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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _____ to _____
COMMISSION FILE NUMBER 0-12167
RATIONAL SOFTWARE CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 54-1217099
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
18880 HOMESTEAD ROAD, CUPERTINO, CA 95014
(Address of principal executive office) (Zip Code)
408-863-9900
(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
COMMON STOCK, PAR VALUE 87,711,445
$.01 PER SHARE
(Class) (Shares outstanding on October 31,
1997)
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<TABLE>
<CAPTION>
CONTENTS PAGE
<S> <C>
PART I -- FINANCIAL INFORMATION
Item 1 -- Consolidated Financial Statements:
Condensed Consolidated Balance Sheets........................ 3
Condensed Consolidated Statements of Operations.............. 5
Condensed Consolidated Statements of Cash Flows.............. 6
Notes to Condensed Consolidated Financial Statements......... 7
Item 2 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 10
PART II -- OTHER INFORMATION
Item 1 -- Legal Proceedings........................................... 24
Item 4 -- Submission of Matters to a Vote of Security Holders......... 24
Item 6 -- Exhibits and Reports on Form 8-K............................ 25
SIGNATURE................................................................ 27
</TABLE>
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RATIONAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
- ------ September 30, March 31,
1997 1997
-------- --------
(Unaudited) (Note A)
<S> <C> <C>
Cash and cash equivalents $141,484 $244,856
Short-term investments 150,094 82,539
Accounts receivable, net 54,349 63,043
Prepaid expenses and other assets 16,464 15,975
-------- --------
Total current assets 362,391 406,413
Property and equipment, at cost:
Computer, office and manufacturing equipment 61,346 46,663
Office furniture 7,844 7,256
Leasehold improvements 6,072 3,789
-------- --------
75,262 57,708
Accumulated depreciation and amortization (37,544) (31,443)
-------- --------
Property and equipment, net 37,718 26,265
Other assets, net 18,974 24,062
-------- --------
Total assets $419,083 $456,740
======== ========
</TABLE>
Note A: The balance sheet at March 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements.
3
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RATIONAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------ September 30, March 31,
1997 1997
--------- ---------
(Unaudited) (Note A)
<S> <C> <C>
Accounts payable $ 10,760 $ 13,783
Accrued employee benefits 24,415 21,256
Other accrued expenses 19,461 19,566
Accrued merger and restructuring expenses, current portion 49,994 24,607
Deferred revenue 41,465 42,217
Current portion of long-term debt and lease obligations 1,782 2,010
--------- ---------
Total current liabilities 147,877 123,439
Accrued rent 333 535
Accrued merger and restructuring expenses, long-term 5,884 916
Long-term debt 1,684 1,741
--------- ---------
Total liabilities 155,778 126,631
--------- ---------
Stockholders' equity:
Common stock, $.01 par value, 150,000
shares authorized 876 845
Additional paid-in capital 492,041 455,753
Treasury stock (1,340) (1,340)
Accumulated deficit (226,480) (123,828)
Cumulative translation adjustment (1,792) (1,321)
--------- ---------
Total stockholders' equity 263,305 330,109
--------- ---------
Total liabilities and stockholders' equity $ 419,083 $ 456,740
========= =========
</TABLE>
Note A: The balance sheet at March 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements.
4
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RATIONAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months ended Six Months ended
September 30, September 30,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Net product revenue $ 46,255 $44,076 $ 84,610 $ 84,569
Consulting and support revenue 28,713 21,942 56,506 42,081
-------- ------- -------- --------
Total revenue 74,968 66,018 141,116 126,650
Cost of product revenue 4,902 2,974 8,775 5,476
Cost of consulting and support revenue 9,014 8,492 20,424 16,752
-------- ------- -------- --------
Total cost of revenue 13,916 11,466 29,199 22,228
-------- ------- -------- --------
Gross margin 61,052 54,552 111,917 104,422
Product research and development expenses 17,490 11,058 30,979 21,522
Sales and marketing expenses 40,987 25,796 69,525 49,950
General and administrative expenses 8,202 5,752 15,121 10,979
Merger costs 63,759 - 63,759 -
-------- ------- -------- --------
Total operating expenses 130,438 42,606 179,384 82,451
-------- ------- -------- --------
Operating income (loss) (69,386) 11,946 (67,467) 21,971
Other income, net 4,716 1,931 9,301 3,639
-------- ------- -------- --------
Income (loss) before income taxes (64,670) 13,877 (58,166) 25,610
Provision (benefit) for income taxes (51) 3,367 1,325 6,156
-------- ------- -------- --------
Net income (loss) $(64,619) $10,510 $(59,491) $ 19,454
======== ======= ======== ========
Net income (loss) per common share $ (0.74) $ 0.12 $ (0.68) $ 0.23
Shares used in computing per share amounts 87,240 84,213 86,898 83,750
</TABLE>
5
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RATIONAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
<TABLE>
<CAPTION>
Six Months ended
September 30,
--------- --------
1997 1996
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net Income (loss) $(59,491) $ 19,454
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 7,746 5,390
Noncash expense for stock options - 1,612
Deferred income taxes - (115)
(Increase) decrease in assets:
Accounts receivable 8,694 (7,786)
Prepaids and other, net 2,954 (2,109)
Increase (decrease) in liabilities:
Accounts payable (3,023) 741
Accrued employee benefits 3,159 (372)
Deferred revenue (752) 2,477
Accrued expenses (307) 2,634
Accrued merger and restructuring expenses 30,355 (1,892)
--------- --------
Net cash provided (used) by operating activities (10,665) 20,034
Cash flows used in investing activities:
Purchase of investments (124,753) (8,491)
Sale of investments 57,198 10,804
Capital expenditures (17,554) (9,982)
Net effect of merger with Pure Atria (12,069) -
--------- --------
Net cash used in investing activities (97,178) (7,669)
Cash flows from financing activities:
Principal payments under debt and lease obligations (285) (948)
Proceeds from issuance of common stock 5,227 11,237
--------- --------
Net cash provided by financing activities 4,942 10,289
--------- --------
Effect of foreign currency exchange rate changes on cash (471) (462)
Net increase (decrease) in cash and cash equivalents (103,372) 22,192
Cash and cash equivalents at beginning of period 244,856 104,672
--------- --------
Cash and cash equivalents at end of period $ 141,484 $126,864
========= ========
</TABLE>
6
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RATIONAL SOFTWARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.BASIS OF PRESENTATION -- The consolidated financial information included
herein has been prepared without audit in accordance with the Company's
accounting policies, as described in its latest annual report filed with the
Securities and Exchange Commission on Form 10-K. In the opinion of management,
all adjustments, which consist only of normal recurring adjustments necessary
for a fair presentation of the Company's financial position, results of
operations, and cash flows for the interim periods presented have been made.
As permitted by Form 10-Q, certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted.
Operating results for the period ended September 30, 1997 are not necessarily
indicative of the results that may be expected for the fiscal year ending
March 31, 1998.
On February 26, 1997 the Company merged with SQA, Inc. ("SQA") and on July
30, 1997 the Company merged with Pure Atria Corporation ("Pure Atria"). Both
mergers were accounted for as a pooling-of-interests and the historical
consolidated financial statements of the Company for prior periods have been
restated to include the financial position, results of operations and cash
flows of both SQA and Pure Atria. See Note 3 and Note 13 in the Notes to
Consolidated Financial Statements in the Company's Annual Report to
Stockholders (Form 10-K) for the year ended March 31, 1997.
