. Included in the accompanying
Consolidated Statement of Operations for the year ended March 31, 1994, are
merger-related expenses totaling $9,922,000 consisting primarily of charges of
$3,321,000 incurred as a result of the closing of duplicate facilities,
severance costs of $2,589,000, merger-related administrative costs of
$2,254,000, and write-downs of $1,758,000 of capitalized software costs and
other costs related to duplicate product lines. During the year ended March 31,
1995, the Company reversed $1,100,000 of the duplicate facilities charge as a
result of greater-than-anticipated recoveries through subleasing. The accrual at
March 31, 1996 represents remaining facilities lease obligations, net of
anticipated sublease proceeds.
6. LONG-TERM DEBT AND CAPITAL OBLIGATIONS.
In November 1989, the Company entered into a product development and loan
agreement with International Business Machines Corporation (IBM) whereby the
Company received interest-free loans of $8,700,000 to develop certain
proprietary software products in which the Company retains full ownership
rights. In exchange, the Company granted IBM distribution and marketing rights
to the products under development, the right to evaluate all of the Company's
technology for a period of five years, and an agreement to refrain from
undertaking any other development that would impair its ability to perform under
the agreement. The Company also provides consulting to IBM in certain technology
areas. The Company has repaid a total of $8,212,000 through March 31, 1996.
The Company leases certain equipment and furniture under capitalized lease
obligations. The related obligations under capital leases represent the present
value of future minimum lease payments. Assets capitalized under leases totaled
$3,942,000 at March 31, 1995 and 1996. Accumulated amortiza-
F-12
<PAGE> 58
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
tion of these leased assets was $3,433,000 and $3,848,000 at March 31, 1995 and
1996, respectively. Long-term debt and capitalized lease obligations consist of
the following at March 31:
<TABLE>
<CAPTION>
1995 1996
------- -----
(IN THOUSANDS)
<S> <C> <C>
Long-term debt to IBM............................................. $ 2,438 $ 488
Present value of capitalized lease obligation to related
parties......................................................... 81 --
Lease obligation to others........................................ 572 166
Note payable to former shareholders............................... 132 --
------- -----
3,223 654
Less current portion of capitalized lease obligations and debt.... (2,572) (654)
------- -----
Due after one year................................................ $ 651 $--
======= =====
</TABLE>
The overall weighted average of the interest rates on capital leases
approximated 8.2% at March 31, 1996. Future minimum payments at March 31, 1996
are as follows:
<TABLE>
<CAPTION>
LONG-TERM LEASE
DEBT OBLIGATIONS
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
1997........................................................... $ 488 $ 172
---- ----
Total minimum payments......................................... 488 172
Amount representing interest................................... -- (4)
---- ----
$ 488 $ 168
==== ====
</TABLE>
7. COMMITMENTS AND CONTINGENCIES.
Commitments. The Company leases its office space at all locations under
operating leases. Rental expense for facilities was approximately $3,129,000,
$1,970,000, $2,520,000, $553,000 and $674,000 in the years ended March 31, 1994,
1995, 1996, and for the three months ended June 30, 1995 and 1996, respectively.
Future minimum rental payments, net of sublease income, at March 31, 1996 are as
follows (in thousands):
<TABLE>
<S> <C>
1997............................................................... $ 3,225
1998............................................................... 3,148
1999............................................................... 3,036
2000............................................................... 2,386
2001............................................................... 1,466
-------
$13,261
=======
</TABLE>
As a result of the merger with old Rational on March 31, 1994, the Company
relocated its corporate headquarters into the facility occupied by old
Rational's corporate headquarters. At March 31, 1996, the Company has accrued
$2,611,000 of estimated costs of future rent associated with the excess office
space in both the Herndon and Santa Clara facilities as part of the
merger-related expenses. Total future rents from sublease agreements are
$919,000, $484,000, $345,000 and $115,000 in fiscal 1997, 1998, 1999 and 2000,
respectively.
Legal actions. 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. The
trial date has been set
F-13
<PAGE> 59
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
8. INCOME TAXES.
Pretax income (loss) from continuing operations is as follows at March 31:
<TABLE>
<CAPTION>
1994 1995 1996
-------- ------ -------
(IN THOUSANDS)
<S> <C> <C> <C>
Domestic.............................................. $(13,881) $4,826 $(4,433)
Foreign............................................... 478 258 1,440
-------- ------ -------
Total....................................... $(13,403) $5,084 $(2,993)
======== ====== =======
</TABLE>
The Company received approximately $220,000, $200,000 and $1,600,000 of
revenue from foreign sources in 1996, 1995 and 1994, respectively, that was
subject to foreign royalty withholding tax.
The provision for income taxes consists of the following at March 31:
<TABLE>
<CAPTION>
1994 1995 1996
----- ---- ------
(IN THOUSANDS)
<S> <C> <C> <C>
Current
Federal.................................................. $(276) $100 $ 28
State.................................................... (84) 70 52
Foreign.................................................. 286 236 948
-----
--
------- -------
(74) 406 1,028
Deferred
Federal.................................................. 478 -- --
State.................................................... -- -- --
-----
--
------- -------
478 -- --
-----
--
------- -------
Total................................................. $ 404 $406 $1,028
======= ======= =======
</TABLE>
The provision for income taxes differs from the amount of income tax
determined by applying the applicable U.S. statutory federal income tax rate as
a result of the following differences at March 31:
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Income tax (benefit) at the federal statutory rate.... $(4,691) $ 1,780 $(1,048)
Net operating loss carryforwards not utilized
(utilized).......................................... 4,253 (1,568) (1,465)
Nondeductible charges for acquired in-process research
and development..................................... -- -- 3,045
State income taxes (benefit).......................... (55) 46 52
Foreign taxes......................................... 152 148 444
Merger related costs.................................. 745 -- --
------- ------- -------
Total............................................ $ 404 $ 406 $ 1,028
======= ======= =======
</TABLE>
F-14
<PAGE> 60
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Company's deferred tax assets are as follows
at March 31:
<TABLE>
<CAPTION>
1995 1996
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets
Net operating loss carryforwards............................. $ 13,045 $ 16,700
Tax credit carryforwards..................................... 2,778 3,131
Inventory valuation accounts................................. 1,108 --
Lease reserve................................................ 1,340 1,379
Compensation accruals........................................ 974 1,120
Depreciation................................................. 1,201 1,323
Other........................................................ 1,274 1,303
-------- --------
Total deferred tax assets.................................... 21,720 24,956
Valuation allowance for deferred tax assets.................. (21,595) (24,956)
-------- --------
Deferred tax assets............................................ 125 --
Deferred tax liabilities.......................................
Computer software............................................ 125 --
-------- --------
Total deferred tax liabilities............................... 125 --
-------- --------
Net deferred tax assets........................................ $ -- $ --
======== ========
</TABLE>
The valuation allowance increased by $3,361,000 and $7,031,000 in 1996 and
1994, respectively, and decreased by $1,685,000 in 1995. Approximately
$4,200,000 of the valuation allowance is attributable to stock options, the
benefit of which will be credited to additional paid-in capital when realized.
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. In addition, the Company had approximately $3,100,000 of tax
credit carryforwards expiring in 1997 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 net operating loss carryforwards and
all of the tax credit carryforwards will be subject to an annual limitation
regarding their utilization against taxable income in future years. Such losses
and credits will be available to offset the income tax liability attributable to
annual taxable income of approximately $8,700,000. In addition, as a result of
the 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.
9. STOCKHOLDERS' EQUITY.
Common stock. On May 22, 1995 the Company's Board of Directors and
stockholders approved a one-for-three reverse stock split. All share and per
share information have been adjusted to reflect this change. Approval was also
given to increase the number of post-reverse-split shares of authorized common
stock from 20,000,000 to 25,000,000 shares.
During June 1995, the Company sold 5,758,000 shares of common stock in a
public offering. Net proceeds from the sale were $29,945,000 after deducting
underwriting discounts, commissions, and other related expenses.
Stock options. The Company provides equity incentives to employees and
directors by means of incentive stock options and nonstatutory options under its
two 1983 Incentive Stock Option Plans, 1986 Stock Option Plan, Non-Employee
Director Stock Option Plan, 1993 Stock Option Plan, and 1994 Stock Option Plan.
Stock options generally vest over a period of four years. Under these plans, the
Company
F-15
<PAGE> 61
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
may grant either nonstatutory or incentive stock options and the option price
per share cannot be less than 85% of fair market value in the case of
nonstatutory stock options, or 100% of fair market value in the case of
incentive stock options, determined on the date the option is granted. Under
these plans, the Company has reserved 5,186,950 shares for issuance at March 31,
1996. Options expire at various dates ranging from 5 to 10 years from the date
of grant.
On July 25, 1995, an amendment was approved during the annual meeting by
the Company's stockholders that established a new formula for determining the
size of director grants and that lengthened the vesting period of director
grants. The compensation expense recognized during fiscal 1996 as a result of
this change was $229,000.
At June 30, 1996, 1,485,289 options were exercisable at an aggregate
exercise price of $4,455,363. Activity under all plans is summarized as follows:
<TABLE>
<CAPTION>
SHARES UNDER OUTSTANDING
OPTIONS
SHARES AVAILABLE ------------------------------
FOR GRANT OPTIONS PRICE PER SHARE
---------------- ---------- ---------------
<S> <C> <C> <C>
Balance at March 31, 1993............... 1,466,792 2,429,398 $2.07 - $ 6.66
Additional shares authorized............ 3,333,332 -- --
Expiration of plan...................... (869,398) -- --
Granted............................... (1,419,942) 1,419,942 3.95 - 5.34
Exercised............................. -- (138,970) 2.07 - 4.46
Canceled.............................. 632,276 (632,276) 2.07 - 6.66
Net transactions of old Rational during
the period from December 26, 1993 to
March 31, 1994 (see Note 3)........... (325,454) (189,398) 2.82 - 3.29
---------- ---------- ------------
Balance at March 31, 1994............... 2,817,606 2,888,696 2.07 - 6.57
Granted............................... (2,416,126) 2,416,126 2.45 - 5.25
Exercised............................. -- (220,170) 2.16 - 4.46
Canceled.............................. 333,492 (333,492) 2.25 - 6.47
Expired............................... (448,620) -- --
---------- ---------- ------------
Balance at March 31, 1995............... 286,352 4,751,160 2.07 - 6.57
Additional shares authorized............ 1,333,332 -- --
Granted............................... (1,245,568) 1,245,568 2.54 - 18.47
Exercised............................. -- (1,167,034) 2.07 - 6.57
Canceled.............................. 156,122 (156,122) 2.54 - 11.19
Expired............................... (16,860) -- --
---------- ---------- ------------
Balance at March 31, 1996............... 513,358 4,673,572 2.07 - 18.47
Granted (unaudited)................... (93,780) 93,780 19.75 - 31.06
Exercised (unaudited)................. -- (449,374) 2.07 - 6.47
Canceled (unaudited).................. 25,143 (25,143) 2.54 - 18.47
Expired (unaudited)................... (6,059) (29,161) --
---------- ---------- ------------
Balance at June 30, 1996 (unaudited).... 438,682 4,263,674 2.07 - 31.06
========== ========== ============
</TABLE>
Employee stock purchase plan. The Company has an employee stock purchase
plan under which substantially all employees may purchase common stock through
payroll deductions at a price equal to 85% of the lower of the fair market
values as of the beginning or end of the offering period. Stock purchases under
the plan are limited to the lesser of 10% of an employee's compensation, $25,000
per year. At June 30, 1996, 519,000 shares had been issued under the Plan and
shares totaling 181,000 reserved for issuance .
F-16
<PAGE> 62
RATIONAL SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. MAJOR CUSTOMERS, RELATED PARTIES, AND INTERNATIONAL SALES.
IBM divested its shares of the Company's outstanding stock during the
secondary offering in the first quarter of fiscal 1996. IBM owned approximately
13% of the Company's outstanding stock at the end of 1994 and 1995 and accounted
for 11% and 3% of the Company's revenue in 1994 and 1995, respectively. Sales to
Lockheed Martin Corporation, which had a member on the Board through September
1995, accounted for 1%, 2%, and 4% of the Company's revenue in 1994, 1995, and
1996, respectively.
Two customers accounted for 12% and 16% of the Company's revenue in the
three months ended June 30, 1996.
The Company also derives revenue from the sale of its products to customers
in international geographic areas, including Western Europe, Asia/Pacific
region, and Canada. Total revenue from international sales and related
consulting and customer support was $21,493,000, $24,839,000, $33,242,000,
$6,827,000 and $7,839,000 for the years ended March 31, 1994, 1995 and 1996 and
for the three months ended June 30, 1995 and 1996, respectively.
