UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-Q
________________
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____ TO ____
Commission file number: 0-25578
SOFTWARE ARTISTRY, INC.
(Exact name of registrant as specified in its charter)
Indiana 35-1731589
(State or other jurisdiction of organization) (I.R.S. Employer
Identification Number)
9449 Priority Way West Drive, Indianapolis, IN 46240
(Address of principal executive offices) (Zip Code)
(317) 843-1663
(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 requirement for the past 90 days.
Yes X No
As of November 5, 1996, there were 6,712,508 shares of Common Stock, no par
value, outstanding.
SOFTWARE ARTISTRY, INC.
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets --
As of September 30, 1996 and December 31, 1995 3
Condensed Consolidated Statements of Income --
For the three months and nine months
ended September 30, 1996 and 1995 4
Condensed Consolidated Statements of Cash Flows --
For the nine months ended September 30, 1996 and 1995 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8
PART II OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K 15
Signatures 15
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
SOFTWARE ARTISTRY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
September 30, December 31,
1996 1995
------------ ------------
(Unaudited)
<S> <C> <C>
Assets
- ----------------------------
Current assets:
Cash and cash equivalents $7,020 $15,816
Marketable securities 10,272 2,263
Trade account receivables, net 9,972 12,442
Prepaid expenses and other current assets 794 672
Deferred income taxes 103 103
------- -------
Total current assets 28,161 31,296
Property and equipment, net 4,524 3,318
Capitalized software development costs, net 1,144 820
Other assets 61 60
------- -------
Total assets $33,890 $35,494
======= =======
Liabilities and Stockholders' Equity
- -------------------------------------------------------
Current liabilities:
Notes payable and capitalized leases $ 4 $ 22
Accounts payable and accrued expenses 1,270 1,095
Accrued compensation and related expenses 986 1,527
Income taxes payable 636 877
Deferred revenues 6,367 5,873
-------- --------
Total current liabilities 9,263 9,394
Deferred income taxes 462 462
-------- -------
Total liabilities 9,725 9,856
-------- -------
Stockholders' equity:
Common stock, no par value; 10,000,000 shares
authorized, 6,702,691 and 6,777,148 shares
outstanding at September 30, 1996 and
December 31,1995, respectively 21,382 23,103
Retained earnings 2,783 2,535
-------- --------
Total stockholders' equity 24,165 25,638
-------- --------
Total liabilities and stockholders' equity $ 33,890 $35,494
======== ========
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
<CAPTION>
SOFTWARE ARTISTRY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
1996 1995 1996 1995
------ ------ ------- ------
<S> <C> <C> <C> <C>
Revenues:
Initial license fees $5,418 $4,573 $13,869 $11,599
Renewal license fees and services 2,843 1,860 7,990 4,775
------ ------ ------ ------
Total revenues 8,261 6,433 21,859 16,374
------ ------ ------ ------
Operating expenses:
Costs of license fees 475 395 1,283 990
Costs of renewal license fees and services 1,786 1,263 4,458 3,007
Sales and marketing 3,515 2,272 10,195 6,250
Product development 1,413 752 3,581 1,980
General and administrative 806 574 2,326 1,458
Severance charge -- -- 207 --
------ ------ ------ ------
Total operating expenses 7,995 5,256 22,050 13,685
------ ------ ------ ------
Income (loss) from operations 266 1,177 (191) 2,689
Interest income, net 204 224 567 491
------ ------ ------ ------
Income before income taxes 470 1,401 376 3,180
Provision for income taxes 160 490 128 1,113
------ ------ ------ ------
Net income $ 310 $ 911 $ 248 $ 2,067
====== ====== ====== ======
Primary:
Net income per share $ 0.04 $ 0.12 $0.03 $ 0.29
====== ====== ====== ======
Shares used in computing net income per share7,413 7,725 7,499 6,969
====== ====== ====== ======
Fully diluted:
Net income per share $ 0.04 $ 0.12 $ 0.03 $ 0.28
====== ====== ====== ======
Shares used in computing net income per share7,413 7,725 7,499 7,460
====== ====== ====== ======
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
<CAPTION>
SOFTWARE ARTISTRY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
1996 1995
--------- ---------
<S> <C> <C>
Operating activities:
Net income $ 248 $ 2,067
Items not affecting cash provided by operations:
Depreciation and amortization of property and equipment 1,083 461
Amortization of software development costs 284 121
Change in allowance for doubtful accounts (118) 41
Disposition of equipment -- 11
Amortization of financing costs -- 1
Changes in assets and liabilities:
Trade accounts receivable 2,588 (3)
Prepaid expenses and other current assets (122) (494)
Accounts payable and accrued expenses 175 (442)
Accrued compensation and related expenses (541) (778)
Income taxes payable (241) 93
Deferred revenues 494 483
--------- --------
Net cash provided by operations 3,850 1,761
--------- --------
Investing activities:
Purchase of marketable securities, net (8,009) (10,935)
Purchase of property and equipment (2,289) (1,236)
Capitalization of software development costs (608) (450)
Increase in other assets (1) (8)
--------- --------
Net cash used in investing activities (10,907) (12,629)
--------- --------