2. MERGER WITH PURE ATRIA CORPORATION
On July 30, 1997, the Company completed the acquisition of Pure Atria
Corporation ("Pure Atria"). Under the terms of the acquisition, which was
accounted for as a pooling of interests, the Company exchanged approximately
thirty nine million (39,000,000) shares of common stock for all of Pure
Atria's outstanding shares and assumed approximately eight million (8,000,000)
options to purchase its common stock, at a common exchange ratio of 0.9 of a
share of the Company's common stock for each share of Pure Atria's common
stock. Pure Atria, based in Cupertino, California, is a leading provider of
software products that enable the production of reliable, high-quality
software and improves the development process. Components of the consolidated
results of operations of Rational and Pure Atria for periods prior to the
acquisition are as follows:
<TABLE>
<CAPTION>
Rational Pure
Software Atria
Corporation Corp. Combined
----------- ------- --------
<S> <C> <C> <C>
Three months ended September 30, 1996
Revenue 34,025 31,993 66,018
Net income 5,872 4,638 10,510
Six months ended September 30, 1996
Revenue 66,027 60,623 126,650
Net income 10,965 8,489 19,454
Three months ended June 30, 1997
Revenue 42,928 23,220 66,148
Net income (loss) 7,814 (2,686) 5,128
</TABLE>
During the second quarter of the fiscal year ending March 31, 1998, the
Company recorded a $63.8 million charge to operating expenses related to
merger and integration costs. Pure Atria
7
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merger costs consist principally of transaction fees for investment bankers,
attorneys, accountants, financial printing, and other related charges of $15.7
million. Pure Atria integration costs include severance and other employee
related charges, elimination of redundant facilities, write-off of excess
property and equipment and certain intangible assets, and other professional
fees of approximately $48.1 million.
3.ACCOUNTS RECEIVABLE -- Accounts receivable were reduced by an allowance for
doubtful accounts of $3,496,000 at September 30, 1997 and $4,064,000 at March
31, 1997, respectively.
4.NET INCOME PER COMMON SHARE -- Net income (loss) per share has been computed
by dividing the net income (loss) by the weighted average numbers of common
and dilutive common equivalent shares outstanding during the period. Common
stock equivalents consist of stock options using the treasury stock method.
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings Per Share, which is required to be adopted on March 31,
1998. At that time the Company will be required to change the method
currently used to compute earnings per share and restate all prior periods.
Under the new requirements for calculating primary earnings per share, the
dilutive effects of stock options will be excluded. The impact is not
expected to result in a change in primary earnings per share for the three-
and six- month periods ended September 30, 1997, and will increase primary
earnings per share for the three- and six-month periods ended September 30,
1996 by $0.01 and $0.02, respectively. The impact of Statement 128 on the
calculation of fully diluted earnings per share for these quarters is not
expected to be material.
5.CONTINGENCY -- On December 16, 1996, the Company filed a lawsuit against
Silicon Graphics, Inc. ("SGI") arising from SGI's failure to pay certain
royalties due to the Company under a software license agreement entered into
between the Company's predecessor, Verdix Corporation, and SGI. SGI has filed
an answer denying the Company's allegations, and also filed a cross-complaint
against the Company for unspecified damages for alleged wrongdoing arising out
of the license agreement with SGI. The Company denies the allegations and
intends to vigorously defend SGI's claims.
The Company and two of its officers were named as defendants in a number of
purported shareholder class action complaints recently filed in federal court
for the Northern District of California, alleging that the Company selectively
disclosed information to a financial analyst on October 8, 1997, in violation
of federal securities laws. The Company believes that the claims are without
merit and intends to defend itself vigorously, although there can be no
assurance that it will be successful in defending these actions.
From time to time the Company is subject to legal claims. Historically, the
cost of resolution of the claims has not been significant, and the Company is
not aware of any asserted or unasserted claims pending against it, including
the suits mentioned above, the resolution of which would have a material
adverse impact on the operations or financial position of the Company.
6.SUBSEQUENT EVENTS
On November 4, 1997 the Company's board of directors approved a program
enabling the Company to re-price stock options for most employees. Excluded
from participating in the program are members of Rational's board of
directors; Rational's CEO, Paul Levy; Rational's president, Mike Devlin; and
other members of the senior executive team. The re-priced options will be
subject to additional lock-up and repurchase restrictions.
8
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The Company has signed an agreement with ObjecTime, Ltd., a Canadian
corporation ("OTL"), whereby (i) Rational has agreed to acquire 19.9% of the
outstanding capital stock of OTL from OTL and certain stockholders of OTL for
approximately $9 million, (ii) the stockholders of OTL are to grant Rational
an option to purchase all of the outstanding capital stock of OTL and all of
the outstanding options, warrants and rights therefor, subject to certain
terms and conditions, for an aggregate price of approximately $62 million, and
(iii) Rational, OTL and certain stockholders of OTL will enter into certain
other agreements related to the foregoing transactions.
9
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ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The statements contained in Management's Discussion and Analysis of Financial
Condition and Results of Operations include "forward looking" information within
the meaning of Sections 27A of the Securities Act of 1993 and 21E of the
Securities and Exchange Act of 1934, as amended, and are subject to the safe
harbor created by those sections. The actual future results of the Company
could differ materially from those projected in the forward looking information.
For a discussion of certain factors that could cause actual results to differ
materially from those projected by the forward looking information see "Factors
That May Affect Future Results", at the end of this item 2.
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 historically there have been only immaterial amounts.
On February 26, 1997 the Company merged with SQA, Inc. ("SQA") and on July 30,
1997 the Company merged with Pure Atria Corporation ("Pure Atria"). Both
mergers were accounted for as a pooling-of-interests and the historical
consolidated financial statements of the Company for prior periods have been
restated to include the financial position, results of operations and cash flows
of both SQA and Pure Atria. See Note 3 and Note 13 in the Notes to Consolidated
Financial Statements in the Company's Annual Report to Stockholders (Form 10-K)
for the year ended March 31, 1997.
COMPARATIVE ANALYSIS OF OPERATING RESULTS FOR THE THREE AND SIX MONTHS ENDED
SEPTEMBER 30, 1997
Total revenue increased 14% and 11%, respectively, for the three- and six-month
periods ended September 30, 1997 from the comparable prior year periods.
Net product revenue increased by 5% and less than 1%, respectively, for the
three- and six-month periods ended September 30, 1997 from the comparable prior
year periods. The increase in net product revenue for these periods was due
primarily to increased revenue from the Company's visual modeling tools (the
Rational Rose family), and configuration management products (ClearCase family),
offset by a decline in revenue from some of the Company's automated software
testing and quality products.
Consulting and support revenue increased 31% and 34%, respectively, for the
three- and six-month periods ended September 30, 1997 from the comparable prior
year periods. This increase reflects 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.
International revenues from product sales and related consulting and customer
support accounted for 32% and 34%, respectively, of total revenues for the
three- and six-month periods ended September 30, 1997, as compared to 31% and
28%, respectively, for the comparable prior year periods. The Company's
international sales are principally priced in foreign currencies and are
generally exported out of the U.S. From time to time the Company enters into
short-term forward exchange contracts to hedge against the impact of foreign
currency fluctuations on the accounts receivable denominated in foreign
currencies. The total amount of these contracts is offset by the underlying
foreign currency denominated accounts receivable. The gains or losses on the
contracts are included in income as the contracts expire and are offset by gains
and losses on the underlying receivables being hedged. At September 30, 1997,
the Company had outstanding forward exchange contracts, all having maturities of
approximately 35 days, to exchange various European currencies for US dollars in
the amounts of $2,704,000. One major U.S. multinational bank is counterparty to
all these contracts. The associated gains and losses were not material to the
Company's results of operations in any period presented. There were no forward
exchange contracts outstanding at September 30, 1996.