Sales into Western Europe accounted for $10,141,000, $12,153,000,
$23,396,000, $4,316,000 and $5,675,000 of total international revenue for the
years ended March 31, 1994, 1995, 1996 and for the three months ended June 30,
1995 and 1996, respectively, with sales into Canada accounting for an additional
$7,282,000, $7,012,000, $4,674,000, $1,010,000 and $200,000 for the years ended
March 31, 1994, 1995, 1996 and the three months ended June 30, 1995 and 1996,
respectively.
11. EVENTS SUBSEQUENT TO REPORT OF INDEPENDENT AUDITORS.
On August 27, 1996, the Company's Board of Directors and Stockholders
approved a two-for-one stock split payable in the form of a stock dividend to
stockholders of record as of September 10, 1996. All shares and per share
information have been adjusted to reflect this change. Approval was also given
to increase the number of shares of authorized common stock from 25,000,000 to
75,000,000.
In September 1996, the Board of Directors authorized management of the
Company to file a registration statement with the Securities and Exchange
Commission for the registration of up to 5,872,725 shares of its common stock.
F-17
<PAGE> 63
- ------------------------------------------------------
- ------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION WOULD BE UNLAWFUL OR TO ANY PERSON TO WHOM IT IS UNLAWFUL. NEITHER
THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF
ANY TIME SUBSEQUENT TO THE DATE HEREOF.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information................. 2
Incorporation of Certain Documents by
Reference........................... 2
Prospectus Summary.................... 3
Risk Factors.......................... 6
Use of Proceeds....................... 12
Price Range of Common Stock and
Dividend Policy..................... 12
Capitalization........................ 13
Selected Consolidated Financial
Data................................ 14
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 15
Business.............................. 23
Management............................ 37
Principal and Selling Stockholders.... 40
Description of Capital Stock.......... 42
Underwriting.......................... 43
Legal Matters......................... 44
Experts............................... 45
Index to Consolidated Financial
Statements.......................... F-1
</TABLE>
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
5,106,718 SHARES
LOGO
COMMON STOCK
-----------------------
PROSPECTUS
-----------------------
HAMBRECHT & QUIST
GOLDMAN, SACHS & CO.
WESSELS, ARNOLD & HENDERSON
, 1996
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 64
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the various expenses incurred or to be
incurred in connection with the sale and distribution of the securities being
registered, other than underwriting discounts and commissions. All of the
amounts shown are estimates except the Securities and Exchange Commission
registration and NASD filing fees.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee....................... $ 55,720
NASD filing fee........................................................... 30,500
Nasdaq listing fee........................................................ 17,500
Legal fees and expenses................................................... 150,000
Accounting fees and expenses.............................................. 80,000
Printing and engraving.................................................... 100,000
Blue Sky fees and expenses (including counsel fees)....................... 10,000
Transfer agent, registrar, and custodian fees and expenses................ 15,000
Insurance Premium......................................................... 150,000
Miscellaneous expenses.................................................... 66,280
--------
Total........................................................... $675,000
========
</TABLE>
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's Board of Directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit such indemnification under
certain circumstances for liabilities (including reimbursement for expenses
incurred) arising under the Securities Act of 1933, as amended (the "Act").
Paragraph 7 of the Company's Amended Certificate of Incorporation (Exhibits
4.01-4.04 hereto) and Article VI of the Company's Bylaws (Exhibit 4.05 hereto)
provide for indemnification of the Company's directors and officers to the
maximum extent permitted by the Delaware General Corporation Law. Reference is
also made to Section 7 of the Underwriting Agreement (Exhibit 1.01 hereto)
indemnifying officers and directors of the Company against certain liabilities.
ITEM 16. EXHIBITS
The following exhibits are filed herewith or incorporated by reference
herein:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ ------------------------------------------------------------------------------------
<C> <S>
1.01 Form of Underwriting Agreement.
2.01 Reorganization Agreement among Verdix Corporation, Rational Acquisition Corporation,
and Rational, dated December 15, 1993, is incorporated herein by reference to
Appendix A filed with the Company's Registration Statement on Form S-4, dated
February 25, 1994 (Registration No. 33-75724).
2.02 Share Purchase Agreement between Telefonaktiebolaget LM Ericsson (publ.) and
Rational Software Corporation, dated September 26, 1995, is incorporated herein by
reference to Exhibit 2 filed with the Company's Form 8-K Current Report dated
October 9, 1995 (File No. 0-12167) ("October 1995 8-K").
2.03 Share Option Agreement between Usecase Engineering S.A. and Rational Software
Corporation, dated October 9, 1995, is incorporated herein by reference to Exhibit 3
filed with the Company's October 1995 8-K.
</TABLE>
II-1
<PAGE> 65
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ ------------------------------------------------------------------------------------
<C> <S>
4.01 Restatement of the Certificate of Incorporation of the Company, dated August 30,
1996.
4.02 Bylaws of the Company as most recently amended are incorporated herein by reference
to Exhibit 3.9 filed with the 1996 10-K.
4.03 Specimen of Common Stock Certificate is incorporated herein by reference to Exhibit
4.06 filed with the Company's Amendment No. 1 to Form S-3 Registration Statement on
May 31, 1995 (File No. 33-91740).
4.04 Rational 1983 Incentive Stock Option Plan, as amended, dated March 24, 1992, is
incorporated herein by reference to Exhibit 4.7 filed with the Company's Form S-8
Registration Statement on April 6, 1994 (Registration No. 33-77382).
4.05 Form of Stock Option Agreements for the Rational 1983 Incentive Stock Option Plan is
incorporated herein by reference to Exhibit 4.8 filed with the Company's Form S-8
Registration Statement on April 6, 1994 (Registration No. 33-77382).
4.06 1983 Incentive Stock Option Plan, as amended, is incorporated herein by reference to
Exhibit 4.3 filed with Verdix's Form 10-K Annual Report for the fiscal year ended
March 31, 1989 (File No. 0-12167).
4.07 Form of Incentive Stock Option Agreement for the 1983 Incentive Stock Option Plan,
as amended, is incorporated herein by reference to Exhibit 4.4 filed with Verdix's
Form 10-K Annual Report for the fiscal year ended March 31, 1989 (File No. 0-12167).
4.08 1986 Stock Option Plan, as amended, is incorporated herein by reference to Exhibit
4.6 filed with Verdix's Registration Statement on Form S-8 (Registration No.
33-20029).
4.09 Form of Stock Option Agreement for the 1986 Stock Option Plan, as amended November
15, 1991, is incorporated herein by reference to Exhibit 4.13 filed with Verdix's
Post Effective Amendment No. 1 to the Registration Statement on Form S-3
(Registration No. 33-12469).
4.10 Rational Software Corporation Stock Option Plan for Directors is incorporated herein
by reference to Exhibit 1 filed with the Company's Form 8-K Current Report dated
October 2, 1996.
4.11 Form of Stock Option Agreements for the Rational Software Corporation Stock Option
Plan for Directors is incorporated herein by reference to Exhibit 4.6 filed with the
Company's Form S-8 Registration Statement on September 18, 1995 (Registration No.
33-97042).
4.12 Rational 1993 Incentive Stock Option Plan is incorporated herein by reference to
Exhibit 4.9 filed with the Company's Form S-8 Registration Statement on April 6,
1994 (Registration No. 33-77382).
4.13 Form of Stock Option Agreements for the Rational 1993 Stock Option Plan is
incorporated herein by reference to Exhibit 4.10 filed with the Company's Form S-8
Registration Statement on April 6, 1994 (Registration No. 33-77382).
4.14 Rational Software Corporation 1994 Stock Option Plan is incorporated herein by
reference to Exhibit 3 filed with the Company's Form 8-K Current Report dated
October 2, 1996.
4.15 Form of Stock Option Agreements for the Rational Software Corporation 1994 Stock
Option Plan is incorporated herein by reference to Exhibit 4.6 filed with the
Company's Form S-8 Registration Statement on September 18, 1995 (Registration No.
33-97044).
4.16 Rational Software Corporation 1994 Employee Stock Purchase Plan is incorporated
herein by reference to Exhibit 2 filed with the Company's Form 8-K Current Report
dated October 2, 1996.
</TABLE>
II-2
<PAGE> 66
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ ------------------------------------------------------------------------------------
<C> <S>
4.17 Rational Software Corporation 1994 Employee Stock Purchase Plan Subscription
Agreement is incorporated herein by reference to Exhibit 4.8 filed with the
Company's Form S-8 Registration Statement on October 31, 1994 (Registration No.
33-85906) and amended September 18, 1995.
4.18 Agreement among the Company, Rational, and International Business Machines
Corporation ("IBM"), dated December 15, 1993, is incorporated by reference to
Exhibit 4.17 filed with the Company's Registration Statement on Form S-4, dated
February 25, 1994 (Registration No. 33-75724).
4.19 Preferred Stock Purchase Agreement between Rational and IBM, dated as of November
29, 1989, is incorporated by reference to Exhibit 4.18 filed with the Company's
Registration Statement on Form S-4, dated February 25, 1994 (Registration No.
33-75724).
4.20 Agreement among the Company, Rational, Martin Marietta Investments, Inc., and Martin
Marietta Technologies, Inc., dated December 15, 1993, is incorporated herein by
reference to Exhibit 10.33 filed with the Company's Registration Statement on Form
S-4, dated February 25, 1994 (Registration No. 33-75724).
4.21 Stock Purchase Agreement between the Company and Martin Marietta Corporation, dated
March 8, 1985, is incorporated herein by reference to Exhibit 4.1 filed with the
Company's Form 8-K Current Report dated March 8, 1985 (File No. 0-12167).
4.22 Letter Agreement among the Company, Martin Marietta Corporation, and Martin Marietta
Investments, Inc., dated June 2, 1987, is incorporated herein by reference to
Exhibit 4.1 filed with the Company's Form 8-K Current Report dated June 2, 1987
(File No. 0-12167).
5.01 Opinion of Wilson Sonsini Goodrich & Rosati, P.C., regarding the legality of
securities being registered.
10.01 *Agreement for Purchase and Sale of Assets between the Company and Microsoft
Corporation, dated October 2, 1996, is incorporated herein by reference to Exhibit 1
filed with the Company's Form 8-K Current Report dated October 2, 1996.
10.02 *Development and License Agreement between the Company and Microsoft Corporation,
dated September 24, 1996, is incorporated herein by reference to Exhibit 2 filed
with the Company's Form 8-K Current Report dated October 2, 1996.
23.01 Consent of Ernst & Young LLP.
23.02 Consent of Wilson Sonsini Goodrich & Rosati, P.C. (see Exhibit 5.01 above).
24.01 Power of Attorney is contained on the signature pages of this Registration
Statement.
</TABLE>
- ------------------------------
* Confidential treatment has been requested with respect to portions of the
referenced exhibit.
II-3
<PAGE> 67
ITEM 17. UNDERTAKINGS
(a) The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to section 13(a) or section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
(b) The Registrant hereby undertakes:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of a registration statement in reliance upon Rule 430A and contained in the
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of the
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
(c) The undersigned Registrant hereby undertakes to provide to the
Underwriters at the closing specified in the Underwriting Agreement certificates
in such denominations and registered in such names as required by the
Underwriters to permit prompt delivery to each purchaser.
(d) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the Registrant's Certificate of Incorporation,
Bylaws, indemnification agreements or otherwise, the Registrant has been advised
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by Registrant of expenses incurred or
paid by a director, officer or controlling person of Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, Registrant will, unless in the opinion of its counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
(e) The undersigned registrant hereby undertakes to deliver or cause to be
delivered with the prospectus, to each person to whom the prospectus is sent or
given, the latest annual report to security holders that is incorporated by
reference in the prospectus and furnished pursuant to and meeting the
requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of
1934; and, where interim financial information required to be presented by
Article 3 of Regulation S-X are not set forth in the prospectus, to deliver, or
cause to be delivered to each person to whom the prospectus is sent or given,
the latest quarterly report that is specifically incorporated by reference in
the prospectus to provide such interim financial information.
II-4
<PAGE> 68
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Santa Clara, State of California.
RATIONAL SOFTWARE CORPORATION
<TABLE>
<S> <C>
Date: October 2, 1996 By: /s/ ROBERT T.
