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UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the transition period from _______ to _______
COMMISSION FILE NUMBER 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 93,315,561
$.01 PER SHARE
(Class) (Shares outstanding on July 31, 2000)
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<PAGE>
CONTENTS
PART I -- FINANCIAL INFORMATION
Item 1 -- Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets......................
Condensed Consolidated Statements of Operations............
Condensed Consolidated Statements of Cash Flows............
Notes to Condensed Consolidated Financial Statements.......
Item 2 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................
PART II -- OTHER INFORMATION
Item 6 -- Exhibits and Reports on Form 8-K...........................
SIGNATURE.............................................................
<PAGE>
Item 1 -- Condensed Consolidated Financial Statements
RATIONAL SOFTWARE CORPORATION
Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
June 30, March 31,
2000 2000
------------ ------------
(unaudited) (Note A)
<S> <C> <C>
ASSETS
-------------------------------------
Current assets:
Cash and cash equivalents.................... $321,574 $413,230
Short-term investments....................... 657,881 493,081
Accounts receivable, net..................... 124,339 148,818
Deferred tax assets.......................... 9,221 9,384
Prepaid expenses and other assets............ 10,917 10,671
------------ ------------
Total current assets.......................... 1,123,932 1,075,184
------------ ------------
Property and equipment, at cost:
Computer, office and manufacturing equipment. 90,757 88,525
Office furniture............................. 16,011 13,957
Leasehold improvements....................... 16,428 13,850
------------ ------------
123,196 116,332
Accumulated depreciation and amortization.... (65,166) (63,892)
------------ ------------
Property and equipment, net................... 58,030 52,440
Other assets, net............................. 95,411 98,152
------------ ------------
Total assets.................................. $1,277,373 $1,225,776
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
-------------------------------------
Current liabilities:
Accounts payable............................. $8,434 $8,496
Accrued employee benefits.................... 38,653 49,290
Income taxes payable......................... 33,068 24,323
Other accrued expenses....................... 41,312 33,257
Current portion of accrued merger and
integration expenses....................... 3,893 5,147
Deferred revenue............................. 122,866 122,813
------------ ------------
Total current liabilities..................... 248,226 243,326
Accrued rent.................................. 336 968
Long-term accrued merger and integration
expenses..................................... 600 700
Convertible subordinated notes 500,000 500,000
------------ ------------
Total liabilities............................. 749,162 744,994
------------ ------------
Minority interest 22,588 24,475
Stockholders' equity:
Common stock, $0.01 par value, 150,000
shares authorized........................... 1,018 996
Additional paid-in capital................... 739,902 709,488
Deferred stock compensation.................. (2,573) (2,763)
Treasury stock............................... (180,851) (180,851)
Accumulated deficit.......................... (41,338) (60,699)
Accumulated other comprehensive loss......... (10,535) (9,864)
------------ ------------
Total stockholders' equity.................... 505,623 456,307
------------ ------------
Total liabilities and stockholders' equity.... $1,277,373 $1,225,776
============ ============
</TABLE>
Note A: The balance sheet at March 31, 2000 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
principal for complete financial statements.
See accompanying notes to condensed consolidated financial statements.