Financing activities:
Proceeds from issuance of common stock, net of issuance costs -- 19,741
Proceeds from exercise of stock options 307 204
Income tax benefit related to stock option exercise -- 57
Purchase of common stock (2,028) --
Redemption of Series D preferred stock -- (563)
Payment of accumulated dividends on preferred stock -- (519)
Payment of interest payable to stockholders -- (362)
Principal payments on equipment obligations (18) (27)
--------- -------
Net cash provided (used) by financing activities (1,739) 8,531
--------- -------
Change in cash and cash equivalents (8,796) 7,663
Cash and cash equivalents, beginning of period 15,816 398
--------- -------
Cash and cash equivalents, end of period $ 7,020 $ 8,061
========= =======
Supplemental disclosures:
Cash paid for:
Interest expense $ 4 $ 14
Income taxes 369 751
Noncash investing and financing activities:
Transfer of preferred stock to common stock -- 2,900
Dividends accrued on preferred stock -- 31
</TABLE>
See accompanying notes.
<PAGE>
SOFTWARE ARTISTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Software Artistry, Inc. (the "Company") develops, internationally
markets, and supports a family of internal and external customer support
software applications. To date, a significant portion of revenues have been
generated from North American customers, although sales to non-North American
customer have been increasing. The Company does not have a concentration of
credit risk in any one industry, geographic region, or customer.
A significant portion of the Company's revenues are derived from licenses of
Expert Advisor, a complete problem management system designed to resolve
customer problems.
The condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
balances and transactions have been eliminated.
1. BASIS OF PRESENTATION
The accompanying interim condensed consolidated financial statements have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission regarding interim financial reporting.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements
and should be read in conjunction with the consolidated financial statements
and notes thereto included in the Company's 1995 Annual Report to
Shareholders. In management's opinion, this information has been prepared on
the same basis as the annual consolidated financial statements and includes
all adjustments (consisting only of normal and recurring adjustments)
necessary for a fair presentation of the information.
The operating results for the interim periods are not necessarily indicative
of the results of operations for the full year.
2. CASH, CASH EQUIVALENTS, AND MARKETABLE SECURITIES
The Company considers all highly liquid investments with a maturity of
three months or less to be cash equivalents. Those instruments with
maturities between three and twelve months are considered to be short-term
marketable securities. Cash equivalents and marketable securities consist
primarily of U.S. government securities, municipal issues and interest-bearing
deposits with major banks.
In accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the
Company classifies all of its marketable debt securities as available-for-sale
securities. These securities are valued at their fair value. There was no
significant difference between cost and fair value at September 30, 1996 or
December 31, 1995.
3. CAPITALIZED SOFTWARE DEVELOPMENT COSTS
Software development costs are accounted for in accordance with Statement
of Financial Accounting Standards No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed." Costs
associated with the planning and designing phase of software development,
including coding and testing activities necessary to establish technological
feasibility, are classified as product development and expensed as incurred.
Once technological feasibility has been determined, additional costs incurred
in development, including coding, testing, and product quality assurance, are
capitalized.
Amortization is provided on a product-by-product basis over the estimated
economic life of the software, not to exceed three years, using the
straight-line method. This method results in greater amortization than the
ratio of current year gross product revenues to current and anticipated future
gross product method. Amortization commences when a product is available for
general release to customers. Unamortized capitalized costs determined to be
in excess of the net realizable value of a product are expensed at the date of
such determination.
<PAGE>
Capitalized software development costs consists of the following amounts (in
thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
--------------- ------------
(Unaudited)
<S> <C> <C>
Capitalized costs $ 1,612 $ 1,004
Less accumulated amortization 468 184
-------- --------
$ 1,144 $ 820
======== ========
</TABLE>
4. NET INCOME PER SHARE
Primary net income per share is computed based upon the weighted average
number of common and common equivalent shares outstanding and gives effect to
certain adjustments. Common equivalent shares include outstanding stock
options and, for periods prior to 1996, Series A redeemable convertible
preferred stock; such stock was redeemed in connection with the Company's
initial public offering in March 1995. Common equivalent shares are included
in the per share calculation using the modified treasury stock method.