BOND-------------------------------------------
Robert T. Bond
Chief Financial Officer and
Senior Vice President
</TABLE>
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Paul D. Levy and Robert T. Bond, jointly
and severally, his true and lawful attorneys-in-fact and agents, each with the
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any amendments (including
post-effective amendments) to this Registration Statement on Form S-3, and to
file the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents, or any of them, or their or his substitutes, may do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this Amendment
to the Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------------- ------------------------------ ----------------
<C> <S> <C>
/s/ PAUL D. Chairman of the Board and October 2, 1996
LEVY Chief Executive Officer
- --------------------------------------------- (Principal Executive
Paul D. Levy Officer)
/s/ MICHAEL T. DEVLIN President and Director October 2, 1996
- ---------------------------------------------
Michael T. Devlin
/s/ ROBERT T. Senior Vice President, October 2, 1996
BOND Chief Operating Officer,
- --------------------------------------------- Chief Financial Officer,
Robert T. Bond and Secretary (Principal
Financial Officer)
/s/ TIMOTHY A. BRENNAN Vice President, October 2, 1996
- --------------------------------------------- Finance and Administration
Timothy A. Brennan (Principal Accounting
Officer)
</TABLE>
II-5
<PAGE> 69
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------------- ------------------------------ ----------------
<C> <S> <C>
/s/ JAMES S. Director October 2, 1996
CAMPBELL
- ---------------------------------------------
James S. Campbell
/s/ DANIEL H. CASE Director October 2, 1996
III
- ---------------------------------------------
Daniel H. Case III
/s/ LESLIE G. Director October 2, 1996
DENEND
- ---------------------------------------------
Leslie G. Denend
/s/ JOHN E. Director October 2, 1996
MONTAGUE
- ---------------------------------------------
John E. Montague
/s/ ALLISON R. SCHLEICHER Director October 2, 1996
- ---------------------------------------------
Allison R. Schleicher
</TABLE>
II-6
<PAGE> 70
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER DESCRIPTION OF DOCUMENT NUMBER
- ------ ---------------------------------------------------------------------------- ------
<C> <S> <C>
1.01 Form of Underwriting Agreement..............................................
2.01 Reorganization Agreement among Verdix Corporation, Rational Acquisition
Corporation, and Rational, dated December 15, 1993, is incorporated herein
by reference to Appendix A filed with the Company's Registration Statement
on Form S-4, dated February 25, 1994 (Registration No. 33-75724)............
2.02 Share Purchase Agreement between Telefonaktiebolaget LM Ericsson (publ.) and
Rational Software Corporation, dated September 26, 1995, is incorporated
herein by reference to Exhibit 2 filed with the Company's Form 8-K Current
Report dated October 9, 1995 (File No. 0-12167) ("October 1995 8-K")........
2.03 Share Option Agreement between Usecase Engineering S.A. and Rational
Software Corporation, dated October 9, 1995, is incorporated herein by
reference to Exhibit 3 filed with the Company's October 1995 8-K............
4.01 Restatement of the Certificate of Incorporation of the Company, dated August
30, 1996....................................................................
4.02 Bylaws of the Company as most recently amended are incorporated herein by
reference to Exhibit 3.9 filed with the 1996 10-K...........................
4.03 Specimen of Common Stock Certificate is incorporated herein by reference to
Exhibit 4.06 filed with the Company's Amendment No. 1 to Form S-3
Registration Statement on May 31, 1995 (File No. 33-91740)..................
4.04 Rational 1983 Incentive Stock Option Plan, as amended, dated March 24, 1992,
is incorporated herein by reference to Exhibit 4.7 filed with the Company's
Form S-8 Registration Statement on April 6, 1994 (Registration No.
33-77382)...................................................................
4.05 Form of Stock Option Agreements for the Rational 1983 Incentive Stock Option
Plan is incorporated herein by reference to Exhibit 4.8 filed with the
Company's Form S-8 Registration Statement on April 6, 1994 (Registration No.
33-77382)...................................................................
4.06 1983 Incentive Stock Option Plan, as amended, is incorporated herein by
reference to Exhibit 4.3 filed with Verdix's Form 10-K Annual Report for the
fiscal year ended March 31, 1989 (File No. 0-12167).........................
4.07 Form of Incentive Stock Option Agreement for the 1983 Incentive Stock Option
Plan, as amended, is incorporated herein by reference to Exhibit 4.4 filed
with Verdix's Form 10-K Annual Report for the fiscal year ended March 31,
1989 (File No. 0-12167).....................................................
4.08 1986 Stock Option Plan, as amended, is incorporated herein by reference to
Exhibit 4.6 filed with Verdix's Registration Statement on Form S-8
(Registration No. 33-20029).................................................
4.09 Form of Stock Option Agreement for the 1986 Stock Option Plan, as amended
November 15, 1991, is incorporated herein by reference to Exhibit 4.13 filed
with Verdix's Post Effective Amendment No. 1 to the Registration Statement
on Form S-3 (Registration No. 33-12469).....................................
4.10 Rational Software Corporation Stock Option Plan for Directors is
incorporated herein by reference to Exhibit 1 filed with the Company's Form
8-K Current Report dated October 2, 1996....................................
</TABLE>
<PAGE> 71
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER DESCRIPTION OF DOCUMENT NUMBER
- ------ ---------------------------------------------------------------------------- ------
<C> <S> <C>
4.11 Form of Stock Option Agreements for the Rational Software Corporation Stock
Option Plan for Directors is incorporated herein by reference to Exhibit 4.6
filed with the Company's Form S-8 Registration Statement on September 18,
1995 (Registration No. 33-97042)............................................
4.12 Rational 1993 Incentive Stock Option Plan is incorporated herein by
reference to Exhibit 4.9 filed with the Company's Form S-8 Registration
Statement on April 6, 1994 (Registration No. 33-77382)......................
4.13 Form of Stock Option Agreements for the Rational 1993 Stock Option Plan is
incorporated herein by reference to Exhibit 4.10 filed with the Company's
Form S-8 Registration Statement on April 6, 1994 (Registration No.
33-77382)...................................................................
4.14 Rational Software Corporation 1994 Stock Option Plan is incorporated herein
by reference to Exhibit 3 filed with the Company's Form 8-K Current Report
dated October 2, 1996.......................................................
4.15 Form of Stock Option Agreements for the Rational Software Corporation 1994
Stock Option Plan is incorporated herein by reference to Exhibit 4.6 filed
with the Company's Form S-8 Registration Statement on September 18, 1995
(Registration No. 33-97044).................................................
4.16 Rational Software Corporation 1994 Employee Stock Purchase Plan is
incorporated herein by reference to Exhibit 2 filed with the Company's Form
8-K Current Report dated October 2, 1996....................................
4.17 Rational Software Corporation 1994 Employee Stock Purchase Plan Subscription
Agreement is incorporated herein by reference to Exhibit 4.8 filed with the
Company's Form S-8 Registration Statement on October 31, 1994 (Registration
No. 33-85906) and amended September 18, 1995................................
4.18 Agreement among the Company, Rational, and International Business Machines
Corporation ("IBM"), dated December 15, 1993, is incorporated by reference
to Exhibit 4.17 filed with the Company's Registration Statement on Form S-4,
dated February 25, 1994 (Registration No. 33-75724).........................
4.19 Preferred Stock Purchase Agreement between Rational and IBM, dated as of
November 29, 1989, is incorporated by reference to Exhibit 4.18 filed with
the Company's Registration Statement on Form S-4, dated February 25, 1994
(Registration No. 33-75724).................................................
4.20 Agreement among the Company, Rational, Martin Marietta Investments, Inc.,
and Martin Marietta Technologies, Inc., dated December 15, 1993, is
incorporated herein by reference to Exhibit 10.33 filed with the Company's
Registration Statement on Form S-4, dated February 25, 1994 (Registration
No. 33-75724)...............................................................
4.21 Stock Purchase Agreement between the Company and Martin Marietta
Corporation, dated March 8, 1985, is incorporated herein by reference to
Exhibit 4.1 filed with the Company's Form 8-K Current Report dated March 8,
1985 (File No. 0-12167).....................................................
4.22 Letter Agreement among the Company, Martin Marietta Corporation, and Martin
Marietta Investments, Inc., dated June 2, 1987, is incorporated herein by
reference to Exhibit 4.1 filed with the Company's Form 8-K Current Report
dated June 2, 1987 (File No. 0-12167).......................................
5.01 Opinion of Wilson Sonsini Goodrich & Rosati, P.C., regarding the legality of
securities being registered.................................................
</TABLE>
<PAGE> 72
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER DESCRIPTION OF DOCUMENT NUMBER
- ------ ---------------------------------------------------------------------------- ------
<C> <S> <C>
10.01 *Agreement for Purchase and Sale of Assets between the Company and Microsoft
Corporation, dated October 2, 1996, is incorporated herein by reference to
Exhibit 1 filed with the Company's Form 8-K Current Report dated October 2,
1996........................................................................
10.02 *Development and License Agreement between the Company and Microsoft
Corporation, dated September 24, 1996, is incorporated herein by reference
to Exhibit 2 filed with the Company's Form 8-K Current Report dated October
2, 1996.....................................................................
23.01 Consent of Ernst & Young LLP................................................
23.02 Consent of Wilson Sonsini Goodrich & Rosati, P.C. (see Exhibit 5.01
above)......................................................................
24.01 Power of Attorney is contained on the signature pages of this Registration
Statement...................................................................
</TABLE>
- ------------------------------
* Confidential treatment has been requested with respect to portions of the
referenced exhibit.
<PAGE> 1
EXHIBIT 1.01
RATIONAL SOFTWARE CORPORATION
5,106,718 SHARES
Common Stock
UNDERWRITING AGREEMENT
October __, 1996
HAMBRECHT & QUIST LLC
GOLDMAN, SACHS & CO.
WESSELS, ARNOLD & HENDERSON, LLC
c/o Hambrecht & Quist LLC
One Bush Street
San Francisco, CA 94104
Ladies and Gentlemen:
Rational Software Corporation, a Delaware corporation (herein called the
Company), proposes to issue and sell 4,150,000 shares of its authorized but
unissued Common Stock, $0.01 par value (herein called the Common Stock), and the
stockholders of the Company named in Schedule II hereto (herein collectively
called the Selling Securityholders) propose to sell an aggregate of 956,718
shares of Common Stock of the Company (said 956,718 shares of Common Stock being
herein called the Underwritten Stock). The Company proposes to grant to the
Underwriters (as hereinafter defined) an option to purchase up to 766,007
additional shares of Common Stock (herein called the Option Stock and with the
Underwritten Stock herein collectively called the Stock). The Common Stock is
more fully described in the Registration Statement and the Prospectus
hereinafter mentioned.
The Company and the Selling Securityholders severally hereby confirm the
agreements made with respect to the purchase of the Stock by the several
underwriters, for whom you are acting, named in Schedule I hereto (herein
collectively called the Underwriters, which term shall also include any
underwriter purchasing Stock pursuant to Section 3(b) hereof). You represent and
warrant that you have been authorized by each of the other Underwriters to enter
into this Agreement on its behalf and to act for it in the manner herein
provided.
1. REGISTRATION STATEMENT.
The Company has filed with the Securities and Exchange Commission (herein
called the Commission) a registration statement on Form S-3 (No. 333-_____),
including the related preliminary prospectus, for the registration under the
Securities Act of 1933, as amended (herein called the Securities Act) of the
Stock. Copies of such registration statement and of each amendment thereto, if
any, including the related preliminary prospectus (meeting the requirements of
Rule 430A of the rules and regulations of the Commission) heretofore filed by
the Company with the
1
<PAGE> 2
Commission have been delivered to you.
The term Registration Statement as used in this agreement shall mean such
registration statement, including all documents incorporated by reference
therein, all exhibits and financial statements, all information omitted
therefrom in reliance upon Rule 430A and contained in the Prospectus referred to
below, in the form in which it became effective, and any registration statement
filed pursuant to Rule 462(b) of the rules and regulations of the Commission
with respect to the Stock (herein called a Rule 462(b) registration statement),
and, in the event of any amendment thereto after the effective date of such
registration statement (herein called the Effective Date), shall also mean (from
and after the effectiveness of such amendment) such registration statement as so
amended (including any Rule 462(b) registration statement). The term Prospectus
as used in this Agreement shall mean the prospectus, including the documents
incorporated by reference therein, relating to the Stock first filed with the
Commission pursuant to Rule 424(b) and Rule 430A (or if no such filing is
required, as included in the Registration Statement) and, in the event of any
supplement or amendment to such prospectus after the Effective Date, shall also
mean (from and after the filing with the Commission of such supplement or the
effectiveness of such amendment) such prospectus as so supplemented or amended.
The term Preliminary Prospectus as used in this Agreement shall mean each
preliminary prospectus, including the documents incorporated by reference
therein, included in such registration statement prior to the time it becomes
effective.