<PAGE>
RATIONAL SOFTWARE CORPORATION
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts, unaudited)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
--------- ---------
2000 1999
--------- ---------
<S> <C> <C>
Net product revenue................ $99,300 $72,415
Consulting and support revenue..... 70,997 45,008
--------- ---------
Total revenue.................. 170,297 117,423
--------- ---------
Cost of product revenue............ 6,488 6,010
Cost of consulting and support
revenue.......................... 18,176 11,613
--------- ---------
Total cost of revenue.......... 24,664 17,623
--------- ---------
Gross margin....................... 145,633 99,800
--------- ---------
Operating expenses:
Research and development......... 38,483 22,525
Sales and marketing.............. 70,950 49,361
General and administrative....... 13,346 10,091
--------- ---------
Total operating expenses....... 122,779 81,977
--------- ---------
Operating income............... 22,854 17,823
Other income, net.................. 6,035 2,584
--------- ---------
Income before income
taxes........................ 28,889 20,407
Provision for income taxes......... 11,517 5,714
Minority interest.................. (1,989) --
--------- ---------
Net income......................... $19,361 $14,693
========= =========
Net income per common
share - basic.................... $0.21 $0.17
Shares used in computing per
share amounts - basic............ 91,484 86,527
Net income per common
share - diluted.................. $0.19 $0.16
Shares used in computing per
share amounts - diluted.......... 100,665 94,104
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
RATIONAL SOFTWARE CORPORATION
Condensed Consolidated Statement of Cash Flows
(in thousands, unaudited)
<TABLE>
<CAPTION>
Three Months Ended
June 30
----------------------
2000 1999
---------- ----------
<S> <C> <C>
Operating activities:
Net income.......................................... $19,361 $14,693
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization..................... 10,287 5,320
Compensation expense related to stock options..... 190 --
Changes in operating assets and liabilities:
Accounts receivable............................. 24,479 5,182
Prepaid expenses and other, net................... (246) (2,046)
Deferred tax assets............................. 163 --
Accounts payable................................ (62) (2,352)
Accrued employee benefits and other accrued
expenses..................................... (3,214) (12,000)
Income taxes payable............................ 8,745 5,788
Accrued merger and integration expenses......... (1,354) (1,591)
Deferred revenue................................ 53 272
---------- ----------
Net cash provided by operating activities.............. 58,402 13,266
---------- ----------
Investing activities:
Purchase of short-term investments.................. (217,863) (95,777)
Maturities and sales of short-term investments...... 53,063 96,731
Purchases of property and equipment................. (10,774) (4,092)
Net change in other assets.......................... (877) (117)
---------- ----------
Net cash used in investing activities............. (176,451) (3,255)
---------- ----------
Financing activities:
Net proceeds from issuance of common stock.......... 28,951 26,959
Repurchases of common stock......................... -- (23,947)
Proceeds from minority investors in Catapulse, Inc.. (1,887) --
---------- ----------
Net cash provided by financing activities................ 27,064 3,012
---------- ----------
Effect of changes in foreign currency exchange
rate on cash.......................................... (671) (1,653)
---------- ----------
Net increase (decrease) in cash and cash equivalents... (91,656) 11,370
Cash and cash equivalents at beginning of period....... 413,230 59,965
---------- ----------
Cash and cash equivalents at end of period............. $321,574 $71,335
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
RATIONAL SOFTWARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION -- The consolidated financial information
included herein has been prepared without an audit and 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. Certain prior year amounts have been reclassified to
conform with current year presentation. 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 June 30, 2000 are not necessarily
indicative of the results that may be expected for the fiscal year
ending March 31, 2001.
2. ACCOUNTS RECEIVABLE - Accounts receivable are presented net of an
allowance for doubtful accounts of $3,082,000 at June 30, 2000 and
$3,259,000 at March 31, 2000.
3. NET INCOME PER COMMON SHARE - The following table sets forth the
computation of basic and diluted net income per share (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
(in thousands, except per share amounts)
Three Months Ended
June 30,
-------------------
2000 1999
--------- ---------
<S> <C> <C>
Numerator:
Net income ....................... $19,361 $14,693
Denominator:
Denominator for basic net income
per share - weighted
average shares.................... 91,484 86,527
Incremental common shares
attributable to shares issuable
under employee stock plans........ 9,181 7,577
--------- ---------
Denominator for diluted net
income per share -
weighted average shares and
assumed conversions............... 100,665 94,104
========= =========
Net income per share - basic. $0.21 $0.17
========= =========
Net income per share -
diluted........................... $0.19 $0.16
========= =========
</TABLE>
The effect of options to purchase 238,256 and 222,107 shares of
Common Stock was not included in the computation of the three months
ended June 30, 2000 and 1999, respectively, diluted earnings per
share because the options' exercise price was greater than the
average market price of common shares. The effect of converting
6,999,150 shares of Common Stock from outstanding Convertible Notes
issued in 2000 was not included in diluted earnings per share
because the assumed conversion would be antidilutive.