Fully diluted net income per share is computed in the same manner as
primary net income per share, except that all outstanding shares of Series B
and C redeemable convertible preferred stock are assumed to have been
converted to common stock at the time of issuance.
5. USE OF MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the unaudited condensed
financial statements and accompanying notes. Actual results could differ from
those estimates.
6. SEVERANCE CHARGE
Severance charge amounts include the compensation and benefits expense
resulting from certain management separations.
7. RECLASSIFICATIONS
Certain amounts in the 1995 unaudited condensed consolidated financial
statements have been reclassified to conform to the 1996 presentation.
<PAGE>
SOFTWARE ARTISTRY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This report includes a number of forward-looking statements which reflect
the Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks
and uncertainties, including those discussed in the Company's 1995 Annual
Report to Shareholders and Form 10-K for the year ended December 31, 1995,
that could cause actual results to differ materially from historical results
or those anticipated. In this report, the words "anticipates," "believes,"
"plans," "expects," or similar expressions identify forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Company undertakes no obligation to update this discussion
except as may be legally required in its reporting statements.
RESULTS OF OPERATIONS
The following table sets forth certain income and expense items as a
percentage of total revenues, and the percentage change in dollar amounts of
such items, for the three and nine months ended September 30, 1996 and 1995.
<TABLE>
<CAPTION>
Period to Period Change
----------------------------
Three Months Nine Months Three Months Nine Months
Ended September 30, Ended September 30,
1996 Compared
1996 1995 1996 1995 to 1995 to 1995
---- ---- ---- ---- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Initial license fees 66% 71% 63% 71% 18% 20%
Renewal license fees and services 34 29 37 29 53 67
----- ----- ----- -----
Total revenues 100 100 100 100 28 33
----- ----- ----- -----
Operating expenses:
Costs of license fees 6 6 6 6 20 30
Costs of renewal license fees
and services 22 20 20 19 41 48
Sales and marketing 42 35 47 38 55 63
Product development 17 12 16 12 88 81
General and administrative 10 9 11 9 40 60
Severance charge -- -- 1 -- * *
----- ----- ----- -----
Total operating expenses 97 82 101 84 52 61
----- ----- ----- -----
Income (loss) from operations 3 18 (1) 16 (77) *
Interest income, net 3 3 3 3 (9) 15
----- ----- ----- -----
Income before income taxes 6 21 2 19 (66) (88)
Provision for income taxes 2 7 1 6 (66) (88)
----- ----- ----- -----
Net income 4% 14% 1% 13% (66) (88)
===== ===== ===== =====
* Not a meaningful percentage
</TABLE>
General
The Company has recognized less North American initial license fees in
1996 compared to 1995 (as discussed later in Initial License Fees). However,
the Company made a strategic decision to continue increasing sales and
marketing activities, product development activities, and general and
administrative expenses during the second and third quarters of 1996. As a
result of the reduced North American initial license fees and the strategic
investing decision, sales and marketing, product development, and general and
administrative expenses were a greater percentage of total revenues in 1996
compared to the corresponding periods in 1995. The Company anticipates that
expenses in these areas may continue to be a higher percentage of total
revenues for 1996 compared to the corresponding periods in 1995. In addition,
the Company expects an increase in its current dollar level of sales and
marketing activities during the fourth quarter of 1996.
<PAGE>
Revenues
The Company's revenues are derived from initial license fees, renewal license
fees, and services. The Company recognizes initial license fees upon shipment.
The Company unbundles the initial product support revenue (typically 12
months) and services revenue included in the license agreement and recognizes
these revenues in renewal license fees and services. The Company's license
agreements do not provide a right of return. Continued support of the
Company's software typically requires the payment of an annual license renewal
fee which is offered at 18% of the then current initial license fee. Renewal
license fees include customer technical support and product enhancements and
are recognized ratably over the term of the license period. The Company
provides a comprehensive range of services, including consulting and
education; services revenue is recognized at the time the service is provided.
Allowances are maintained for potential credit losses, which have not been
significant to date.