10
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Cost of product revenue consists principally of materials, packaging and
freight, amortization of developed technology and royalties. Cost of product
revenue increased 65% and 60%, respectively, for the three- and six-month
periods ended September 30, 1997 from the comparable prior year periods. These
costs represented 11% and 10%, respectively, of total product revenue for the
three- and six-month periods ended September 30, 1997, as compared to 7% and 6%
for the comparable prior year periods. The increase in product cost as a
percentage of product revenue was due mainly to amortization of developed
technology associated with recent mergers and acquisitions.
Cost of consulting and support revenue consists principally of personnel costs
for training, consulting and customer support. Cost of consulting and support
increased 6% and 22% respectively, for the three- and six-month periods ended
September 30, 1997 from the comparable prior year periods. These costs
represented 31% and 36%, respectively, of total consulting and support revenue
for the three- and six-month periods ended September 30, 1997 as compared to 39%
and 40% for the comparable prior year periods. The decrease in cost as a
percentage of related revenue is primarily due to changes to the Company's
customer support business model as a result of merging the Pure Atria and
Rational service organizations, combined with the impact of an underlying
relatively fixed support cost base being spread over increased revenues.
Total expenditures for research and development increased 58% and 44%
respectively, for the three- and six-month periods ended September 30, 1997 from
the comparable prior year periods. These costs represented 23% and 22%,
respectively, of total revenue for the three- and six-month periods ended
September 30, 1997 as compared to 17% for both of the comparable prior year
periods. The increase in expenditures for research and development is due
primarily to the cost of additional personnel and related costs incurred in
maintaining existing products and developing new product releases and increased
operating expenses resulting from the recently completed merger with Pure Atria.
Sales and marketing expenses increased 59% and 39% respectively, for the three-
and six-month periods ended September 30, 1997 from the comparable prior year
periods. These costs represented 55% and 49%, respectively, of total revenue
for the three- and six-month periods ended September 30, 1997 as compared to 39%
for both of the comparable prior year periods. The comparative increase in
sales and marketing expenses reflect the additional personnel, commissions and
related costs required in sales and marketing departments to expand Rational's
sales channels, to penetrate new markets, and to increase its market share in
core markets. In the current quarter the Company also incurred additional
marketing and field training costs associated with the recently completed merger
with Pure Atria.
General and administrative expense consists of personnel costs for
administration, finance, information systems, human resources and general
management, as well as legal and accounting expenses. General and administrative
expense increased 43% and 38% respectively, for the three- and six-month periods
ended September 30, 1997 from the comparable prior year periods. These costs
represented 11% of total revenue for both of the three- and six-month periods
ended September 30, 1997 as compared to 9% for both of the comparable prior year
periods. The increased expense for the fiscal 1998 period resulted from employee
related expenses associated with the staffing requirements needed to support the
Company's expanding business, and from an increase in amortization of purchased
intangibles related to the Company's recent mergers and acquisitions.
In the three month period ended September 30, 1997 the Company recorded a charge
of $63.8 million related to the combination of Rational and Pure Atria. There
can be no assurance that Rational will not incur additional charges associated
with the merger or that management will be successful in its efforts to
integrate the operations of the two companies.
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 has fluctuated as a result of the amount of cash available
for investment in interest-bearing accounts and from foreign currency
transactions. Other income, net increased $2,785,000 and $5,662,000,
respectively, for the three- and
11
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six-month periods ended September 30, 1997 from the corresponding prior year
periods. The increases are primarily the result of investment earnings on the
additional cash generated by the Company's public offering in October 1996.
The provision for income taxes for the three- and six-month periods ended
September 30, 1997 is based on the estimated annual effective tax rate applied
to the profit before income taxes (excluding one-time charges for acquired in-
process research and development) and includes current federal, state and
foreign income taxes. The provision for income taxes for the three- and six-
month periods ending September 30, 1997 consists primarily of foreign income
taxes as well as federal and state minimum taxes. The effective tax rates for
fiscal 1998 and 1997 differ from the federal statutory rate, primarily, as a
result of the utilization of net operating loss carryforwards, the
non-deductability of certain merger related costs, and by certain foreign and
state taxes.
LIQUIDITY AND CAPITAL RESOURCES AT SEPTEMBER 30, 1997
As of September 30, 1997, the Company had cash, cash equivalents and short-term
investments of $291,578,000 and working capital of $214,514,000. Net cash used
in operating activities for the period ending September 30, 1997 was composed
primarily of the operating loss and a decrease in accounts payable, offset by an
increase in accrued merger costs and accrued employee benefits. Net cash used in
investing activities is primarily a result of increased short-term cash
investments, capital expenditures and the net effect of the merger with Pure
Atria Corporation. Net cash provided by financing activities is primarily the
result of issuance of common stock under the 1994 Employee Stock Purchase Plan
and exercise of employee stock options.
The Company believes that expected cash flow from operations combined with
existing cash and cash equivalents and short-term investments will be sufficient
to meet its cash requirements for the foreseeable future.
12
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FACTORS THAT MAY AFFECT FUTURE RESULTS
Risks related to the Recent Acquisition of Pure Atria Corporation.
- -----------------------------------------------------------------
Rational acquired Pure Atria Corporation ("Pure Atria") on July 30, 1997 with
the expectation that the acquisition would result in long-term strategic
benefits. The realization of these anticipated benefits will depend in part on
whether the companies' operations can be integrated in an efficient and
effective manner. There can be no assurance that this will occur. The successful
integration of Pure Atria's operations into Rational will require, among other
things, integration of the companies' respective product offerings and
coordination of the companies' sales and marketing efforts and research and
development efforts. Successful integration of the companies' respective sales
forces will require sales personnel to quickly become familiar with the sales
cycles and sales approaches required for products newly added to their
portfolios, and any failure to do so may result in sales delays and decreased
revenues for the Company. It is possible that the intended integration of the
companies' respective products, and the creation of integrated bundles and
suites, may not be accomplished in a timely manner or may prove to be
technologically infeasible. The difficulties of integrating the two companies'
respective operations will be compounded by the fact that each company has
significant operations on both the East Coast and the West Coast of the United
States and in a number of foreign countries. The acquisition of Pure Atria may
cause resellers and present and potential customers of either company to delay
or cancel orders as a result of concerns and uncertainty over evolution,
integration and support of products. If affiliates of Rational or Pure Atria
sold their Rational Common Stock despite their contractual obligations not to do
so until Rational publicly announced financial results covering at least 30 days
of combined operations, the acquisition of Pure Atria may not qualify for
accounting as a pooling of interests. The failure of such acquisition to
qualify for accounting as a pooling of interests for any reason would materially
and adversely affect Rational's reported earnings and, potentially, its stock
price.
Fluctuations In Operating Results.
- ---------------------------------
Revenue in any quarter is substantially dependent on orders booked and shipped
in that quarter. Because staffing and operating expenses are based on
anticipated revenue levels, and a high percentage of the 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 these trends continue, 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. The
Company's revenue is difficult to forecast due to the fact that Rational's
sales cycles, from initial evaluation to purchase, vary substantially from
customer to customer and from product to product, and because the markets for
Rational's products are rapidly evolving. In addition, the Company's results
will be affected by the number, timing and significance of new product
announcements by it and its competitors, its ability to develop, introduce and
market new and enhanced and integrated versions of its products on a timely
basis, the level of product and price competition, changes in operating
expenses, changes in average selling prices and product mix, any changes in its
sales incentive strategy, the experience level of and any changes in sales
personnel, any changes in sales cycles, the mix of direct and indirect sales,
product returns and general economic factors, among others. The Company's sales
will also be sensitive to existing and prospective customers' budgeting
practices and to potential cutbacks in defense spending, which has historically
been a significant factor for Rational.