4. COMPREHENSIVE INCOME - As of April 1, 1998 the Company adopted
Statement of Financial Accounting Standards No. 130 (SFAS 130),
"Reporting Comprehensive Income." SFAS 130 establishes new rules for
the reporting and display of comprehensive income and its
components; however, the adoption of this statement had no impact on
the Company's net income or stockholders' equity. SFAS 130 requires
unrealized gains or losses on the Company's available-for-sale
securities and foreign translation adjustments, which have been
included in stockholders' equity and excluded from net income, to be
included in comprehensive income.
For the three months ended June 30, 2000, total comprehensive income
amounted to approximately $18,690,000 compared to a comprehensive
income of $13,040,000 for the same period last year.
5. RECENT PRONOUNCEMENTS - In June 1998, the Financial Accounting
Standards Board issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which is required to be adopted
in years beginning after June 15, 2000. Because of the Company's
limited use of derivatives, management does not anticipate that the
adoption of the new statement will have a significant effect on
earnings or the financial position of the Company.
On March 31, 2000, the Financial Accounting Standards Board issued
FASB Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation", an interpretation of APB Opinion No.
25. The Interpretation is generally effective for new stock awards
or transactions entered into on or after July 1, 2000. The Company
does not anticipate that the adoption of the new Interpretation will
have a significant effect on earnings or the financial position of
the Company.
6. STOCK REPURCHASE - Under a program approved in October 1998, the
Company is authorized to repurchase up to 6 million shares of its
common stock from time to time in the open market. In the quarter
ended June 30, 2000, there were no repurchases. In the quarter
ended June 30, 1999 the Company repurchased 822,500 shares of its
common stock for a total cash outlay of approximately $23.9 million.
A purpose of the stock repurchase program is to offset the dilution
resulting from shares issued under the Company's employee option and
purchase plans. The timing and size of any future stock repurchases
are subject to market conditions, stock prices, the Company's cash
position and other cash requirements going forward.
<PAGE>
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"
statements within the meaning of Sections 27A of the Securities Act of
1993 and 21E of the Securities and Exchange Act of 1934, as amended,
including statements about international revenue, and liquidity and
capital resources, 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 statements. 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 generally recognizes software license revenues when a
customer purchase order has been received and accepted, the software
product has been shipped, there are no uncertainties surrounding
product acceptance, the fees are fixed and determinable, and collection
is considered probable. 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.
Comparative Analysis of Operating Results for the Three Months Ended
June 30, 2000
Total revenue increased 45% for the three month period ended June 30,
2000 from the comparable prior year period. Net product revenue and
consulting and support revenue increased 37% and 58%, respectively, for
the three month period ended June 30, 2000 compared to the prior year.
The overall increase reflects continued strong customer acceptance
across the majority of the Company's products and services. The
increase in consulting and support revenue is a result of growing
demand for the Company's consulting services and continued strong sales
and renewals of customer support arrangements.
International revenue from product sales and consulting and customer
support accounted for 37% of total revenue for the three month period
ended June 30, 2000, and 42% for the comparable prior year period. The
Company expects international sales to continue to account for a major
portion of total revenue in future periods, although the percentage of
international revenues could fluctuate from period to period due to
economic or other factors in international regions. The Company's
international sales are principally priced in local currencies. The
Company enters into short-term forward currency contracts to hedge
against the impact of foreign currency exchange rate fluctuations on
balance sheet exposures denominated in currencies other than the
functional currency of the Company or its subsidiaries. The total
amount of these contracts is approximately offset by the underlying
assets and liabilities denominated in non-functional currencies and
such contracts are carried at fair market value. The associated gains
and losses were not material to the Company's results of operations in
any period presented. See "Factors That May Affect Future Results: Our
international operations expose us to greater management, collections,
currency, intellectual property, regulatory, and other risks."
Cost of product revenue consists principally of materials, packaging
and freight, amortization of developed technology and royalties. These
costs represented 7% of total product revenue for the three month
period ended June 30, 2000, as compared to 8% for the comparable prior
year period. The decrease in product cost as a percentage of certain
product revenue was due mainly to economies of scale from increased
shipments as well as a higher average selling price of shipments in the
current period.