The Registration Statement has been declared effective under the Securities
Act, and no post-effective amendment to the Registration Statement has been
filed as of the date of this Agreement. The Company has caused to be delivered
to you copies of each Preliminary Prospectus and has consented to the use of
such copies for the purposes permitted by the Securities Act.
2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE SELLING
SECURITYHOLDERS.
(a) The Company hereby represents and warrants as follows:
(i) Each of the Company and its subsidiaries has been duly
incorporated and is validly existing as a corporation in good standing under
the laws of the jurisdiction of its incorporation, has full corporate power
and authority to own or lease its properties and conduct its business as
described in the Registration Statement and the Prospectus and as being
conducted, and is duly qualified as a foreign corporation and in good
standing in all jurisdictions in which the character of the property owned
or leased or the nature of the business transacted by it makes qualification
necessary (except where the failure to be so qualified would not have a
material adverse effect on the business, properties, financial condition or
results of operations of the Company and its subsidiaries, taken as a
whole).
(ii) Since the respective dates as of which information is given in
the Registration Statement and the Prospectus, there has not been any
materially adverse change in the business, properties, financial condition
or results of operations of the Company and its subsidiaries, taken as a
whole, whether or not arising from transactions in the ordinary course of
business, other than as set forth in the Registration Statement and the
Prospectus, and since such dates, except in the ordinary course of business,
neither the Company nor any of its subsidiaries has entered into any
transaction material to the Company and its subsidiaries (taken as a whole)
not referred to in the Registration Statement and the Prospectus.
2
<PAGE> 3
(iii) The Registration Statement and the Prospectus comply, and on the
Closing Date (as hereinafter defined) and any later date on which Option
Stock is to be purchased, the Prospectus will comply, in all material
respects, with the provisions of the Securities Act and the Securities
Exchange Act of 1934, as amended (herein called the Exchange Act) and the
rules and regulations of the Commission thereunder; on the Effective Date,
the Registration Statement did not contain any untrue statement of a
material fact and did not omit to state any material fact required to be
stated therein or necessary in order to make the statements therein not
misleading; and, on the Effective Date the Prospectus did not and, on the
Closing Date and any later date on which Option Stock is to be purchased,
will not contain any untrue statement of a material fact or omit to state
any material fact necessary in order to make the statements therein, in the
light of the circumstances under which they were made, not misleading;
provided, however, that none of the representations and warranties in this
subparagraph (iii) shall apply to statements in, or omissions from, the
Registration Statement or the Prospectus made in reliance upon and in
conformity with information herein or otherwise furnished in writing to the
Company by or on behalf of the Underwriters for use in the Registration
Statement or the Prospectus.
(iv) The Stock is duly and validly authorized, is (or, in the case of
shares of the Stock to be sold by the Company, will be, when issued and sold
to the Underwriters as provided herein) duly and validly issued, fully paid
and nonassessable and conforms to the description thereof in the Prospectus.
No further approval or authority of the stockholders or the Board of
Directors of the Company will be required for the transfer and sale of the
Stock to be sold by the Selling Securityholders or the issuance and sale of
the Stock as contemplated herein.
(v) The Stock to be sold by the Selling Securityholders is listed and
duly admitted to trading on the Nasdaq National Market, and prior to the
Closing Date the Stock to be issued and sold by the Company will be
authorized for listing by the Nasdaq National Market upon official notice of
issuance.
(b) Each of the Selling Securityholders hereby represents and
warrants as follows:
(i) Such Selling Securityholder has good and marketable title to all
the shares of Stock to be sold by such Selling Securityholder hereunder,
free and clear of all liens, encumbrances, equities, security interests and
claims whatsoever, with full right and authority to deliver the same
hereunder, subject, in the case of each Selling Securityholder, to the
rights of Chasemellon Shareholder Services, L.L.C., as Custodian (herein
called the Custodian), and that upon the delivery of and payment for such
shares of the Stock hereunder, the several Underwriters will receive good
and marketable title thereto, free and clear of all liens, encumbrances,
equities, security interests and claims whatsoever.
(ii) Certificates in negotiable form for the shares of the Stock to be
sold by such Selling Securityholder have been placed in custody under a
Custody Agreement for delivery under this Agreement with the Custodian; such
Selling Securityholder specifically agrees that the shares of the Stock
represented by the certificates so held in custody for such Selling
Securityholder are subject to the interests of the several Underwriters and
the Company, that the arrangements made by such Selling Securityholder for
such custody, including the Power of Attorney provided for in such Custody
Agreement, are to that extent irrevocable, and that the obligations of such
Selling Securityholder shall not be terminated by any act of such Selling
Securityholder or by operation of law, whether by the death or incapacity of
such Selling Securityholder (or, in the
3
<PAGE> 4
case of a Selling Securityholder that is not an individual, the dissolution
or liquidation of such Selling Securityholder) or the occurrence of any
other event; if any such death, incapacity, dissolution, liquidation or
other such event should occur before the delivery of such shares of the
Stock hereunder, certificates for such shares of the Stock shall be
delivered by the Custodian in accordance with the terms and conditions of
this Agreement as if such death, incapacity, dissolution, liquidation or
other event had not occurred, regardless of whether the Custodian shall have
received notice of such death, incapacity, dissolution, liquidation or other
event.
(iii) Such Selling Securityholder has reviewed the Registration
Statement and Prospectus and, although such Selling Securityholder has not
independently verified the accuracy or completeness of all the information
contained therein, nothing has come to the attention of such Selling
Securityholder that would lead such Selling Securityholder to believe that
on the Effective Date, the Registration Statement contained any untrue
statement of a material fact or omitted to state any material fact required
to be stated therein or necessary in order to make the statements therein
not misleading; and, on the Effective Date the Prospectus contained and, on
the Closing Date and any later date on which Option Stock is to be
purchased, contains any untrue statement of a material fact or omitted or
omits to state any material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made, not
misleading.
3. PURCHASE OF THE STOCK BY THE UNDERWRITERS.
(a) On the basis of the representations and warranties and subject to the
terms and conditions herein set forth, the Company agrees to issue and sell
4,150,000 shares of the Underwritten Stock to the several Underwriters, each
Selling Securityholder agrees to sell to the several Underwriters the number of
shares of the Underwritten Stock set forth in Schedule II opposite the name of
such Selling Securityholder, and each of the Underwriters agrees to purchase
from the Company and the Selling Securityholders the respective aggregate number
of shares of Underwritten Stock set forth opposite its name in Schedule I. The
price at which such shares of Underwritten Stock shall be sold by the Company
and the Selling Securityholders and purchased by the several Underwriters shall
be $___ per share. The obligation of each Underwriter to the Company and each of
the Selling Securityholders shall be to purchase from the Company and the
Selling Securityholders that number of shares of the Underwritten Stock which
represents the same proportion of the total number of shares of the Underwritten
Stock to be sold by each of the Company and the Selling Securityholders pursuant
to this Agreement as the number of shares of the Underwritten Stock set forth
opposite the name of such Underwriter in Schedule I hereto represents of the
total number of shares of the Underwritten Stock to be purchased by all
Underwriters pursuant to this Agreement, as adjusted by you in such manner as
you deem advisable to avoid fractional shares. In making this Agreement, each
Underwriter is contracting severally and not jointly; except as provided in
paragraphs (b) and (c) of this Section 3, the agreement of each Underwriter is
to purchase only the respective number of shares of the Underwritten Stock
specified in Schedule I.
(b) If for any reason one or more of the Underwriters shall fail or refuse
(otherwise than for a reason sufficient to justify the termination of this
Agreement under the provisions of Section 8 or 9 hereof) to purchase and pay for
the number of shares of the Stock agreed to be purchased by such Underwriter or
Underwriters, the Company or the Selling Securityholders shall immediately give
notice thereof to you, and the non-defaulting Underwriters shall have the right
within 24 hours after the receipt by you of such notice to purchase, or procure
one or more other Underwriters to
4
<PAGE> 5
purchase, in such proportions as may be agreed upon between you and such
purchasing Underwriter or Underwriters and upon the terms herein set forth, all
or any part of the shares of the Stock which such defaulting Underwriter or
Underwriters agreed to purchase. If the non-defaulting Underwriters fail so to
make such arrangements with respect to all such shares and portion, the number
of shares of the Stock which each non-defaulting Underwriter is otherwise
obligated to purchase under this Agreement shall be automatically increased on a
pro rata basis to absorb the remaining shares and portion which the defaulting
Underwriter or Underwriters agreed to purchase; provided, however, that the
non-defaulting Underwriters shall not be obligated to purchase the shares and
portion which the defaulting Underwriter or Underwriters agreed to purchase if
the aggregate number of such shares of the Stock exceeds 10% of the total number
of shares of the Stock which all Underwriters agreed to purchase hereunder. If
the total number of shares of the Stock which the defaulting Underwriter or
Underwriters agreed to purchase shall not be purchased or absorbed in accordance
with the two preceding sentences, the Company and the Selling Securityholders
shall have the right, within 24 hours next succeeding the 24-hour period above
referred to, to make arrangements with other underwriters or purchasers
satisfactory to you for purchase of such shares and portion on the terms herein
set forth. In any such case, either you or the Company and the Selling
Securityholders shall have the right to postpone the Closing Date determined as
provided in Section 5 hereof for not more than seven business days after the
date originally fixed as the Closing Date pursuant to said Section 5 in order
that any necessary changes in the Registration Statement, the Prospectus or any
other documents or arrangements may be made. If neither the non-defaulting
Underwriters nor the Company and the Selling Securityholders shall make
arrangements within the 24-hour periods stated above for the purchase of all the
shares of the Stock which the defaulting Underwriter or Underwriters agreed to
purchase hereunder, this Agreement shall be terminated without further act or
deed and without any liability on the part of the Company or the Selling
Securityholders to any non-defaulting Underwriter and without any liability on
the part of any non-defaulting Underwriter to the Company or the Selling
Securityholders. Nothing in this paragraph (b), and no action taken hereunder,
shall relieve any defaulting Underwriter from liability in respect of any
default of such Underwriter under this Agreement.
(c) On the basis of the representations, warranties and covenants herein
contained, and subject to the terms and conditions herein set forth, the Company
grants an option to the several Underwriters to purchase, severally and not
jointly, up to 766,007 shares in the aggregate of the Option Stock from the
Company at the same price per share as the Underwriters shall pay for the
Underwritten Stock. Said option may be exercised only to cover over-allotments
in the sale of the Underwritten Stock by the Underwriters and may be exercised
in whole or in part at any time (but not more than once) on or before the
thirtieth day after the date of this Agreement upon written or telegraphic
notice by you to the Company setting forth the aggregate number of shares of the
Option Stock as to which the several Underwriters are exercising the option.
Delivery of certificates for the shares of Option Stock, and payment therefor,
shall be made as provided in Section 5 hereof. The number of shares of the
Option Stock to be purchased by each Underwriter shall be the same percentage of
the total number of shares of the Option Stock to be purchased by the several
Underwriters as such Underwriter is purchasing of the Underwritten Stock, as
adjusted by you in such manner as you deem advisable to avoid fractional shares.
4. OFFERING BY UNDERWRITERS.
The terms of the initial public offering by the Underwriters of the Stock to
be purchased by them shall be as set forth in the Prospectus. The Underwriters
may from time to time change the
5
<PAGE> 6
public offering price after the closing of the initial public offering and
increase or decrease the concessions and discounts to dealers as they may
determine.
5. DELIVERY OF AND PAYMENT FOR THE STOCK.
(a) Delivery of certificates for the shares of the Underwritten Stock and
the Option Stock (if the option granted by Section 3(c) hereof shall have been
exercised not later than 7:00 a.m., San Francisco time, on the date two business
days preceding the Closing Date), and payment therefor, shall be made at the
office of Wilson, Sonsini, Goodrich & Rosati, 650 Page Mill Road, Palo Alto, CA
94304, at 7:00 a.m., San Francisco time, on the fourth business day after the
date of this Agreement, or at such time on such other day, not later than seven
full business days after such fourth business day, as shall be agreed upon in
writing by the Company, the Selling Securityholders and you. The date and hour
of such delivery and payment (which may be postponed as provided in Section 3(b)
hereof) are herein called the Closing Date.
(b) If the option granted by Section 3(c) hereof shall be exercised after
7:00 a.m., San Francisco time, on the date two business days preceding the
Closing Date, delivery of certificates for the shares of Option Stock, and
payment therefor, shall be made at the office of Wilson, Sonsini, Goodrich &
Rosati, 650 Page Mill Road, Palo Alto, CA 94304, at 7:00 a.m., San Francisco
time, on the third business day after the exercise of such option.