13
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The Company incurred direct transaction costs associated with the
acquisition of Pure Atria of approximately $15 million, which resulted in a non-
recurring charge to operations upon consummation of such transaction. The
Company incurred non-recurring charges to operations of approximately $64
million in the quarter ending September 30, 1997, the quarter in which such
transaction was consummated, to reflect costs associated with integrating the
two companies. Unanticipated expenses associated with the integration of the two
companies may arise, or the Company may incur additional material charges in
subsequent quarters to reflect additional costs associated with the integration
of the two companies. Total costs associated with such transactions are
anticipated to result in an operating loss and a net loss for the Company's
fiscal year ending March 31, 1998, and could negatively impact financial results
in future periods for the reasons discussed above.
Although Rational has experienced growth in revenues in recent years, there
can be no assurance that, in the future, Rational will sustain revenue growth or
be profitable on a quarterly or annual basis. Further, the revenues and
operating income (exclusive of nonrecurring operating, restructuring and merger-
related expenses) experienced by Rational in recent quarters are not necessarily
indicative of future results, and period-to-period comparisons of Rational's
financial results should not be relied upon as an indication of future
performance. Fluctuations in operating results may also result in volatility in
the prices of Rational's Common Stock.
Due to all of the foregoing factors, it is possible that in some future
quarter Rational's operating results will be below the expectations of public
market analysts and investors. In such event, the price of Rational's Common
Stock would likely be materially adversely affected, and significant declines in
stock prices frequently result in costly and lengthy securities litigation, with
its attendant costs, distraction and liability exposure.
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.
Any shortfall in anticipated operating results could have an immediate and
significant adverse effect on the market price of the Company's Common Stock.
Potential business synergies, if achieved, of Rational and Pure Atria may not
offset any such dilution. Further, the Company incurred substantial merger-
related charges in the quarter ending September 30, 1997. Rational expects the
merger to be accretive in the long-term. However, this forward-looking
statement may not prove to be an accurate prediction due to unforseen changes,
inaccurate or incomplete assumptions regarding the current business or future
prospects of either or both of the companies, or other reasons. Rational expects
that the Pure Atria merger will be dilutive in the initial periods following its
effective time, and there can be no assurance as to when the merger will become
accretive, if ever. Any failure of the Pure Atria merger to meet expectations
as to potential business synergies or any failure of the Pure Atria merger to be
accretive in any quarter could have an immediate and significant adverse effect
on the market price of the Company's Common Stock.
14
<PAGE>
Statements or changes in opinions, ratings, or earnings estimates made by
brokerage firms or industry analysts relating to the market for software and
high technology company stocks or relating to Rational specifically have
resulted, and could in the future result, in an immediate and adverse effect on
the market price of Rational's Common Stock. Statements by financial or
industry analysts regarding the extent of the dilution in Rational's net income
per share resulting from operating results, the Pure Atria merger or other
developments and the extent to which such analysts expect potential business
synergies to offset such dilution can be expected to contribute to volatility in
the market price of Rational's Common Stock. 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,
including Rational, in certain cases for reasons unrelated to the operating
performance of the specific companies. These broad market fluctuations may
adversely affect the market price of the Rational Common Stock.
Risks Associated With Recent And Future Acquisitions.
- ----------------------------------------------------
During approximately the past three years, and the past year in particular,
Rational has made a number of strategic acquisitions. Rational acquired Pure
Atria on July 30, 1997, SQA, Inc., Performance Awareness Corporation, Requisite,
Inc., Softlab AB, and Software 9000 in the quarter ended March 31, 1997; the
Visual Test product from Microsoft in October 1996; and made other acquisitions
in earlier periods. Acquisitions result in the diversion of management's
attention from day-to-day operations and include numerous other risks, including
difficulties in the integration of operations, products and personnel. To the
extent that acquisitions have in the past resulted, or may in the future result,
in a diversion of resources or that efforts to integrate recent and future
acquisitions fail, there could be a material adverse effect on Rational's
business, results of operations and financial condition. Acquisitions have the
potential to result in dilutive issuances of equity securities, the incurrence
of debt, and amortization expenses related to goodwill and other intangible
assets. Rational management has historically evaluated on an ongoing basis the
strategic opportunities available to the Company. Rational may in the near- or
long-term future pursue acquisitions of complementary products, technologies or
businesses. See also footnote 6 to these financial statements for the Company's
announced agreement with ObjecTime.
Dependence Upon Market Growth And Development Of Industry Standards.
- -------------------------------------------------------------------
Rational's future growth and financial performance will depend in part upon
continued growth in the need for and sales of tools for automating software
application development and management. Sales of these products may not continue
to grow or the Company may be unable to respond effectively to evolving customer
requirements. The number of software developers using Rational's products is
relatively small compared to the number of developers using more traditional
technology and products. The adoption of the Company's products by software
programmers who have traditionally used other technology requires re-orientation
to significantly different programming methods. The acceptance of the Company's
products, therefore, may not expand beyond sophisticated programmers who are
early adopters of the technology. Furthermore, potential customers may be
unwilling to make the investment required to retrain programmers to build
software using the Company's products rather than traditional programming
techniques. Many of Rational's customers have purchased only small quantities
of the Company's products, and these or new customers may decide not to broadly
implement or purchase additional units of such products.
Rational'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 Rational's ability to
15
<PAGE>
play a leading role in the establishment of those standards. The Company has
developed the Unified Modeling Language ("UML") for visual modeling and has
submitted an application to the Object Management Group ("OMG"), an industry
consortium, for inclusion of the UML in their Object Analysis and Design
Facility specification. 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 Rational's business, operating results and financial condition.
Expansion Of Product Lines; Dependence Upon New Product Introductions.
- ----------------------------------------------------------------------
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, as well as integrated product suites and bundles, that support software
development for a number of implementation languages. This will require the
Company to modify and enhance its current products and to continue to develop,
introduce and integrate 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 operating systems. 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 broaden its
customer base and to further increase its share within its existing market
segments. The Company may be unable to successfully develop and market such a
broad line of products, or may encounter unexpected difficulties and delays in
integrating new products with existing product lines.
Rational has plans to introduce new products and enhanced versions of current
products during the next few fiscal quarters. Delay in the start of shipment of
new, enhanced or integrated products, suites and bundles would have an adverse
effect on the Company's revenues, gross profit and operating income. As a result
of Rational's business alliance with Microsoft, certain of Rational'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 Rational's
revenues from new products.
Rational attempts to make adequate allowances in its 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.
Competition
- ----------
The industry for tools for automating software application development and
management is extremely competitive and rapidly changing. Rational expects to
continue to experience significant and increasing levels of competition in the
future. Bases of competition include corporate and product reputation,
innovation with frequent product enhancement, breadth of integrated product
line, the availability of integrated suites and bundles, product architecture,
functionality and features, product quality, performance, ease-of-use, support,
availability of technical consulting services and price. Rational faces intense
competition for each product within its product lines, generally from both
Windows and UNIX vendors. Because individual product sales are often the first
step in a broader customer relationship, Rational's success will depend in part
upon its ability to successfully compete with numerous competitors at each point
within its product line.