Cost of consulting and support revenue consists principally of
personnel costs for training, consulting and customer support. Cost of
consulting and support increased 57% for the three month period ended
June 30, 2000 from the comparable prior year period. These costs
represented 26% of total consulting and support revenue for the three
month periods ended June 30, 2000 and 1999. The increase in period
over period costs of consulting and support is primarily a result of
increased personnel costs necessary to service the growing demand for
support, consulting, and education.
Total expenditures for research and development increased 71% for the
three month period ended June 30, 2000 from the comparable prior year
period. These costs represented 23% of total revenue for the three
month period ended June 30, 2000 compared to 19% for the same period
last year. The increase in expenditures for research and development
is due primarily to the $6.6 million costs incurred by Catapulse, the
recently formed Internet venture in which Rational invested $50.0
million in December, 1999. See "Factors That May Affect Future
Results: The recent formation of Catapulse, a new Internet company, by
our founders could divert the attention of our management away from our
business and affairs and create potential conflicts of interest."
Sales and marketing expenses increased 44% for the three month period
ended June 30, 2000 from the comparable prior year period. These costs
represented 42% of total revenue for the three month periods ended June
30, 2000 and 1999. The increase in expenditures for sales and
marketing is due to personnel costs associated with additional sales
capacity, and costs associated with marketing programs to raise Company
visibility.
General and administrative expense increased 32% for the three month
period ended June 30, 2000 from the comparable prior year period.
These costs represented 8% of total revenue for the three month period
ended June 30, 2000 as compared to 9% for the comparable prior year
period. The period over period increase in general and administrative
expense is due primarily to additional amortization of goodwill related
to the January, 2000 acquisition of ObjecTime Limited.
Other income, net consists primarily of interest income, interest
expense and gains and losses due to fluctuations in foreign currency
exchange rates. Other income has fluctuated as a result of the amount
of cash available for investment in interest-bearing instruments and
from fluctuations in foreign currency exchange rates. Other income, net
increased $3.5 million for the three month period ended June 30, 2000
from the comparable prior year period. The current year increase is
due primarily to increased interest earnings on higher cash balances,
offset by interest expense on convertible debt.
The provision for income taxes for the three month period ended June
30, 2000 is based on the estimated annual effective tax rate applied to
the profit before income taxes and includes federal, state and foreign
income taxes. The effective tax rates for fiscal 2001 and 2000 differ
from the federal statutory rate primarily as a result of permanently
invested international income subject to a lower overall tax rate,
investment in tax exempt securities, and research credits. The
effective tax rate for fiscal 2001 increased from fiscal 2000 as a
result of decreased investment in tax exempt securities and a greater
proportion of international income subject to higher overall rates.
Minority Interest
In the first quarter of fiscal 2001 the Company's subsidiary,
Catapulse, Inc., incurred $6.6 million of research and development
costs and earned $1.1 million of interest income on cash balances.
Minority interest, net of tax, in the same period was approximately
$2.0 million.
Liquidity and Capital Resources at June 30, 2000
As of June 30, 2000, the Company had cash, cash equivalents and short-
term investments of $979.5 million and working capital of $875.7
million. Net cash provided by operating activities for the quarter
ended June 30, 2000 was composed primarily of operating income, a
decrease in accounts receivable and an increase in taxes payable,
offset by a decrease in accrued employee benefits and other accrued
expenses, and accrued merger costs. Net cash used by investing
activities resulted primarily from an increase in short-term
investments and an increase in capital expenditures. Net cash provided
in financing activities resulted primarily from the issuance of common
stock under the Employee Stock Purchase Plan and the exercise of
employee stock options offset by the change in minority interest.
The Company believes that expected cash flow from operations combined
with existing cash and cash equivalents and short-term investments will
be sufficient to meet its cash requirements for the foreseeable future.
Factors That May Affect Future Results
Significant unanticipated fluctuations in our quarterly revenues and
operating results may cause us not to meet securities analysts' or
investors' expectations and may result in a decline in the price of our
Common Stock.
Our net revenues and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter. If our
revenues, operating results, earnings, or future projections are
below the levels expected by securities analysts, our stock price is
likely to decline.