(c) Payment for the Stock purchased from the Company shall be made to the
Company or its order, and payment for the Stock purchased from the Selling
Securityholders shall be made to the Custodian, for the account of the Selling
Securityholders, in each case by one or more certified or official bank check or
checks in same day funds (and the Company and the Selling Securityholders agree
not to deposit any such check in the bank on which drawn until the day following
the date of its delivery to the Company or the Custodian, as the case may be).
Such payment shall be made upon delivery of certificates for the Stock to you
for the respective accounts of the several Underwriters against receipt therefor
signed by you. Certificates for the Stock to be delivered to you shall be
registered in such name or names and shall be in such denominations as you may
request at least one business day before the Closing Date, in the case of
Underwritten Stock, and at least one business day prior to the purchase thereof,
in the case of the Option Stock. Such certificates will be made available to the
Underwriters for inspection, checking and packaging at the offices of Lewco
Securities Corporation, 2 Broadway, New York, New York 10004 on the business day
prior to the Closing Date or, in the case of the Option Stock, by 3:00 p.m., New
York time, on the business day preceding the date of purchase.
It is understood that you, individually and not on behalf of the
Underwriters, may (but shall not be obligated to) make payment to the Company
and the Selling Securityholders for shares to be purchased by any Underwriter
whose check shall not have been received by you on the Closing Date or any later
date on which Option Stock is purchased for the account of such Underwriter. Any
such payment by you shall not relieve such Underwriter from any of its
obligations hereunder.
6. FURTHER AGREEMENTS OF THE COMPANY AND THE SELLING
SECURITYHOLDERS.
Each of the Company and the Selling Securityholders respectively covenants
and agrees as follows:
6
<PAGE> 7
(a) The Company will (i) prepare and timely file with the Commission under
Rule 424(b) a Prospectus containing information previously omitted at the time
of effectiveness of the Registration Statement in reliance on Rule 430A and (ii)
not file any amendment to the Registration Statement or supplement to the
Prospectus of which you shall not previously have been advised and furnished
with a copy or to which you shall have reasonably objected in writing or which
is not in compliance with the Securities Act or the rules and regulations of the
Commission.
(b) The Company will promptly notify each Underwriter in the event of (i)
the request by the Commission for amendment of the Registration Statement or for
supplement to the Prospectus or for any additional information, (ii) the
issuance by the Commission of any stop order suspending the effectiveness of the
Registration Statement, (iii) the institution or notice of intended institution
of any action or proceeding for that purpose, (iv) the receipt by the Company of
any notification with respect to the suspension of the qualification of the
Stock for sale in any jurisdiction, or (v) the receipt by it of notice of the
initiation or threatening of any proceeding for such purpose. The Company and
the Selling Securityholders will make every reasonable effort to prevent the
issuance of such a stop order and, if such an order shall at any time be issued,
to obtain the withdrawal thereof at the earliest possible moment.
(c) The Company will (i) on or before the Closing Date, deliver to you a
signed copy of the Registration Statement as originally filed and of each
amendment thereto filed prior to the time the Registration Statement becomes
effective and, promptly upon the filing thereof, a signed copy of each
post-effective amendment, if any, to the Registration Statement (together with,
in each case, all exhibits thereto unless previously furnished to you) and will
also deliver to you, for distribution to the Underwriters, a sufficient number
of additional conformed copies of each of the foregoing (but without exhibits)
so that one copy of each may be distributed to each Underwriter, (ii) as
promptly as possible deliver to you and send to the several Underwriters, at
such office or offices as you may designate, as many copies of the Prospectus as
you may reasonably request, and (iii) thereafter from time to time during the
period in which a prospectus is required by law to be delivered by an
Underwriter or dealer, likewise send to the Underwriters as many additional
copies of the Prospectus and as many copies of any supplement to the Prospectus
and of any amended prospectus, filed by the Company with the Commission, as you
may reasonably request for the purposes contemplated by the Securities Act.
(d) If at any time during the period in which a prospectus is required by
law to be delivered by an Underwriter or dealer any event relating to or
affecting the Company, or of which the Company shall be advised in writing by
you, shall occur as a result of which it is necessary, in the opinion of counsel
for the Company or of counsel for the Underwriters, to supplement or amend the
Prospectus in order to make the Prospectus not misleading in the light of the
circumstances existing at the time it is delivered to a purchaser of the Stock,
the Company will forthwith prepare and file with the Commission a supplement to
the Prospectus or an amended prospectus so that the Prospectus as so
supplemented or amended will not contain any untrue statement of a material fact
or omit to state any material fact necessary in order to make the statements
therein, in the light of the circumstances existing at the time such Prospectus
is delivered to such purchaser, not misleading. If, after the initial public
offering of the Stock by the Underwriters and during such period, the
Underwriters shall propose to vary the terms of offering thereof by reason of
changes in general market conditions or otherwise, you will advise the Company
in writing of the proposed variation, and, if in the opinion either of counsel
for the Company or of counsel for the Underwriters such proposed variation
requires that the Prospectus be supplemented or amended, the Company will
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<PAGE> 8
forthwith prepare and file with the Commission a supplement to the Prospectus or
an amended prospectus setting forth such variation. The Company authorizes the
Underwriters and all dealers to whom any of the Stock may be sold by the several
Underwriters to use the Prospectus, as from time to time amended or
supplemented, in connection with the sale of the Stock in accordance with the
applicable provisions of the Securities Act and the applicable rules and
regulations thereunder for such period.
(e) Prior to the filing thereof with the Commission, the Company will submit
to you, for your information, a copy of any post-effective amendment to the
Registration Statement and any supplement to the Prospectus or any amended
prospectus proposed to be filed.
(f) The Company will cooperate, when and as requested by you, in the
qualification of the Stock for offer and sale under the securities or blue sky
laws of such jurisdictions as you may designate and, during the period in which
a prospectus is required by law to be delivered by an Underwriter or dealer, in
keeping such qualifications in good standing under said securities or blue sky
laws; provided, however, that the Company shall not be obligated to file any
general consent to service of process or to qualify as a foreign corporation in
any jurisdiction in which it is not so qualified. The Company will, from time to
time, prepare and file such statements, reports, and other documents as are or
may be required to continue such qualifications in effect for so long a period
as you may reasonably request for distribution of the Stock.
(g) During a period of five years commencing with the date hereof, the
Company will furnish to you, and to each Underwriter who may so request in
writing, copies of all periodic and special reports furnished to stockholders of
the Company and of all information, documents and reports filed with the
Commission.
(h) Not later than the 45th day following the end of the fiscal quarter
first occurring after the first anniversary of the Effective Date, the Company
will make generally available to its security holders an earnings statement in
accordance with Section 11(a) of the Securities Act and Rule 158 thereunder.
(i) The Company and the Selling Securityholders jointly and severally agree
to pay all costs and expenses incident to the performance of their obligations
under this Agreement, including all costs and expenses incident to (i) the
preparation, printing and filing with the Commission and the National
Association of Securities Dealers, Inc. ("NASD") of the Registration Statement,
any Preliminary Prospectus and the Prospectus, (ii) the furnishing to the
Underwriters of copies of any Preliminary Prospectus and of the several
documents required by paragraph (c) of this Section 6 to be so furnished, (iii)
the printing of this Agreement and related documents delivered to the
Underwriters, (iv) the preparation, printing and filing of all supplements and
amendments to the Prospectus referred to in paragraph (d) of this Section 6, (v)
the furnishing to you and the Underwriters of the reports and information
referred to in paragraph (g) of this Section 6 and (vi) the printing and
issuance of stock certificates, including the transfer agent's fees. The Selling
Securityholders will pay any transfer taxes incident to the transfer to the
Underwriters of the shares the Stock being sold by the Selling Securityholders.
(j) The Company and the Selling Securityholders jointly and severally agree
to reimburse you, for the account of the several Underwriters, for blue sky fees
and related disbursements (including counsel fees and disbursements and cost of
printing memoranda for the Underwriters) paid
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<PAGE> 9
by or for the account of the Underwriters or their counsel in qualifying the
Stock under state securities or blue sky laws and in the review of the offering
by the NASD.
(k) The provisions of paragraphs (i) and (j) of this Section are intended to
relieve the Underwriters from the payment of the expenses and costs which the
Company and the Selling Securityholders hereby agree to pay and shall not affect
any agreement which the Company and the Selling Securityholders may make, or may
have made, for the sharing of any such expenses and costs.
(l) The Company and each of the Selling Securityholders hereby agrees that,
without the prior written consent of Hambrecht & Quist LLC on behalf of the
Underwriters, the Company or such Selling Securityholder, as the case may be,
will not, for a period of 90 days following the commencement of the public
offering of the Stock by the Underwriters, directly or indirectly, (i) sell,
offer, contract to sell, make any short sale, pledge, sell any option or
contract to purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase or otherwise transfer or dispose of any shares of
Common Stock or any securities convertible into or exchangeable or exercisable
for or any rights to purchase or acquire Common Stock or (ii) enter into any
swap or other agreement that transfers, in whole or in part, any of the economic
consequences or ownership of Common Stock, whether any such transaction
described in clause (i) or (ii) above is to be settled by delivery of Common
Stock or such other securities, in cash or otherwise. The foregoing sentence
shall not apply to (A) the Stock to be sold to the Underwriters pursuant to this
Agreement, (B) shares of Common Stock issued upon the exercise of options or
rights granted under the stock option or stock purchase plans of the Company
(the "Plans"), all as described in footnote 1 to the table under the caption
"Capitalization" in the Preliminary Prospectus, and (C) options or rights to
purchase Common Stock granted under the Plans.
7. INDEMNIFICATION AND CONTRIBUTION.
(a) Subject to the provisions of paragraph (f) of this Section 7, the
Company and the Selling Securityholders jointly and severally agree to indemnify
and hold harmless each Underwriter and each person (including each partner or
officer thereof) who controls any Underwriter within the meaning of Section 15
of the Securities Act from and against any and all losses, claims, damages or
liabilities, joint or several, to which such indemnified parties or any of them
may become subject under the Securities Act, the Exchange Act, or the common law
or otherwise, and the Company and the Selling Securityholders jointly and
severally agree to reimburse each such Underwriter and controlling person for
any legal or other expenses (including, except as otherwise hereinafter
provided, reasonable fees and disbursements of counsel) incurred by the
respective indemnified parties in connection with defending against any such
losses, claims, damages or liabilities or in connection with any investigation
or inquiry of, or other proceeding which may be brought against, the respective
indemnified parties, in each case arising out of or based upon (i) any untrue
statement or alleged untrue statement of a material fact contained in the
Registration Statement (including the Prospectus as part thereof and any Rule
462(b) registration statement) or any post-effective amendment thereto
(including any Rule 462(b) registration statement), or the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading, or (ii) any untrue
statement or alleged untrue statement of a material fact contained in any
Preliminary Prospectus or the Prospectus (as amended or as supplemented if the
Company shall have filed with the Commission any amendment thereof or supplement
thereto) or the omission or alleged omission to state therein a material fact
necessary in
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<PAGE> 10
order to make the statements therein, in the light of the circumstances under
which they were made, not misleading; provided, however, that (1) the indemnity
agreements of the Company and the Selling Securityholders contained in this
paragraph (a) shall not apply to any such losses, claims, damages, liabilities
or expenses if such statement or omission was made in reliance upon and in
conformity with information furnished as herein stated or otherwise furnished in
writing to the Company by or on behalf of any Underwriter for use in any
Preliminary Prospectus or the Registration Statement or the Prospectus or any
such amendment thereof or supplement thereto, and (2) each Selling
Securityholder shall only be liable under this paragraph with respect to (A)
information pertaining to such Selling Securityholder furnished by or on behalf
of such Selling Securityholder expressly for use in any Preliminary Prospectus
or the Registration Statement or the Prospectus or any such amendment thereof or
supplement thereto or (B) facts that would constitute a breach of any
representation or warranty of such Selling Securityholder set forth in Section
2(b) hereof. The indemnity agreements of the Company and the Selling
Securityholders contained in this paragraph (a) and the representations and
warranties of the Company and the Selling Securityholders contained in Section 2
hereof shall remain operative and in full force and effect regardless of any
investigation made by or on behalf of any indemnified party and shall survive
the delivery of and payment for the Stock.