16
<PAGE>
Rational faces competition from software development tools and processes
developed internally by customers, including ad hoc integrations of numerous
stand-alone development tools. Customers may be reluctant to purchase products
offered by independent vendors such as the Company. As a result, the Company
must educate prospective customers as to the advantages of the Company's
products versus internally developed software quality systems.
Rational faces competition from, among others, Intersolv, Inc., Platinum
Technology, Inc., Select Software Tools plc, Cayenne, Oracle, IBM, Sun
Microsystems, and Sybase Inc. as well as numerous privately held tool suppliers
offering traditional CASE tools that compete with the Rational Rose approach to
visual modeling and component-based development. Oracle's recent announcement of
its intent to add visual modeling capability to its development products would
result in an increased level of competition to the Company's Rose products.
Rational's RequisitePro requirements management product faces competition from
companies such as GEC-Marconi. Rational's software testing tools--SQA Suite,
Rational Visual Test and preVue--face competition from Compuware, Mercury
Interactive Corporation, Segue Software, Inc., Intersolv, Inc., Computer
Associates, Platinum Technologies, Terodyne, Cyrano, SQL Bench International,
Inc., and several private companies offering testing automation tools.
Microsoft, Compuware, Oracle, Sybase and several of the major UNIX platform
vendors, including Sun Microsystems, Hewlett Packard, Digital Equipment
Corporation, Silicon Graphics Inc., and IBM, also compete with Rational with
respect to software quality products and testing tools, with testing products
customized to certain of their other software products. Rational Apex for C/C++
faces competition from, among others, major UNIX platform vendors such as Sun
Microsystems, Hewlett-Packard 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.
Rational's Apex Ada and VADs product lines face competition from Aonix, Green
Hills Software, Inc. and a large number of other suppliers offering Ada products
for native and embedded systems.
The Company also experiences competition with respect to a number of its
products, both from utilities commonly bundled with versions of operating
systems and from stand-alone product offerings. For example, versions of UNIX
are commonly bundled with utilities (such as SCCS and RCS) that provide version
control, which is part of the functionality provided by ClearCase. Some system
vendors, such as Sun, already have products, such as Workshop, that provide
features similar to those in Purify or other of the Company's products and would
compete directly with such products if offered on a stand-alone basis. There can
be no assurance that Sun, which has a license to some of the Company's patents,
will not introduce stand-alone products that compete with the Company's
products. Companies offering products competitive with Rational Summit and
ClearCase in the UNIX marketplace include Sun, which offers TeamWare, IBM, which
offers Configuration Management/Version Control ("CMVC"), Computer Associates
("CA") through its acquisition of LEGENT Corporation, which offers the Endeavor
WSX product, and Platinum through its acquisition of Softool Corp., which
markets CCC Harvest. In addition, there are several smaller, privately-held
companies that market competitive products, including Continuous Software
Corporation, which markets Continuus/CM. Other companies have offered version
control or configuration management products outside the UNIX market. Companies
in this category include CA, Intersolv and Microsoft. CA has a large installed
base of its configuration management product on IBM mainframes. Intersolv has a
large installed base of DOS and Windows software developers. In 1994, Microsoft
acquired OneTree Software, which offers a version control product. The Company
expects additional competition from other established and emerging companies.
Digital Equipment Corporation has spun-off an independently operated subsidiary,
TracePoint Technology, Inc., which has stated that it intends to produce
development and testing tools and compete against the Company.
Rational believes that the increased level of competition it observed in
fiscal 1997 will continue to increase. Certain of Rational's competitors are
more experienced than Rational in the development of software-engineering tools,
databases or software-development products. Some of Rational's competitors have,
and new competitors may have, larger technical staffs, more established
distribution channels and greater financial resources than Rational. There can
be no assurance that
17
<PAGE>
either existing or new competitors will not develop products that are superior
to Rational's products or that achieve greater market acceptance. Rational'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. Future competition may result in price
reductions, reduced margins or loss of sales which in turn would have a material
adverse effect on the Company's business, results of operations and financial
condition.
Dependence Upon Sales Force And Other Channels Of Distribution.
- ------------------------------------------------------------
Rational currently distributes its products primarily through field sales
personnel teamed with highly trained technical support personnel. Rational
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 Rational's products, the services provided by these
personnel have historically yielded lower margins for Rational than the
Company's product business. If these services constitute a higher proportion of
total revenues in the future, the Company's margins will be adversely affected.
Rational markets and sells its products and services directly through telesales
organizations, field operations, sales organizations and indirectly through
channels such as VARs and distributors. There can be no assurance that such
channels will be successful in increasing sales of the Company's products or in
reducing its sales costs on a percentage basis.
Dependence on Key Personnel.
- ---------------------------
Rational believes that the hiring and retaining of qualified individuals at
all levels in the Company will be essential to 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. The Company
will be particularly dependent upon the efforts and abilities of its senior
management personnel. The departure of any of the senior management members or
other key personnel of the Company could have a material adverse effect on the
Company's business, financial condition, or results of operations depending upon
the timing of the departure, changes in the Company's business prior to such
time, the availability of qualified personnel to replace them, and whether such
personnel depart singly contemporaneously, or as a group, among other factors.
Merger activities, such as the acquisition of Pure Atria, can be accompanied or
followed by the departure of key personnel, which can compound the difficulty of
integrating the operations of the parties to the business combination. None of
the Rational executive officers is subject to any agreement not to compete or
severance agreement with Rational.
The ability of the Company to attract and retain the highly trained technical
personnel that are integral to its direct sales and product development teams
may limit the rate at which the Company can develop products and generate 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. Merger activities, such as the acquisition of Pure
Atria, may have a destabilizing effect on employee retention at all levels
within the Company. Departures of existing personnel, particularly in key
technical, sales, marketing or management positions, can be disruptive and can
result in departures of other existing personnel, which in turn could have a
material adverse effect upon the Company's business, operating results and
financial condition.
A traditional means of retaining employees following declines in a
corporation's stock price, such as those experienced recently by Rational, is to
re-price "underwater" stock options, both to offer an
18
<PAGE>
equity incentive to existing employees and to avoid inequities relative to new
employees offered lower-priced options. On November 4, 1997 the Company's board
of directors approved a program enabling the Company to re-price stock options
for most employees. The re-priced options will be subject to additional lock-up
and repurchase restrictions. Attempts to address potential employee attrition by
re-pricing employee stock options could be negatively interpreted by analysts
and investors and possibly negatively affect the pooling-of-interests accounting
treatment for the Pure Atria Merger. If substantial numbers of options remain
underwater, Rational may suffer employee attrition in excess of historical
rates, which could have a material adverse effect on the Company's business,
results of operations and financial condition.
Rapid Technological Change.
- --------------------------
The industry for tools for automating software application development and
management is characterized by rapid technological advances, changes in customer
requirements and frequent new product introductions and enhancements. The
introduction of products embodying new technologies and the emergence of new
industry standards and practices can render existing products obsolete and
unmarketable. The Company must respond rapidly to developments related to
Internet and intranet applications, 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, introduction or
integration could result in a loss of competitiveness or revenue. To the extent
the Company does not respond to technological change or evolving customer
requirements with new products or product enhancements, such new products or
product enhancements may fail to achieve market acceptance.
In addition, rapid growth of interest in and use of Internet and intranet
environments is a recent and emerging phenomenon. The Company's success may
depend, in part, on the compatibility of its products with Internet and intranet
applications. The Company may fail to effectively adapt its products for use in
Internet or intranet environments or to produce competitive Internet and
intranet applications.