Factors that may cause quarterly fluctuations in our operating
results include:
- the discretionary nature of our customers' purchase and budget
cycles;
- difficulty predicting the size and timing of customer orders;
- long sales cycles;
- seasonal variations in operating results;
- introduction or enhancement of our products or our competitors'
products;
- changes in our pricing policies or the pricing policies of our
competitors;
- an increase in our operating costs;
- whether we are able to expand our sales and marketing programs;
- the mix of our products and services sold;
- the level of sales incentives for our direct sales force;
- the mix of sales channels through which our products and services
are sold;
- the mix of our domestic and international sales;
- an increase in the level of our product returns;
- fluctuations in foreign currency exchange rates;
- costs associated with acquisitions; and
- global economic conditions.
In addition, the timing of our product revenues is difficult to
predict because our sales cycles vary substantially from product to
product and customer to customer. We base our operating expenses on
our expectations regarding future revenue levels. As a result, if
total revenues for a particular quarter are below our expectations,
we could not proportionately reduce operating expenses for that
quarter. Therefore, a revenue shortfall would have a
disproportionate effect on our operating results for that quarter.
In addition, because our service revenues are largely correlated
with our license revenues, a decline in license revenues could also
cause a decline in our service revenues in the same quarter or
subsequent quarters.
As a result of these and other factors, our operating results are
subject to significant variation from quarter to quarter, and we
believe that period-to-period comparisons of our results of
operations are not necessarily useful. If our operating results are
below investors' or securities analysts' expectations, the price of
our Common Stock could decline significantly.
If market acceptance of our sophisticated software development tools
fails to grow adequately, our business may suffer.
Our future growth and financial performance will depend in part on
broad market acceptance of off-the-shelf products that address
critical elements of the software development process. Currently,
the number of software developers using our products is relatively
small compared with the number of developers using more traditional
technology and products, internally developed tools, or manual
approaches. Potential customers may be unwilling to make the
significant capital investment needed to purchase our products and
retrain their software developers to build software using our
products rather than traditional techniques. Many of our customers
have purchased only small quantities of our products, and these or
new customers may decide not to broadly implement or purchase
additional units of our products.
If industry standards relating to our business do not gain general
acceptance, we may be unable to continue to develop and market our
products and our business may suffer.
Our future growth and financial performance depends on the
development of industry standards that facilitate the adoption of
component-based development, as well as enhance our ability to play
a leading role in the establishment of those standards. For example,
we developed the Unified Modeling Language for visual modeling,
which was adopted by the Object Management Group, or OMG, a software
industry consortium, for inclusion in its object analysis and design
facility specification. The official sanction in the future of a
competing standard by the OMG or the promulgation of a competing
standard by one or more major platform vendors could harm our
marketing and sales efforts and, in turn, our business.
If we do not develop and enhance new and existing products to keep pace
with technological, market, and industry changes, our revenues may
decline.
The industry for tools automating software application development
and management is characterized by rapid technological advances,
changes in customer requirements, and frequent new product
introductions and enhancements. If we fail to anticipate or respond
adequately to technology developments, industry standards, or
practices and customer requirements, or if we experience any
significant delays in product development, introduction, or
integration, our products may become obsolete or unmarketable, our
ability to compete may be impaired, and our revenues may decline. We
must respond rapidly to developments related to Internet and
intranet applications, hardware platforms, operating systems, and
programming languages. These developments will require us to make
substantial product-development investments.
In addition, rapid growth of, interest in, and use of Internet and
intranet environments is a recent and emerging phenomenon. Our
success may depend, in part, on the compatibility of our products
with Internet and intranet applications. We may fail to effectively
adapt our products for use in Internet or intranet environments, or
to produce competitive Internet and intranet applications.
If we do not effectively compete with new and existing competitors, our
revenues and operating margins will decline.
The industry for tools that automate software development and
management is extremely competitive and rapidly changing. We expect
competition to intensify in the future. We believe our continued
success will become increasingly dependent on our ability to:
- support multiple platforms, including Microsoft Windows and
Windows NT, IBM, commercial UNIX, and Linux;
- use the latest technologies to support Web-based development of
business-critical applications;
- develop and market a broader line of products for programming
languages such as C++, Visual Studio.NET, Java, and Java Beans;
and
- continually support the rapidly changing standards and
technologies used in the development of Web-based applications as
well as off-the-shelf products.