(b) Each Underwriter severally agrees to indemnify and hold harmless the
Company, each of its officers who signs the Registration Statement on his own
behalf or pursuant to a power of attorney, each of its directors, each other
Underwriter and each person (including each partner or officer thereof) who
controls the Company or any such other Underwriter within the meaning of Section
15 of the Securities Act, and the Selling Securityholders from and against any
and all losses, claims, damages or liabilities, joint or several, to which such
indemnified parties or any of them may become subject under the Securities Act,
the Exchange Act, or the common law or otherwise and to reimburse each of them
for any legal or other expenses (including, except as otherwise hereinafter
provided, reasonable fees and disbursements of counsel) incurred by the
respective indemnified parties in connection with defending against any such
losses, claims, damages or liabilities or in connection with any investigation
or inquiry of, or other proceeding which may be brought against, the respective
indemnified parties, in each case arising out of or based upon (i) any untrue
statement or alleged untrue statement of a material fact contained in the
Registration Statement (including the Prospectus as part thereof and any Rule
462(b) registration statement) or any post-effective amendment thereto
(including any Rule 462(b) registration statement) or the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading or (ii) any untrue
statement or alleged untrue statement of a material fact contained in the
Prospectus (as amended or as supplemented if the Company shall have filed with
the Commission any amendment thereof or supplement thereto) or the omission or
alleged omission to state therein a material fact necessary in order to make the
statements therein, in the light of the circumstances under which they were
made, not misleading, in each case to the extent, but only to the extent that
such statement or omission was made in reliance upon and in conformity with
information furnished in writing to the Company by or on behalf of such
indemnifying Underwriter expressly for use in the Registration Statement or the
Prospectus or any such amendment thereof or supplement thereto. The indemnity
agreement of each Underwriter contained in this paragraph (b) shall remain
operative and in full force and effect regardless of any investigation made by
or on behalf of any indemnified party and shall survive the delivery of and
payment for the Stock.
(c) Each party indemnified under the provision of paragraphs (a) and (b) of
this Section 7 agrees that, upon the service of a summons or other initial legal
process upon it in any action or suit
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<PAGE> 11
instituted against it or upon its receipt of written notification of the
commencement of any investigation or inquiry of, or proceeding against, it in
respect of which indemnity may be sought on account of any indemnity agreement
contained in such paragraphs, it will promptly give written notice (herein
called the Notice) of such service or notification to the party or parties from
whom indemnification may be sought hereunder. No indemnification provided for in
such paragraphs shall be available to any party who shall fail so to give the
Notice if the party to whom such Notice was not given was unaware of the action,
suit, investigation, inquiry or proceeding to which the Notice would have
related and was prejudiced by the failure to give the Notice, but the omission
so to notify such indemnifying party or parties of any such service or
notification shall not relieve such indemnifying party or parties from any
liability which it or they may have to the indemnified party for contribution or
otherwise than on account of such indemnity agreement. Any indemnifying party
shall be entitled at its own expense to participate in the defense of any
action, suit or proceeding against, or investigation or inquiry of, an
indemnified party. Any indemnifying party shall be entitled, if it so elects
within a reasonable time after receipt of the Notice by giving written notice
(herein called the Notice of Defense) to the indemnified party, to assume (alone
or in conjunction with any other indemnifying party or parties) the entire
defense of such action, suit, investigation, inquiry or proceeding, in which
event such defense shall be conducted, at the expense of the indemnifying party
or parties, by counsel chosen by such indemnifying party or parties and
reasonably satisfactory to the indemnified party or parties; provided, however,
that (i) if the indemnified party or parties reasonably determine that there may
be a conflict between the positions of the indemnifying party or parties and of
the indemnified party or parties in conducting the defense of such action, suit,
investigation, inquiry or proceeding or that there may be legal defenses
available to such indemnified party or parties different from or in addition to
those available to the indemnifying party or parties, then counsel for the
indemnified party or parties shall be entitled to conduct the defense to the
extent reasonably determined by such counsel to be necessary to protect the
interests of the indemnified party or parties and (ii) in any event, the
indemnified party or parties shall be entitled to have counsel chosen by such
indemnified party or parties participate in, but not conduct, the defense. If,
within a reasonable time after receipt of the Notice, an indemnifying party
gives a Notice of Defense and the counsel chosen by the indemnifying party or
parties is reasonably satisfactory to the indemnified party or parties, the
indemnifying party or parties will not be liable under paragraphs (a) through
(c) of this Section 7 for any legal or other expenses subsequently incurred by
the indemnified party or parties in connection with the defense of the action,
suit, investigation, inquiry or proceeding, except that (A) the indemnifying
party or parties shall bear the legal and other expenses incurred in connection
with the conduct of the defense as referred to in clause (i) of the proviso to
the preceding sentence and (B) the indemnifying party or parties shall bear such
other expenses as it or they have authorized to be incurred by the indemnified
party or parties. If, within a reasonable time after receipt of the Notice, no
Notice of Defense has been given, the indemnifying party or parties shall be
responsible for any legal or other expenses incurred by the indemnified party or
parties in connection with the defense of the action, suit, investigation,
inquiry or proceeding.
(d) If the indemnification provided for in this Section 7 is unavailable or
insufficient to hold harmless an indemnified party under paragraph (a) or (b) of
this Section 7, then each indemnifying party, in lieu of indemnifying such
indemnified party, shall contribute to the amount paid or payable by such
indemnified party as a result of the losses, claims, damages or liabilities
referred to in paragraph (a) or (b) of this Section 7 (i) in such proportion as
is appropriate to reflect the relative benefits received by each indemnifying
party from the offering of the Stock or (ii) if the allocation provided by
clause (i) above is not permitted by applicable law, in such proportion as is
appropriate
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to reflect not only the relative benefits referred to in clause (i) above but
also the relative fault of each indemnifying party in connection with the
statements or omissions that resulted in such losses, claims, damages or
liabilities, or actions in respect thereof, as well as any other relevant
equitable considerations. The relative benefits received by the Company and the
Selling Securityholders on the one hand and the Underwriters on the other shall
be deemed to be in the same respective proportions as the total net proceeds
from the offering of the Stock received by the Company and the Selling
Securityholders and the total underwriting discount received by the
Underwriters, as set forth in the table on the cover page of the Prospectus,
bear to the aggregate public offering price of the Stock. Relative fault shall
be determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged omission to state
a material fact relates to information supplied by each indemnifying party and
the parties' relative intent, knowledge, access to information and opportunity
to correct or prevent such untrue statement or omission.
The parties agree that it would not be just and equitable if contributions
pursuant to this paragraph (d) were to be determined by pro rata allocation
(even if the Underwriters were treated as one entity for such purpose) or by any
other method of allocation which does not take into account the equitable
considerations referred to in the first sentence of this paragraph (d). The
amount paid by an indemnified party as a result of the losses, claims, damages
or liabilities, or actions in respect thereof, referred to in the first sentence
of this paragraph (d) shall be deemed to include any legal or other expenses
reasonably incurred by such indemnified party in connection with investigation,
preparing to defend or defending against any action or claim which is the
subject of this paragraph (d). Notwithstanding the provisions of this paragraph
(d), no Underwriter shall be required to contribute any amount in excess of the
underwriting discount applicable to the Stock purchased by such Underwriter. No
person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Securities Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation. The Underwriters'
obligations in this paragraph (d) to contribute are several in proportion to
their respective underwriting obligations and not joint.
Each party entitled to contribution agrees that upon the service of a
summons or other initial legal process upon it in any action instituted against
it in respect of which contribution may be sought, it will promptly give written
notice of such service to the party or parties from whom contribution may be
sought, but the omission so to notify such party or parties of any such service
shall not relieve the party from whom contribution may be sought from any
obligation it may have hereunder or otherwise (except as specifically provided
in paragraph (c) of this Section 7).
(e) Neither the Company nor the Selling Securityholders will, without the
prior written consent of each Underwriter, settle or compromise or consent to
the entry of any judgment in any pending or threatened claim, action, suit or
proceeding in respect of which indemnification may be sought hereunder (whether
or not such Underwriter or any person who controls such Underwriter within the
meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act is
a party to such claim, action, suit or proceeding) unless such settlement,
compromise or consent includes an unconditional release of such Underwriter
indemnified party and each such controlling person from all liability arising
out of such claim, action, suit or proceeding.
(f) The liability of each Selling Securityholder under the indemnity and
reimbursement agreements contained in the provisions of this Section 7 and
Section 11 hereof shall be limited to an amount equal to the initial public
offering price of the stock sold by such Selling Securityholder to
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<PAGE> 13
the Underwriters. The Company and the Selling Securityholders may agree, as
among themselves and without limiting the rights of the Underwriters under this
Agreement, as to the respective amounts of such liability for which they each
shall be responsible.
8. TERMINATION. This Agreement may be terminated by you at any time prior to
the Closing Date by giving written notice to the Company and the Selling
Securityholders if after the date of this Agreement trading in the Common Stock
shall have been suspended, or if there shall have occurred (i) the engagement in
hostilities or an escalation of hostilities by the United States or the
declaration of war or a national emergency by the United States on or after the
date hereof, (ii) any outbreak of hostilities or other national or international
calamity or crisis or change in economic or political conditions if the effect
of such outbreak, calamity, crisis or change in economic or political conditions
in the financial markets of the United States would, in the Underwriters'
judgment, make the offering or delivery of the Stock impracticable or
inadvisable, (iii) suspension of trading in securities generally or a material
adverse decline in value of securities generally on the New York Stock Exchange,
the American Stock Exchange, or The Nasdaq Stock Market, or limitations on
prices (other than limitations on hours or numbers of days of trading) for
securities on either such exchange or system, (iv) the enactment, publication,
decree or other promulgation of any federal or state statute, regulation, rule
or order of, or commencement of any proceeding or investigation by, any court,
legislative body, agency or other governmental authority which in the
Underwriters' reasonable opinion materially and adversely affects or will
materially or adversely affect the business or operations of the Company, (v)
declaration of a banking moratorium by either federal or New York State
authorities or (vi) the taking of any action by any federal, state or local
government or agency in respect of its monetary or fiscal affairs which in the
Underwriters' reasonable opinion has a material adverse effect on the securities
markets in the United States. If this Agreement shall be terminated pursuant to
this Section 8, there shall be no liability of the Company or the Selling
Securityholders to the Underwriters and no liability of the Underwriters to the
Company or the Selling Securityholders; provided, however, that in the event of
any such termination the Company and the Selling Securityholders agree to
indemnify and hold harmless the Underwriters from all costs or expenses incident
to the performance of the obligations of the Company and the Selling
Securityholders under this Agreement, including all costs and expenses referred
to in paragraphs (i) and (j) of Section 6 hereof.
9. CONDITIONS OF UNDERWRITERS' OBLIGATIONS. The obligations of the several
Underwriters to purchase and pay for the Stock shall be subject to the
performance by the Company and by the Selling Securityholders of all their
respective obligations to be performed hereunder at or prior to the Closing Date
or any later date on which Option Stock is to be purchased, as the case may be,
and to the following further conditions:
(a) The Registration Statement shall have become effective; and no
stop order suspending the effectiveness thereof shall have been issued and
no proceedings therefor shall be pending or threatened by the Commission.
(b) The legality and sufficiency of the sale of the Stock hereunder
and the validity and form of the certificates representing the Stock, all
corporate proceedings and other legal matters incident to the foregoing, and
the form of the Registration Statement and of the Prospectus (except as to
the financial statements contained therein), shall have been approved at or
prior to the Closing Date by Cooley Godward LLP, counsel for the
Underwriters.
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(c) You shall have received from Wilson, Sonsini, Goodrich & Rosati
(or with respect to certain foreign subsidiaries, from foreign counsel
reasonably acceptable to you), counsel for the Company, and from counsel for
each Selling Securityholder, an opinion, addressed to the Underwriters and
dated the Closing Date, covering the matters set forth in Annex A hereto,
and if Option Stock is purchased at any date after the Closing Date,
additional opinions from such counsel for the Company, addressed to the
Underwriters and dated such later date, confirming that the statements
expressed as of the Closing Date in such opinions remain valid as of such
later date.