Rational believes that factors affecting the ability of its products to
achieve broad consumer acceptance include product performance, price, ease of
adoption, displacement of existing approaches and adaptation to rapid
technological change and competitive product offerings. The Company may be
unable to respond promptly and effectively to the challenges of technological
change and its competitors' innovations, and it is possible that the Company
will be unable to achieve the necessary market acceptance, or compete
effectively, in new markets.
Dependence On Strategic Relationships.
- -------------------------------------
Rational's development, marketing and distribution strategies rely
increasingly on its ability to form long-term strategic relationships with major
software and hardware vendors, many of whom are substantially larger than
Rational. These business relationships often consist of cooperative marketing
programs, joint customer seminars, lead referrals or joint development projects.
Although certain aspects of some of these relationships are contractual in
nature, many important aspects of these relationships depend upon the continued
cooperation of each party with Rational. Merger activity, such as the
acquisition of Pure Atria, may disrupt these relationships or activities, and
certain partners may reassess the value of their relationship with Rational as a
result of such merger activity. Divergence in strategy between Rational and any
given partner, a change in focus by any given partner, or competitive product
offerings introduced by any given partner, may interfere with Rational's ability
to develop, market, sell or support its products, which in turn would have a
material
19
<PAGE>
adverse effect on Rational's business, results of operations and financial
condition. See "- Business Alliance with Microsoft."
Business Alliance With Microsoft.
- --------------------------------
On October 2, 1996, Rational and Microsoft announced the formation of a
business alliance which consists of Rational's acquisition of Microsoft's Visual
Test product, technology cross-licensing, joint development projects and joint
marketing programs. While Rational 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 Rational 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.
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 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 software testing tools area. There can be no
assurance that Microsoft will not use such rights to create and distribute
products that compete with other Rational products. Rational has also granted
Microsoft a five-year 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."
Licensing Of Rose Technology To Microsoft.
- -----------------------------------------
In October 1996, Microsoft and Rational entered into a two-year 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 customer base, and is not to generate direct
product revenue from Microsoft. The Company expects that changes in the
Company's pricing models and
20
<PAGE>
combinations of features within product lines will be required to appeal to this
customer base, and there can be no assurance that such changes will achieve
customer 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.
Dependence Upon Major Operating Systems.
- ---------------------------------------
Many of Rational's major products have historically been licensed for use
principally on certain versions of the UNIX platform. These products constitute
a substantial portion of Rational's product and service revenues. Any factors
adversely affecting the demand for, or use of, the UNIX operating system that
would require changes to Rational's products would have a material adverse
effect upon the business, operating results and financial condition of Rational.
Likewise, other of Rational's major products have historically been licensed for
use purely on the Windows operating system. These products also constitute a
substantial portion of Rational's product and service revenues. Any factors
adversely affecting the demand for, or use of, the Windows operating system that
would require changes to Rational's products would have a material adverse
effect upon the business, operating results and financial condition of Rational.
In addition, any changes to the underlying components of or interfaces to the
UNIX or Windows operating systems that would require changes to Rational's
products for those platforms would materially adversely affect Rational if it
were not able to successfully develop or implement such changes in a timely
fashion.
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 customer base than its historical customer base, and to encourage
potential customers 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.
- --------------------
Rational has experienced rapid growth, particularly as a result of its
acquisitions, and the Company is experiencing a period of aggressive product
introductions that have placed, and may continue to place, a significant strain
on its financial, operational, management, marketing and sales systems and
resources, including its personnel. Projects such as the expansion of or
enhancements to product lines, efforts to address broader markets and to expand
distribution channels, numerous acquisitions as described in "Risks Related to
the Recent Acquisition of Pure Atria Corporation" and "Risks Associated with
Recent and Future Acquisitions'' and business alliances such as the recent
21
<PAGE>
arrangement between Rational and Microsoft, when added to the day-to day
activities of Rational, have placed and will continue to place further strain on
management resources and personnel. If Rational's management is unable to
effectively manage growth, its business, competitive position, results of
operations and financial condition will be materially and adversely affected.
Risk Of Software Defects.
- ------------------------
Software products as complex as 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 the 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. Errors or
performance problems may also 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.
Further, because the Company relies on its own products in connection with the
development of its software, any such errors could make it more difficult to
sell such products in the future. Rational attempts to make adequate allowance
in its new product release schedule 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 by the Company 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.
Risks Associated with International Operations.
- ----------------------------------------------
International sales accounted for approximately 28%, 32%, and 31% of
Rational's revenues in fiscal 1995, 1996 and 1997, respectively, and represented
34% for the six months ended September 30, 1997. Rational expects that
international sales will continue to account for a significant portion of the
Company's revenues in future periods. International sales are subject to
inherent risks, including unexpected changes in regulatory requirements and
tariffs, difficulties in staffing and managing foreign operations, longer
payment cycles, greater difficulty in accounts receivable collection,
potentially adverse tax consequences, price controls or other restrictions on
foreign currency, difficulties in obtaining export and import licenses, costs of
localizing products for foreign markets, lack of acceptance of localized
products in foreign markets, and the efforts of high local wage scales and other
expenses. 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. Rational's international
sales are generally denominated in foreign currencies. Rational has engaged in
only limited hedging activities. 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 a 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.
Limited Protection of Intellectual Property and Proprietary Rights.
- ------------------------------------------------------------------
Rational relies on a combination of copyright, trademark and trade secret
laws, employee and third-party nondisclosure agreements and other methods to
protect its proprietary rights. Despite these precautions, it may be possible
for unauthorized third parties to copy certain portions of the
22
<PAGE>
Company's products or reverse engineer or obtain and use information that
Rational regards as proprietary. Rational generally licenses its software
products to end-users on a "right to use" basis pursuant to a perpetual license.
Rational 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, its exposure
to unauthorized copying and use of its products and proprietary information will
increase.
The scope 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 Rational's products.
Rational also relies on certain software that it licenses from third parties,
including software that is integrated with internally developed software and
used in its products to perform key functions. There can be no assurance that
these third-party software licenses will continue to be available to the Company
on commercially reasonable terms, or that the software will be appropriately
supported, maintained or enhanced by the licensors. The loss of licenses to, or
inability to support, maintain and enhance any of such software could result in
increased costs, or in delays or deductions in product shipments until
equivalent software could be developed, identified, licensed and integrated,
which would materially adversely affect the Company's business, operating
results and financial condition.
Risks of Litigation.
- -------------------
Competitors and potential competitors may resort to litigation as a means of
competition. Such litigation or other legal disputes may be costly and expose
the Company to new claims that it may not have anticipated. In the past,
Rational has instituted litigation against several companies. Although patent
and intellectual property disputes in the software area have often been settled
through licensing, cross-licensing or similar arrangements, costs associated
with such arrangements may be substantial. Any litigation involving the Company,
whether as plaintiff or defendant, regardless of the outcome, may result in
substantial costs and expenses to the Company and significant diversion of
effort by the Company's technical and management personnel. In addition, there
can be no assurance that litigation, either instituted by or against the
Company, will not be necessary to resolve issues that may arise from time to
time in the future. Any such litigation could have a material adverse effect
upon the Company's business, operating results and financial condition.
Rational expects that software product developers will be increasingly subject
to infringement claims as the number of products and competitors grows and the
functionality of products in different industry segments overlaps. 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 business, results of operations and
financial condition.