We face intense competition for each of our products, generally from
both Windows and UNIX vendors. Because individual product sales
often lead to a broader customer relationship, each of our products
must be able to successfully compete with numerous competitors'
offerings. Many of our competitors or potential competitors are much
larger than we are and may have significantly more resources and
more experience. Moreover, many of our strategic partners compete
with each other and this may adversely impact our relationship with
an individual partner or a number of partners.
The recent formation of Catapulse, a new Internet company, by our
founders could divert the attention of our management away from our
business and affairs, creating potential conflicts of interest.
On December 3, 1999, we closed a $50,000,000 investment in the
Series A Preferred Stock of Catapulse, founded by Paul Levy and Mike
Devlin. As of March 31, 2000, after taking into account additional
investments by third parties in Catapulse, our Series A Preferred
Stock represented approximately 40% of the voting power of the
outstanding capital stock of this entity. Paul Levy serves as its
Chief Executive Officer and Mike Devlin serves as the Vice-Chairman
of the board of directors. Catapulse's board of directors is made up
of five directors. Rational has the right to designate two of the
members of its board of directors. As of the date hereof, four of
its directors also serve on our board of directors. Paul Levy and
Mike Devlin will continue in their roles as our Chairman of the
Board and Chief Executive Officer, respectively. Catapulse is a
business-to-business application service provider that will focus on
developing a portal to meet the needs of the global community of
software professionals. Catapulse also intends to develop an
electronic marketplace for products and services relating to
software development and intends to develop and deploy a hosted
development service for Internet software development. Rational and
Catapulse intend to enter into a strategic business relationship on
terms negotiated at arms-length. This strategic relationship could
give rise to conflicts of interest involving the two companies and
the founders in the future. In addition, Catapulse could divert the
attention of Paul Levy and Mike Devlin away from the business and
affairs of Rational.
If we are unable to manage our growth, our business will suffer.
We have experienced rapid growth in recent years. This growth has
placed a significant strain on our financial, operational,
management, marketing, and sales systems and resources. If we are
unable to effectively manage growth, our business, competitive
position, results of operations, and financial condition could
suffer.
To achieve and manage continued growth, we must continue to expand
and upgrade our information-technology infrastructure and its
scalability, including improvements to various operations,
financial, and management information systems, and expand, train,
and manage our work force. We may not be successful in implementing
these initiatives effectively and in a timely fashion.
Our international operations expose us to greater management,
collections, currency, intellectual property, regulatory, and other
risks.
International sales accounted for approximately 41% of our revenues
in fiscal 2000, 40% in 1999, 34% in 1998 and 37% for the three
months ended June 30, 2000. We expect that international sales will
continue to account for a significant portion of our revenues in
future periods. Our business would be harmed if our international
operations experienced a material downturn. In addition,
international sales are subject to inherent risks, including:
- unexpected changes in regulatory requirements and tariffs;
- unexpected changes in global economic conditions;
- 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 some markets;
- lack of acceptance of localized products in international markets;
and
- the effects of high local wage scales and other expenses.
Our international sales are generally transacted through our
international sales subsidiaries. The revenues generated by these
subsidiaries, as well as their local expenses, are generally
denominated in local currencies. Accordingly, the functional
currency of each international sales subsidiary is the local
currency. We have engaged in limited hedging activities to protect
us against losses arising from remeasuring assets and liabilities
denominated in currencies other than the functional currency of the
related subsidiary. We are also exposed to foreign exchange rate
fluctuations as the financial results of international subsidiaries
are translated into U.S. dollars in consolidation. As exchange rates
vary, these results, when translated, may vary from expectations and
adversely impact our overall expected profitability. We currently do
not hedge against this exposure. Fluctuations in foreign currencies
could harm our financial condition and operating results.
We are subject to risks associated with the European monetary
conversion.