(d) You shall be satisfied that (i) as of the Effective Date, the
statements made in the Registration Statement and the Prospectus were true
and correct and neither the Registration Statement nor the Prospectus
omitted to state any material fact required to be stated therein or
necessary in order to make the statements therein, respectively, not
misleading, (ii) since the Effective Date, no event has occurred which
should have been set forth in a supplement or amendment to the Prospectus
which has not been set forth in such a supplement or amendment, (iii) since
the respective dates as of which information is given in the Registration
Statement in the form in which it originally became effective and the
Prospectus contained therein, there has not been any material adverse change
or any development involving a prospective material adverse change in or
affecting the business, properties, financial condition or results of
operations of the Company and its subsidiaries, taken as a whole, whether or
not arising from transactions in the ordinary course of business, and, since
such dates, except in the ordinary course of business, neither the Company
nor any of its subsidiaries has entered into any transaction material to the
Company and its subsidiaries, taken as a whole, not referred to in the
Registration Statement in the form in which it originally became effective
and the Prospectus contained therein, (iv) neither the Company nor any of
its subsidiaries has any contingent obligations material to the Company and
its subsidiaries, taken as a whole, which are not disclosed in the
Registration Statement and the Prospectus, (v) there are not any pending or
known threatened legal proceedings to which the Company or any of its
subsidiaries is a party or of which property of the Company or any of its
subsidiaries is the subject which are material to the Company and its
subsidiaries, taken as a whole, and which are not disclosed in the
Registration Statement and the Prospectus, (vi) there are not any
franchises, contracts, leases or other documents which are required to be
filed as exhibits to the Registration Statement which have not been filed as
required, (vii) the representations and warranties of the Company herein are
true and correct in all material respects as of the Closing Date or any
later date on which Option Stock is to be purchased, as the case may be, and
(viii) there has not been any material change in the market for securities
in general or in political, financial or economic conditions from those
reasonably foreseeable as to render it impracticable in your reasonable
judgment to make a public offering of the Stock, or a material adverse
change in market levels for securities in general (or those of companies in
particular) or financial or economic conditions which render it inadvisable
to proceed.
(e) You shall have received on the Closing Date and on any later date
on which Option Stock is purchased a certificate, dated the Closing Date or
such later date, as the case may be, and signed by the President and the
Chief Financial Officer of the Company, stating that the respective signers
of said certificate have carefully examined the Registration Statement in
the form in which it originally became effective and the Prospectus
contained therein and any supplements or amendments thereto, and that the
statements included in clauses (i) through (vii) of paragraph (d) of this
Section 9 are true and correct.
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<PAGE> 15
(f) You shall have received from Ernst & Young LLP, a letter or
letters, addressed to the Underwriters and dated the Closing Date and any
later date on which Option Stock is purchased, confirming that they are
independent public accountants with respect to the Company within the
meaning of the Securities Act and the applicable published rules and
regulations thereunder and based upon the procedures described in their
letter delivered to you concurrently with the execution of this Agreement
(herein called the Original Letter), but carried out to a date not more than
three business days prior to the Closing Date or such later date on which
Option Stock is purchased (i) confirming, to the extent true, that the
statements and conclusions set forth in the Original Letter are accurate as
of the Closing Date or such later date, as the case may be, and (ii) setting
forth any revisions and additions to the statements and conclusions set
forth in the Original Letter which are necessary to reflect any changes in
the facts described in the Original Letter since the date of the Original
Letter or to reflect the availability of more recent financial statements,
data or information. The letters shall not disclose any change, or any
development involving a prospective change, in or affecting the business or
properties of the Company or any of its subsidiaries which, in your sole
judgment, makes it impractical or inadvisable to proceed with the public
offering of the Stock or the purchase of the Option Stock as contemplated by
the Prospectus.
(g) You shall have received from Ernst & Young LLP, a letter stating
that their review of the Company's system of internal accounting controls,
to the extent they deemed necessary in establishing the scope of their
examination of the Company's financial statements as at March 31, 1996, did
not disclose any weakness in internal controls that they considered to be
material weaknesses.
(h) You shall have been furnished evidence in usual written or
telegraphic form from the appropriate authorities of the several
jurisdictions, or other evidence satisfactory to you, of the qualification
referred to in paragraph (f) of Section 6 hereof.
(i) Prior to the Closing Date, the Stock to be issued and sold by the
Company shall have been duly authorized for listing by the Nasdaq National
Market upon official notice of issuance.
(j) On or prior to the Closing Date, you shall have received from all
directors and officers, and their affiliates, agreements, in form reasonably
satisfactory to Hambrecht & Quist LLC, stating that without the prior
written consent of Hambrecht & Quist LLC on behalf of the Underwriters, such
person or entity will not, for a period of 90 days following the
commencement of the public offering of the Stock by the Underwriters,
directly or indirectly, (i) sell, offer, contract to sell, make any short
sale, pledge, sell any option or contract to purchase, purchase any option
or contract to sell, grant any option, right or warrant to purchase or
otherwise transfer or dispose of any shares of Common Stock or any
securities convertible into or exchangeable or exercisable for or any rights
to purchase or acquire Common Stock or (ii) enter into any swap or other
agreement that transfers, in whole or in part, any of the economic
consequences or ownership of Common Stock, whether any such transaction
described in clause (i) or (ii) above is to be settled by delivery of Common
Stock or such other securities, in cash or otherwise.
15
<PAGE> 16
All the agreements, opinions, certificates and letters mentioned above or
elsewhere in this Agreement shall be deemed to be in compliance with the
provisions hereof only if Cooley Godward LLP, counsel for the Underwriters,
shall be satisfied that they comply in form and scope.
In case any of the conditions specified in this Section 9 shall not be
fulfilled, this Agreement may be terminated by you by giving notice to the
Company and to the Selling Securityholders. Any such termination shall be
without liability of the Company or the Selling Securityholders to the
Underwriters and without liability of the Underwriters to the Company or the
Selling Securityholders; provided, however, that (i) in the event of such
termination, the Company and the Selling Securityholders agree to indemnify and
hold harmless the Underwriters from all costs or expenses incident to the
performance of the obligations of the Company and the Selling Securityholders
under this Agreement, including all costs and expenses referred to in paragraphs
(i) and (j) of Section 6 hereof, and (ii) if this Agreement is terminated by you
because of any refusal, inability or failure on the part of the Company or the
Selling Securityholders to perform any agreement herein, to fulfill any of the
conditions herein, or to comply with any provision hereof other than by reason
of a default by any of the Underwriters, the Company will reimburse the
Underwriters severally upon demand for all out-of-pocket expenses (including
reasonable fees and disbursements of counsel) that shall have been incurred by
them in connection with the transactions contemplated hereby.
10. CONDITIONS OF THE OBLIGATION OF THE COMPANY AND THE SELLING
SECURITYHOLDERS. The obligation of the Company and the Selling Securityholders
to deliver the Stock shall be subject to the conditions that (a) the
Registration Statement shall have become effective and (b) no stop order
suspending the effectiveness thereof shall be in effect and no proceedings
therefor shall be pending or threatened by the Commission.
In case either of the conditions specified in this Section 10 shall not be
fulfilled, this Agreement may be terminated by the Company and the Selling
Securityholders by giving notice to you. Any such termination shall be without
liability of the Company and the Selling Securityholders to the Underwriters and
without liability of the Underwriters to the Company or the Selling
Securityholders; provided, however, that in the event of any such termination
the Company and the Selling Securityholders jointly and severally agree to
indemnify and hold harmless the Underwriters from all costs or expenses incident
to the performance of the obligations of the Company and the Selling
Securityholders under this Agreement, including all costs and expenses referred
to in paragraphs (i) and (j) of Section 6 hereof.
11. REIMBURSEMENT OF CERTAIN EXPENSES. In addition to their other
obligations under Section 7 of this Agreement (and subject, in the case of a
Selling Securityholder, to the provisions of paragraph (f) of Section 7), the
Company and the Selling Securityholders hereby jointly and severally agree to
reimburse on a quarterly basis the Underwriters for all reasonable legal and
other expenses incurred in connection with investigating or defending any claim,
action, investigation, inquiry or other proceeding arising out of or based upon
any statement or omission, or any alleged statement or omission, described in
paragraph (a) of Section 7 of this Agreement, notwithstanding the absence of a
judicial determination as to the propriety and enforceability of the obligations
under this Section 11 and the possibility that such payments might later be held
to be improper; provided, however, that (i) to the extent any such payment is
ultimately held to be improper, the persons receiving such payments shall
promptly refund them and (ii) such persons shall provide to the Company, upon
request, reasonable assurances of their ability to effect any refund, when and
if due.
16
<PAGE> 17
12. PERSONS ENTITLED TO BENEFIT OF AGREEMENT. This Agreement shall inure to
the benefit of the Company, the Selling Securityholders and the several
Underwriters and, with respect to the provisions of Section 7 hereof, the
several parties (in addition to the Company, the Selling Securityholders and the
several Underwriters) indemnified under the provisions of said Section 7, and
their respective personal representatives, successors and assigns. Nothing in
this Agreement is intended or shall be construed to give to any other person,
firm or corporation any legal or equitable remedy or claim under or in respect
of this Agreement or any provision herein contained. The term "successors and
assigns" as herein used shall not include any purchaser, as such purchaser, of
any of the Stock from any of the several Underwriters.
13. NOTICES. Except as otherwise provided herein, all communications
hereunder shall be in writing or by facsimile and, if to the Underwriters, shall
be mailed, faxed, telegraphed or delivered to Hambrecht & Quist LLC, One Bush
Street, San Francisco, California 94104; and if to the Company, shall be mailed,
faxed, telegraphed or delivered to it at its office, 2800 San Tomas Expressway,
Santa Clara, CA 95051, Attention: Chief Financial Officer, with a copy to
Wilson, Sonsini, Goodrich & Rosati, 650 Page Mill Road, Palo Alto, California
94304, Attention: Francis S. Currie; and if to the Selling Securityholders,
shall be mailed, faxed, telegraphed or delivered to the Selling Securityholders
at their respective addresses set forth in Schedule II hereto. All notices given
by facsimile or telegraph shall be promptly confirmed by letter.
14. MISCELLANEOUS. The reimbursement, indemnification and contribution
agreements contained in this Agreement and the representations, warranties and
covenants in this Agreement shall remain in full force and effect regardless of
(a) any termination of this Agreement, (b) any investigation made by or on
behalf of any Underwriter or controlling person thereof, or by or on behalf of
the Company or the Selling Securityholders or their respective directors or
officers, and (c) delivery and payment for the Stock under this Agreement;
provided, however, that if this Agreement is terminated prior to the Closing
Date, the provisions of paragraph (1) of Section 6 hereof shall be of no further
force or effect.
This Agreement may be executed in two or more counterparts, each of which
shall be deemed an original, but all of which together shall constitute one and
the same instrument.
This Agreement shall be governed by, and construed in accordance with, the
laws of the State of California.
Please sign and return to the Company and to the Selling Securityholders in
care of the Company the enclosed duplicates of this letter, whereupon this
letter will become a binding agreement among the Company, the Selling
Securityholders and the several Underwriters in accordance with its terms.
Very truly yours,
RATIONAL SOFTWARE CORPORATION
By______________________________________
Paul D. Levy
Chairman and Chief Executive Officer
17
<PAGE> 18
SELLING SECURITYHOLDERS:
ERICSSON INC.
By_______________________________________
Name_____________________________________
Title____________________________________
_________________________________________
IVAR JACOBSON
The foregoing Agreement is hereby confirmed
and accepted as of the date first above written.
HAMBRECHT & QUIST LLC
GOLDMAN, SACHS & CO.
WESSELS, ARNOLD & HENDERSON, LLC
By Hambrecht & Quist LLC
By __________________________
Acting on behalf of the several Underwriters,
including themselves, named in Schedule I hereto.
18
<PAGE> 19
SCHEDULE I
UNDERWRITERS
NUMBER OF
SHARES TO BE
UNDERWRITER PURCHASED
- ----------- ------------
Hambrecht & Quist LLC...............................................
Goldman, Sachs & Co.................................................
Wessels, Arnold & Henderson, LLC....................................