23
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1 Legal Proceedings
The Company and two of its officers were named as defendants in a number of
purported shareholder class action complaints recently filed in federal court
for the Northern District of California, alleging that the Company selectively
disclosed information to a financial analyst on October 8, 1997, in violation of
federal securities laws. The Company believes that the claims are without merit
and intends to defend itself vigorously, although there can be no assurance that
it will be successful in defending these actions.
ITEM 4 Submission of Matters to a Vote of Security Holders
On September 25, 1997, the Company held its annual meeting of stockholders. The
following items were submitted to a vote of the stockholders:
1. To elect three Class II members of the Board of Directors.
<TABLE>
<CAPTION>
Election of Director Votes For Votes Withheld
- -------------------- --------- --------------
<S> <C> <C>
Daniel H. Case III 75,209,111 286,048
Paul D. Levy 75,274,583 220,576
John E. Montague 75,280,389 214,770
</TABLE>
As a result, Messrs. Case, Levy and Montague were elected directors of the
Company.
2. To approve amendment to the 1997 Stock Option Plan reserving an additional
4,000,000 shares of the Company's Common Stock for issuance thereunder:
<TABLE>
<CAPTION>
Votes
----------
<S> <C>
For 39,851,313
Against 19,321,313
Abstain 420,833
Broker Non-Vote 15,901,700
</TABLE>
This proposal was approved.
3. To approve amendment to the 1994 Employee Stock Purchase Plan reserving an
additional 1,000,000 shares of the Company's Common Stock for issuance
thereunder:
<TABLE>
<CAPTION>
Votes
----------
<S> <C>
For 44,486,501
Against 14,695,861
Abstain 413,096
Broker Non-Vote 15,899,701
</TABLE>
This proposal was approved.
4. To ratify the appointment of Ernst & Young LLP as the Company's independent
auditors to examine the financial statements of the Company for fiscal year
1998:
<TABLE>
<CAPTION>
Votes
----------
<S> <C>
For 75,243,023
Against 64,747
Abstain 187,389
Broker Non-Vote 0
</TABLE>
This proposal was approved.
24
<PAGE>
On July 30, 1997 the Company held a special meeting of the stockholders. The
following items were submitted to a vote of the stockholders:
1. The reservation and issuance of shares of the Common Stock, par value $0.01
per share, of Rational (the "Rational Common Stock") to the stockholders of Pure
Atria Corporation ("Pure Atria") pursuant to an Agreement and Plan of
Reorganization, dated as of April 7, 1997 (the "Agreement"), by and among
Rational, Pure Atria and Wings Merger Corporation, a wholly owned subsidiary of
Rational ("Merger Sub"), providing, among other things, (i) for the merger of
Merger Sub with and into Pure Atria, resulting in Pure Atria becoming a wholly
owned subsidiary of Rational (the "Merger"), (ii) for the conversion of
outstanding shares of Common Stock, par value $.0001 per share, of Pure Atria
("Pure Atria Common Stock") into the right to receive 0.9 (the "Exchange Ratio")
shares of Rational Common Stock, and (iii) for each outstanding option or right
to purchase Pure Atria Common Stock under the Pure Atria stock option plans and
the Pure Atria stock purchase plan to be assumed by Rational and to become an
option or right to purchase Rational Common Stock, with appropriate adjustments
to be made to the number of shares issuable thereunder and the exercise price
thereof based on the Exchange Ratio.
<TABLE>
<CAPTION>
Votes
----------
<S> <C>
For 29,824,495
Against 4,475,239
Abstain 24,352
Broker Non-Vote 0
</TABLE>
This proposal was approved.
2. To approve the amendment of Rational's Certificate of Incorporation to
increase the authorized number of Common Stock from 75,000,000 to 150,000,000:
<TABLE>
<CAPTION>
Votes
----------
<S> <C>
For 29,810,710
Against 4,445,654
Abstain 67,722
Broker Non-Vote 0
</TABLE>
This proposal was approved.
ITEM 6 - Exhibits and Reports on Form 8-K
(a) Exhibit 3.1: Amended and Restated Certificate of Incorporation of Rational
Software Corporation
Exhibit 3.2: Bylaws of Rational as most recently amended are incorporated
herein by reference to Exhibit 3.09 filed with Rational's Form 10-K for the
fiscal year ended March 31, 1996.
Exhibit 3.3: Amendment to Section 3.2 of Bylaws of Rational are
incorporated herein by reference to Exhibit 3.02 filed with Rational's
Form 10-K for the fiscal year ended March 31, 1997.
Exhibit 4.1: Rational Software Corporation's 1997 Supplemental Stock Plan
and form of Stock Option Agreement thereunder, incorporated by reference to
Rational's S-8 Registration.
25
<PAGE>
Statement, registration number 333-31505, as filed with the Securities and
Exchange Commission on July 17, 1997.
Exhibit 4.2: Rational Software Corporation's 1997 Stock Option Plan and
form of Stock Option Agreement thereunder, incorporated by reference to
Rational's S-8 Registration Statement, registration number 333-39569, as
filed with the Securities and Exchange Commission on November 5, 1997.
Exhibit 4.3: Rational Software Corporation's 1994 Employee Stock Purchase
Plan, incorporated by reference to Rational's S-8 Registration Statement,
registration number 333-39455, as filed with the Securities Exchange
Commission on November 4, 1997.
Exhibit 10: Relocation Bonus for key employee
Exhibit 11: Statement of Computation of Net Income per Common Share
Exhibit 27: Financial Data Schedule
(b) Reports on Form 8-K:
On July 16, 1997 the Company filed Form 8-K regarding the adoption by the Board
of Directors of the 1997 Supplemental Stock Plan and reservation of 350,000
shares of the Company's stock for issuance thereunder.
On August 11, 1997 the Company filed Form 8-K regarding the Agreement and Plan
of Reorganization dated April 7, 1997 by and among the Company, Wings Merger
Corp., a wholly owned subsidiary of the Company, and Pure Atria Corporation, a
Delaware corporation.
26
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RATIONAL SOFTWARE CORPORATION
by: /s/ Robert T. Bond
-------------------------------------
Robert T. Bond
Senior Vice President
Chief Operating Officer,
Chief Financial Officer and Secretary
November 14, 1997
27
<PAGE>
Exhibit 3.1
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 one hundred fifty million (150,000,000) 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>
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>
EXHIBIT 10
RATIONAL SOFTWARE CORPORATION
-----------------------------
RELOCATION BONUS AGREEMENT
--------------------------
This Relocation Bonus Agreement (the "Agreement") is entered into effective
as of September 10, 1997 (the "Effective Date"), by and between Rational
Software Corporation, a Delaware corporation (the "Company"), and David H.
Bernstein (the "Employee").
1. Nature of Employment. The Company agrees to employ Employee as
--------------------
Senior Vice President, Products. The Company and Employee agree that Employee's
employment with the Company is and shall continue to be "at-will" and may be
terminated at any time with or without cause or notice by either the Company or
Employee.
2. Terms of Relocation Bonus.
-------------------------
(a) Relocation Bonus. Upon the Effective Date, Employee shall
-----------------
receive a relocation bonus of $1,000,000 (the "Relocation Bonus"). The Employee
shall also receive (i) a payment from the Company sufficient to pay Employee's
federal and state income taxes arising from the Relocation Bonus (the "Tax
Payment"), and (ii) an additional payment from the Company sufficient to pay
federal and state income taxes arising from the Tax Payment (the Tax Payment and
this additional payment shall be collectively referred to as the "Gross-Up
Payment"). It is the intention of the parties that the net economic effect of
the payments to the Employee under this subparagraph 2(a), on an after tax
basis, be as if state and federal income taxes did not apply to the Relocation
Bonus.