In January 1999, the new ''Euro'' currency was introduced in certain
European countries that are part of the European Monetary Union, or
EMU. During 2002, all EMU countries are expected to begin operating
with the Euro as their single currency. A significant amount of
uncertainty exists as to the effect the Euro will have on the
marketplace generally and, additionally, all of the final rules and
regulations have not yet been defined and finalized by the European
Commission with regard to the Euro currency. We are currently
assessing the effect the introduction of the Euro will have on
internal accounting systems and the sales of products. We are not
aware of any material operational issues or costs associated with
preparing internal systems for the Euro. However, we do utilize
third-party vendor equipment and software products that may or may
not be EMU-compliant. The failure of any critical components to
operate properly after introduction of the Euro may harm our
business or results of operations or require additional costs to
remedy these problems.
If we lose key personnel or cannot hire enough qualified personnel, our
ability to manage our business, develop new products, and increase our
revenues will suffer.
We believe that the hiring and retaining of qualified individuals at
all levels in our organization will be essential to our ability to
sustain and manage growth successfully. Competition for highly
qualified technical personnel is intense and we may not be
successful in attracting and retaining the necessary personnel,
which may limit the rate at which we can develop products and
generate sales. We will be particularly dependent on the efforts and
abilities of our senior management personnel. The departure of any
of our senior management members or other key personnel could harm
our business. Merger activities 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.
If we fail to maintain and expand our distribution channels, our
business will suffer.
We currently distribute our products primarily through field sales
personnel teamed with highly trained technical support personnel as
well as through our telesales organizations, our Web site, and
indirectly through channels such as value-added resellers and
distributors. Our ability to achieve revenue growth in the future
will depend in large part on our success in expanding our direct
sales force and in maintaining a high level of technical consulting,
training, and customer support.
We depend on strategic relationships and business alliances for
continued growth of our business.
Our development, marketing, and distribution strategies rely
increasingly on our 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 on the
continued cooperation of each party with us. Merger activity, such
as the acquisition of ObjecTime Ltd., may disrupt these
relationships or activities, and some companies may reassess the
value of their relationship with us as a result of this merger
activity. Divergence in strategy or change in focus by or
competitive product offerings by any of these companies may
interfere with our ability to develop, market, sell, or support our
products, which in turn could harm our business. In addition, one or
more of these companies may use the information they gain from their
relationship with us to develop or market competing products.
Our products could contain software defects that could reduce our
revenues and make it more difficult for us to achieve market acceptance
of our products.
Software products as complex as those sold by us often contain
undetected errors, or ''bugs,'' or performance problems. These
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, our 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 our products
could result in loss of revenues or delays in market acceptance,
which could harm our business. Further, because we rely on our own
products in connection with the development of our software, these
errors may make it more difficult to sell our products in the
future.
If we fail to adequately protect our intellectual property rights,
competitors may use our technology and trademarks, which could weaken
our competitive position, reduce our revenues, and increase our costs.
We rely on a combination of copyright, trademark, patent, and trade-
secret laws, employee and third-party nondisclosure agreements, and
other arrangements to protect our proprietary rights. Despite these
precautions, it may be possible for unauthorized third parties to
copy our products or obtain and use information that we regard as
proprietary to create products that compete against ours. In
addition, some license provisions protecting against unauthorized
use, copying, transfer, and disclosure of our licensed programs may
be unenforceable under the laws of certain jurisdictions and foreign
countries.
In addition, the laws of some countries do not protect proprietary
rights to the same extent as do the laws of the United States. To
the extent that we increase our international activities, our
exposure to unauthorized copying and use of our 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 that
would relate to our products.
We rely on software licensed from third parties that is used in our
products.
We also rely on some software that we license from third parties,
including software that is integrated with internally developed
software and used in our products to perform key functions. These
third-party software licenses may not be available to us on
commercially reasonable terms or at all. Further, the software may
not be appropriately supported, maintained, or enhanced by the
licensors. The loss of licenses to or the inability to support,
maintain, and enhance any of this software could result in increased
costs or in delays or reductions in our product shipments until
equivalent software could be developed, identified, licensed, and
integrated.
Third parties could assert that our software products and services
infringe on their intellectual property rights, which could expose us
to increased costs and litigation.
We expect that we 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.