------------
Total 5,106,718
<PAGE> 20
SCHEDULE II
SELLING SECURITYHOLDERS
<TABLE>
<CAPTION>
NUMBER OF
NAME AND ADDRESS SHARES
OF SELLING SECURITYHOLDER TO BE SOLD
- ------------------------- ----------
<S> <C>
Ericsson Inc.......................................................... 544,174
Attn: Mr. Joseph L. Hagan
740 E. Campbell Road
Richardson, TX 75081
Ivar Jacobson......................................................... 412,544
Nybrogatan 45 C
S-11439 Stockholm, Sweden
-----------
Total 956,718
</TABLE>
<PAGE> 21
ANNEX A
MATTERS TO BE COVERED IN THE OPINION OF COUNSEL FOR THE COMPANY
(i) Each of the Company and its material subsidiaries has been duly
incorporated and is validly existing as a corporation in good standing under
the laws of the jurisdiction of its incorporation, is duly qualified as a
foreign corporation and in good standing in each state of the United States
of America in which its ownership or leasing of property requires such
qualification (except where the failure to be so qualified would not have a
material adverse effect on the business, properties, financial condition or
results of operations of the Company and its subsidiaries, taken as a
whole), and has full corporate power and authority to own or lease its
properties and conduct its business as described in the Registration
Statement; all the issued and outstanding capital stock of each of the
subsidiaries of the Company has been duly authorized and validly issued and
is fully paid and nonassessable, and is owned by the Company free and clear
of all liens, encumbrances and security interests, and to the best of such
counsel's knowledge, no options, warrants or other rights to purchase,
agreements or other obligations to issue or other rights to convert any
obligations into shares of capital stock or ownership interests in such
subsidiaries are outstanding;
(ii) the authorized capital stock of the Company consists of
seventy-five million (75,000,000) shares of Common Stock, $0.01 par value,
of which there are outstanding ________ shares (including the Underwritten
Stock plus the number of shares of Option Stock issued on the date hereof);
proper corporate proceedings have been taken validly to authorize such
authorized capital stock; all of the outstanding shares of such capital
stock (including the Underwritten Stock and the shares of Option Stock
issued, if any) have been duly and validly issued and are fully paid and
nonassessable; any Option Stock purchased after the Closing Date, when
issued and delivered to and paid for by the Underwriters as provided in the
Underwriting Agreement, will have been duly and validly issued and be fully
paid and nonassessable; and no preemptive rights of, or rights of refusal in
favor of, stockholders exist with respect to the Stock, or the issue and
sale thereof, pursuant to the Certificate of Incorporation or Bylaws of the
Company and, to the knowledge of such counsel, there are no contractual
preemptive rights that have not been waived, rights of first refusal or
rights of co- sale which exist with respect to the Stock being sold by the
Selling Securityholders or the issue and sale of the Stock;
(iii) the Registration Statement has become effective under the
Securities Act and, to the best of such counsel's knowledge, no stop order
suspending the effectiveness of the Registration Statement or suspending or
preventing the use of the Prospectus is in effect and no proceedings for
that purpose have been instituted or are pending or contemplated by the
Commission;
(iv) the Registration Statement and the Prospectus (except as to the
financial statements and schedules and other financial data contained
therein, as to which such counsel need express no opinion) comply as to form
in all material respects with the requirements of the Securities Act, the
Exchange Act and with the rules and regulations of the Commission
thereunder;
A-1
<PAGE> 22
(v) such counsel have no reason to believe that the Registration
Statement (except as to the financial statements and schedules and other
financial data contained or incorporated by reference therein, as to which
such counsel need not express any opinion or belief) at the Effective Date
contained any untrue statement of a material fact or omitted to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading, or that the Prospectus (except as to the
financial statements and schedules and other financial data contained or
incorporated by reference therein, as to which such counsel need not express
any opinion or belief) as of its date or at the Closing Date (or any later
date on which Option Stock is purchased), contained or contains any untrue
statement of a material fact or omitted or omits to state a material fact
necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading;
(vi) the information required to be set forth in the Registration
Statement in answer to Items 9 and 10 (insofar as it relates to such
counsel) of Form S-3 is to the best of such counsel's knowledge accurately
and adequately set forth therein in all material respects or no response is
required with respect to such Items, and, to the best of such counsel's
knowledge, the description of the Company's stock option plans and the
options granted and which may be granted thereunder and the options granted
otherwise than under such plans set forth or incorporated by reference in
the Prospectus accurately and fairly presents the information required to be
shown with respect to said plans and options to the extent required by the
Securities Act and the rules and regulations of the Commission thereunder;
(vii) such counsel do not know of any franchises, contracts, leases,
documents or legal proceedings, pending or threatened, which in the opinion
of such counsel are of a character required to be described in the
Registration Statement or the Prospectus or to be filed as exhibits to the
Registration Statement, which are not described and filed or incorporated by
reference as required;
(viii) the Underwriting Agreement has been duly authorized, executed
and delivered by the Company;
(ix) the issue and sale by the Company of the shares of Stock sold by
the Company as contemplated by the Underwriting Agreement will not conflict
with, or result in a breach of, the Certificate of Incorporation or Bylaws
of the Company or any of its subsidiaries or any agreement or instrument
known to such counsel to which the Company or any of its subsidiaries is a
party or any applicable law or regulation, or so far as is known to such
counsel, any order, writ, injunction or decree, of any jurisdiction, court
or governmental instrumentality;
(x) to the best knowledge of such counsel, all holders of securities
of the Company having rights to the registration of shares of Common Stock,
or other securities, because of the filing of the Registration Statement by
the Company have waived such rights or such rights have expired by reason of
lapse of time following notification of the Company's intent to file the
Registration Statement; and
(xi) the Stock sold by the Selling Securityholders is listed and duly
admitted to trading on the Nasdaq National Market, and the Stock issued and
sold by the Company will been duly authorized for listing by the Nasdaq
National Market upon official notice of issuance.
A-2
<PAGE> 23
------------------------------------
Counsel rendering the foregoing opinion may rely as to questions of law not
involving the laws of the United States or of the State of Delaware, upon
opinions of local counsel satisfactory in form and scope to counsel for the
Underwriters. Copies of any opinions so relied upon shall be delivered to the
Representatives and to counsel for the Underwriters and the foregoing opinion
shall also state that counsel knows of no reason the Underwriters are not
entitled to rely upon the opinions of such local counsel.
A-3
<PAGE> 24
MATTERS TO BE COVERED IN THE OPINION OF COUNSEL FOR THE SELLING SECURITYHOLDERS
(i) Based insofar as factual matters are concerned solely upon
certificates of the Selling Securityholders, the accuracy of which we have
no reason to question, (A) the Underwriting Agreement has been duly executed
and delivered by or on behalf of each of the Selling Securityholders; (B)
the Custody Agreement between the Selling Securityholders and Chasemellon
Shareholder Services, L.L.C., as Custodian, and the Power of Attorney
referred to in such Custody Agreement have been duly executed and delivered
by such Selling Securityholder; (C) the Custody Agreement entered into by,
and the Power of Attorney given by, such Selling Securityholder is valid and
binding on such Selling Securityholder; and (D) each Selling Securityholder
has full legal right and authority to enter into the Underwriting Agreement
and to sell, transfer and deliver in the manner provided in the Underwriting
Agreement the shares of Stock sold by such Selling Securityholder hereunder;
(ii) good and marketable title to the shares of Stock sold by the
Selling Securityholders under the Underwriting Agreement, free and clear of
all liens, encumbrances, equities, security interests and claims, has been
transferred to the Underwriters who have severally purchased such shares of
Stock under the Underwriting Agreement, assuming for the purpose of this
opinion that the Underwriters purchased the same in good faith without
notice of any adverse claims; and
(iii) based insofar as factual matters with respect to the stock to be
sold by the Selling Securityholders are concerned solely upon certificates
of the Selling Securityholders, the accuracy of which such counsel have no
reason to question, no consent, approval, authorization or order of any
court or governmental agency or body is required for the consummation of the
transactions contemplated in the Underwriting Agreement, except such as have
been obtained under the Securities Act and such as may be required under
state securities or blue sky laws in connection with the purchase and
distribution of the Stock by the Underwriters.
A-4
<PAGE> 1
Exhibit 4.01
<PAGE> 2
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
OF
RATIONAL SOFTWARE CORPORATION
1. The name of the corporation is:
RATIONAL SOFTWARE CORPORATION.
2. The address of its registered office in the State of Delaware
is located at Corporation Trust Center, 1209 Orange Street, City of Wilmington,
County of New Castle and the name of its registered agent at such address is The
Corporation Trust Company.
3. The nature of the business or purposes to be conducted or
promoted is to engage in any lawful act or activity for which corporations may
be organized under the General Corporation Law of Delaware.
4. (a) The total number of shares of Common Stock which the
corporation shall have authority to issue shall be seventy-five million
(75,000,000) and each of such shares shall have a par value of one cent ($0.01).
(b) The shares of Common Stock may be issued from time to time
for such consideration as the Board of Directors may determine. Each holder of
shares of Common Stock shall be entitled to one vote for each share of Common
Stock held of record on all matters on which the holders of Common Stock are
entitled to vote.
5. The Board of Directors is authorized to make, alter or
repeal the By-laws of the corporation. Election of directors need not be by
ballot.
6. The name and mailing address of the incorporator is:
L. M. Custis
100 West Tenth Street
Wilmington, Delaware 19801
7. (a) To the fullest extent permitted by the Delaware General
Corporation Law as the same exists or as may hereafter be amended, a director of
the Corporation shall not be personally liable to the Corporation or its
stockholders for monetary damages for breach of fiduciary duty as a director.
(b) The Corporation may indemnify to the fullest extent
permitted by law any person made or threatened to be made a party to an action
or proceeding, whether criminal, civil, administrative or investigative, by
reason of the fact that he, his testator or intestate is or was a director,
officer or employee of the Corporation or any predecessor of the Corporation or
serves or served at any other
<PAGE> 3
enterprise as a director, officer or employee at the request of the Corporation
or any predecessor to the Corporation.
(c) Neither any amendment nor repeal of this Paragraph Seven,
nor the adoption of any provision of this Corporation's Certificate of
Incorporation inconsistent with this Paragraph Seven, shall eliminate or reduce
the effect of this Paragraph Seven, in respect of any matter occurring, or any
action or proceeding accruing or arising or that, but for this Paragraph Seven,
would accrue or arise, prior to such amendment, repeal or adoption of an
inconsistent provision.
8. The authorized number of directors of this Corporation shall
be not less than 5 and not more than 13. The number of directors within this
range shall be stated in the Corporation's By-laws, as may be amended from time
to time. When the number of directors is changed, the Board of Directors shall
determine the class or classes to which the increased or decreased number of
directors shall be apportioned; provided that the directors in each class shall
be as nearly equal in number as possible. No decrease in the number of directors
shall have the effect of shortening the term of any incumbent director.
Effective as of the annual meeting of stockholders in 1992,
the Board of Directors shall be divided into three classes, designated as Class
I, Class II and Class III, as nearly equal in number as possible, and the term
of office of directors of one class shall expire at each annual meeting of
stockholders and in all cases until their successors shall be elected and shall
qualify, or until their earlier resignation, removal from office, death or
incapacity. The initial term of office of Class I shall expire at the annual
meeting of stockholders in 1993, that of Class II shall expire at the annual
meeting in 1994, and that of Class III shall expire at the annual meeting in
1995, and in all cases as to each director until his successor shall be elected
and shall qualify, or until his earlier resignation, removal from office, death
or incapacity.
Subject to the foregoing, at each annual meeting of
stockholders the successors to the class of directors whose term shall then
expire shall be elected to hold office for a term expiring at the third
succeeding annual meeting and until their successors shall be elected and
qualified.
The directors remaining in office acting by a majority vote,
or a sole remaining director, although less than a quorum, are hereby expressly
delegated the power to fill any vacancies in the Board of Directors, however
occurring, whether by an increase in the number of directors, death,
resignation, retirement, disqualification, removal from office or otherwise, and
any director so chosen shall hold office until the next election of the class
for which such director shall have been chosen and until his successor shall
have been elected and qualified, or until his earlier resignation, removal from
office, death or incapacity.
<PAGE> 1
Exhibit 5.01
<PAGE> 2
October 2, 1996
Rational Software Corporation
2800 San Tomas Expressway
Santa Clara, CA 95051
RE: REGISTRATION STATEMENT ON FORM S-3
Gentlemen:
We have examined the Registration Statement on Form S-3 to
be filed by you with the Securities and Exchange Commission on October 2, 1996
(the "Registration Statement"), in connection with the registration under the
Securities Act of 1933, as amended, of 5,872,725 shares of your Common Stock
(the "Shares"), 4,916,007 of which are authorized but heretofore unissued
(including an over-allotment option for 766,007 shares) and 956,718 of which
will be sold by certain selling shareholders (including an over-allotment option
for 0 shares). The Shares are to be sold to the underwriters for resale to the
public as described in the Registration Statement and pursuant to the
Underwriting Agreement filed as an exhibit thereto. As your counsel, we have
examined the proceedings proposed to be taken in connection with said sale and
issuance of the Shares.
It is our opinion that, upon completion of the proceedings
being taken or contemplated by us, as your counsel, to be taken prior to the
issuance of the Shares, and upon completion of the proceedings being taken in
order to permit such transactions to be carried out in accordance with the
securities laws of the various states, where required, the Shares when issued
and sold in the manner referred to in the Registration Statement will be legally
and validly issued, fully paid and nonassessable.
We consent to the use of this opinion as an exhibit to the
Registration Statement, and further consent to the use of our name wherever
appearing in the Registration Statement, including the Prospectus constituting a
part thereof, and any amendment thereto.
Very truly yours,
/s/ Wilson Sonsini Goodrich & Rosati
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
<PAGE> 1
EXHIBIT 23.01
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to the
use of our reports dated, April 22, 1996, in the Registration Statement (Form
S-3) and related Prospectus of Rational Software Corporation for the
registration of up to 5,872,725 shares of its common stock.
ERNST & YOUNG LLP
San Jose, California
October 1, 1996