(b) Voluntary Termination: Termination for Cause. If (i) Employee
---------------------------------------------
voluntarily terminates his employment with the Company, or (ii) the Company
terminates Employee for Cause, Employee shall be obligated to repay to the
Company all or a portion of the Relocation Bonus and/or the Gross-Up Payment in
accordance with the following schedule:
<TABLE>
<CAPTION>
Portion of Portion of
Relocation Gross-Up
Termination Bonus Payment
Occurs During to be Repaid to be Repaid
------------- ------------ ------------
<S> <C> <C>
Year 1 $1,000,000 $859,000
Year 2 $1,000,000 $200,000
Year 3 $ 600,000 $ -0-
Year 4 $ 100,000 $ -0-
</TABLE>
<PAGE>
(c) Other Termination. If Employee's employment is terminated by the
-----------------
Company other than for Cause, Employee shall be under no obligation to repay any
portion of the Relocation Bonus or the Gross-Up payment. A reduction in
Employee's base compensation by more than fifteen percent (15%) shall be deemed
a termination by the Company under this section (c). In addition, Employee shall
not be obligated to repay any portion of the Relocation Bonus, or "Gross-Up
Payment" if Employee's employment terminates by reason of Employee's death or
disability.
3. Definition.
----------
(a) Year. For purposes of this Agreement, the term "Year" shall mean
----
the year-long period following the Effective Date, or the year-long period
following the last day of immediately preceding Year, as applicable.
(b) Cause. For purposes of this Agreement, the term "Cause" shall
-----
mean (i) Employee's conviction by, or entry of a plea of guilty or nolo
contendere in, a court of competent and final, jurisdiction for any intentional
crime which constitutes a felony in the jurisdiction involved; or (ii)
Employee's conviction of an act of fraud or misappropriation of material
property, subsequent to the date hereof, upon the Company, or any of its
respective affiliates.
(c) Disability. The inability of the Employee, due to physical or
----------
mental impairment to perform the usual and customary duties of his employment.
4. Right to Advice of Counsel. Employee acknowledges that he has had
--------------------------
the right to consult with counsel and is fully aware of his rights and
obligations under this Agreement.
5. Arbitration and Equitable Relief.
--------------------------------
(a) Except as provided in Section 5(c) below, the Company and
Employee agree that any dispute or controversy arising out of, relating to, or
in connection with this Agreement, or the interpretation, validity,
construction, performance, breach, or termination thereof shall be settled by
arbitration to be held in Massachusetts in accordance with the National Rules
for the Resolution of Employment Disputes then in effect of the American
Arbitration Association (the "Rules"). The arbitrator may grant injuctions or
other relief in such dispute or controversy. The decision of the arbitrator
shall be final, conclusive and binding on the parties to the
<PAGE>
arbitration. Judgment may be entered on the arbitrator's decision in any court
having jurisdiction.
(b) The Company shall pay all costs and expenses of such arbitration.
(c) The parties may apply to any court of competent jurisdiction for
a temporary restraining order, preliminary injunction or other interim or
conservatory relief as necessary, without breach of this arbitration agreement
and without abridgment of the powers of the arbitrator.
(d) EMPLOYEE HAS READ AND UNDERSTANDS THIS SECTION 5, WHICH DISCUSSES
ARBITRATION. EMPLOYEE UNDERSTANDS THAT BY SIGNING THIS AGREEMENT, EMPLOYEE
AGREES, EXCEPT AS PROVIDED IN SECTION 5 (c), TO SUBMIT ANY FUTURE CLAIMS ARISING
OUT OF, RELATING TO, OR IN CONNECTION WITH THIS AGREEMENT, OR THE
INTERPRETATION, VALIDITY, CONSTRUCTION, PERFORMANCE, BREACH, OR TERMINATION
THEREOF TO BINDING ARBITRATION, AND THAT THIS ARBITRATION CLAUSE CONSTITUTES A
WAIVER OF EMPLOYEE'S RIGHT TO A JURY TRIAL AND RELATES TO THE RESOLUTION OF
ALL DISPUTES RELATING TO ALL ASPECTS OF THE EMPLOYER/EMPLOYEE RELATIONSHIP.
6. Reimbursement/Relocation.
------------------------
(a) In the event that the Company relocates the Employee, or the
Company terminates the Employee (other than for Cause), the Company will
reimburse Employee for any loss sustained by Employee as a result of Employee's
sale of Employee's home at 25 Glezen Lane, Wayland MA if such sale occurs within
five (5) years of the Effective Date. The amount of the reimbursement to be
paid by Company to Employee shall be the difference between the price Employee
paid to purchase said property and the sales price of said property realized at
said sale.
(b) In the event that the Company relocates the Employee, or the
Company terminates the Employee (other than for Cause), the Company will
reimburse Employee, under the Company's standard relocation policy, for all of
Employee's costs to relocate Employee's family to California if such relocation
occurs within five (5) years of the Effective Date. These costs shall include:
1. The cost of selling Employee's home, including brokerage commission
<PAGE>
2. The cost of relocating Employee's family to California
3. The cost of temporary living quarters for Employee's family in
California until Employee obtains permanent housing.
The Company's reimbursement of said costs to Employee under this
subparagraph (b) shall be "grossed-up" at Employee's tax rate, currently
estimated at forty-six percent (46%).
RATIONAL SOFTWARE CORPORATION (Company)
BY:
--------------------------------------------
--------------------------------------------
DAVID H. BERNSTEIN (Employee)
<PAGE>
Exhibit 11
Statement of Computation of Net Income Per Common Share
<TABLE>
<CAPTION>
(In thousands, except per share amounts) Three Months Ended Six Months Ended
September 30, September 30,
1997 1996 1997 1996
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Primary:
Weighted average
shares outstanding 87,240 76,990 86,897 76,528
Dilutive stock options - 7,223 - 7,222
------------------------------- ------------------------------
Total 87,240 84,213 86,897 83,750
================================ ==============================
Fully diluted:
Weighted average
shares outstanding 87,240 76,990 86,897 76,528
Dilutive stock options - 7,346 - 7,284
-------------------------------- ------------------------------
Total 87,240 84,336 86,897 83,812
================================ ==============================
Net income (loss) ($64,619) $10,510 $(59,491) $19,454
Income (loss) per common share
Primary: (.74) .12 (.68) .23
Fully diluted: (.74) .12 (.68) .23
</TABLE>
1
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 141,484
<SECURITIES> 150,094
<RECEIVABLES> 57,845
<ALLOWANCES> 3,496
<INVENTORY> 0
<CURRENT-ASSETS> 362,391
<PP&E> 75,262
<DEPRECIATION> 37,544
<TOTAL-ASSETS> 419,083
<CURRENT-LIABILITIES> 147,877
<BONDS> 3,466
0
0
<COMMON> 876
<OTHER-SE> 262,429
<TOTAL-LIABILITY-AND-EQUITY> 419,083
<SALES> 84,610
<TOTAL-REVENUES> 141,116
<CGS> 8,775
<TOTAL-COSTS> 29,199
<OTHER-EXPENSES> 179,384
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (9,301)
<INCOME-PRETAX> (58,166)
<INCOME-TAX> 1,325
<INCOME-CONTINUING> (59,491)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (59,491)
<EPS-PRIMARY> (.68)
<EPS-DILUTED> (.68)
</TABLE>