Third parties may assert infringement claims against us in the
future and their claims may or may not be successful. We could incur
substantial costs in defending ourselves and our customers against
their claims. Parties making their claims may be able to obtain
injunctive or other equitable relief that could effectively block
our ability to sell our products in the United States and abroad and
could result in an award of substantial damages against us. In the
event of a claim of infringement, we may be required to obtain one
or more licenses from third parties. We cannot be sure that we can
obtain necessary licenses from third parties at a reasonable cost or
at all. Defense of any lawsuit or failure to obtain any required
license could delay shipment of our products and increase our costs.
Promotional product versions may adversely impact our actual product
sales.
Our marketing strategy relies in part on making elements of our
technology available for no charge or at a very low price, either
directly or by incorporating these elements into products offered by
third parties, such as Microsoft, with whom we have strategic
alliances. This strategy is designed to expose our products to a
broader customer base than to our historical customer base and to
encourage potential customers to purchase an upgrade or other
higher-priced product from us. We may not be able to introduce
enhancements to our full-price products or versions of our products
with intermediate functionality at a rate necessary to adequately
differentiate them from the promotional versions, particularly in
cases where our partners are distributing versions of our products
with other desirable features, which could reduce sales of our
products.
If we cannot successfully integrate our past and future acquisitions
and achieve intended financial or strategic benefits, our revenues may
decline and our expenses increase.
We have acquired a number of businesses, technologies, and products,
most recently in January 2000. If we fail to achieve the intended
financial or strategic benefits of past and future acquisitions, our
operating results will suffer. Acquisitions entail numerous risks,
including:
- difficulty with the assimilation of acquired operations and
products;
- failure to achieve targeted synergies;
- inability to retain key employees of the acquired companies;
- loss of key business relationships of the acquired company; and
- diversion of the attention of our management team.
In addition, if we undertake future acquisitions, we may issue
dilutive securities, assume or incur additional debt obligations,
incur large, one-time expenses, or acquire intangible assets that
would result in significant future amortization expense. Any of
these events could harm our business.
<PAGE>
ITEM 3-Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risk, including changes in
currency exchange rates and interest rates. To manage the volatility
relating to these exposures, the Company employs established policies
and procedures to manage its exposure to changes in known or forecasted
currency exchange rates and to fluctuations in interest rates. As of
June 30, 2000 no significant changes have occurred since our Annual
Report on Form 10-K for the year ended March 31, 2000.
Foreign Currency Risk
A portion of the Company's business is conducted in currencies
other than the U.S. dollar. Changes in the value of major foreign
currencies relative to the local or "functional" currency of the
Company or its subsidiaries may adversely effect operating results.
The Company enters into short-term forward foreign exchange contracts
designed to mitigate the impact of foreign currency exchange rate
fluctuations on balance sheet exposures denominated in currencies other
than the "functional" currency. The total amount of these contracts is
approximately offset by the underlying assets and liabilities
denominated in nonfunctional currencies. Forward contracts are
accounted for on a mark-to-market basis with realized and unrealized
gains or losses recognized in the period in which they are incurred.
Such contracts meet the criteria established in FAS 52 for hedge
accounting treatment. As the Company finds it impractical to hedge all
foreign currency exposures, the Company will continue to experience
foreign currency gains and losses. The Company does not use derivative
financial instruments for speculative trading purposes, nor does it
hold or issue leveraged derivative financial instruments.
Interest Rate Risk
The Company's exposure to market rate risk for changes in
interest rates relates primarily to the Company's investment portfolio.
All the Company's cash equivalents and short-term investments are
classified as available-for-sale and are recorded at amounts that
approximate fair value. Unrecognized gains and losses and declines in
value judged to be other than temporary on available-for-sale
securities are included in other income. The cost of securities sold is
based on the specific identification method.
<PAGE>
PART II -- OTHER INFORMATION
ITEM 6 - Exhibits and Reports on Form 8-K
(a) Exhibit 27: Financial Data Schedule
<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/ Timothy A. Brennan
--------------------------------
Timothy A. Brennan
Senior Vice President
Chief Financial Officer and Secretary
August 4, 2000