Initial License Fees
Initial license fee revenues increased by 18% to $5.4 million for the
quarter ended September 30, 1996, from $4.6 million for the quarter ended
September 30, 1995. For the nine month period ended September 30, 1996,
initial license fees revenues increased by 20% to $13.9 million from $11.6
million for the comparable 1995 period. The continued growth in initial
license fee revenues is primarily a result of expanding the European sales
force and distributor sales channels and increased marketing efforts.
North American initial license fees were $3.4 million and $4.5 million for the
three months ended September 30, 1996 and 1995, respectively. For the nine
month periods ended September 30, 1996 and 1995, North American initial
license fees were $9.9 million and $10.9 million. The results in the third
quarter and first nine months of 1996 reflect the effects of increased
domestic competitive pressures and the impact of the change in warranty period
(discussed below in last paragraph of Initial License Fees).
Initial license fees from outside North America were $2.0 million, or 37% of
total initial license fee revenues, for the quarter ended September 30, 1996,
compared with $112,000, or 2% of total initial license fee revenues, in the
same period in 1995. For the nine month period ended September 30, 1996,
initial license fees from outside North America were $4.0 million, or 29%
compared with $609,000, or 5% of total initial license fee revenues, in the
same period in 1995. The increase in non-North American initial license fees
is primarily the result of increased sales and marketing activities in Europe.
During 1995, the Company added both a Vice President, European Operations and
a Vice President, Asia/Pacific Operations. The Company expects that
international revenue will continue to be a larger portion of total revenues
during the remainder of 1996 than in 1995.
Beginning on April 1, 1996, the Company extended its standard warranty period,
which includes initial product support, from three months to 12 months on all
new contracts. As a result of extending the standard warranty period, a larger
percentage of each contract is now unbundled, which may have negatively
impacted the amount of initial license fee revenues recognized in the quarter
ended September 30, 1996. However, the impact of this change in standard
warranty period cannot be conclusively determined due to various factors
involved in the contract negotiation process.
Renewal License Fees and Services
Renewal license fees include a portion of initial license fee amounts
representing support (unbundled from the initial license fee) and annual
license renewals. Renewal license fee revenues increased by 61% to $1.7
million in the three months ended September 30, 1996 from $1.1 million for the
comparable period in 1995. For the nine month period ended September 30,
1996, renewal license fee revenues increased by 72% to $4.9 million from $2.9
million for the comparable 1995 period. These increases are due to an
expanded user base as a result of an increased number of product installations
and license expansions.
Services revenues increased by 42% to $1.1 million in the third quarter of
1996 from $785,000 in the third quarter of 1995. For the nine month period
ended September 30, 1996, service revenues increased by 60% to $3.1 million
from $1.9 million for the comparable 1995 period. These increases were
attributable to the increase in revenues from the initial licensing of the
Company's products and a continuing emphasis on providing complete services
solutions to existing customers.
Costs of License Fees
Costs of license fees consist primarily of third party royalty and
commission payments, product media, documentation, duplication, shipment, and
amortization of capitalized software costs. Costs of license fees increased by
20% in the third quarter of 1996 and 30% for the first nine months of 1996
from comparable periods in 1995. Costs of license fees represented 6% of
total revenues for each of the periods presented. The Company expects these
costs to remain a similar percentage of total revenues for the remainder of
1996.
Costs of Renewal License Fees and Services
Costs of renewal license fees and services consist primarily of the costs
of providing customer technical support, consulting, education, and account
management. Costs of renewal license fees and services constituted 22% and 20%
of total revenues and 63% and 68% of renewal license fees and services revenue
in the third quarters of 1996 and 1995, respectively. Costs of renewal
license fees and services constituted 20% and 19% of total revenues and 56%
and 63% of renewal license fees and services revenue in the first nine months
of 1996 and 1995, respectively. The dollar increase was due primarily to the
growth in the Company's installed customer base and the growth of customer
technical support, consulting, training, and account management staff. These
costs increased as a percentage of total revenue also in part due to the
increase in services revenues. The Company anticipates that the costs of
renewal license fees and services will increase in dollars during the
remainder of 1996 compared to 1995.
Sales and Marketing
Sales and marketing expenses were 42% and 35% of total revenues in the
third quarters of 1996 and 1995, respectively. For the nine month periods
ended September 30, 1996 and 1995, sales and marketing expenses were 47% and
38% of total revenues, respectively. The dollar increase in sales and
marketing expenses was due to both an increase in domestic and international
sales staff and a significant expansion of marketing expenses, including
increased staff and promotional activities. The Company anticipates that the
dollar amount of sales and marketing expenses will continue to be a higher
percentage of revenues in 1996 compared to 1995.
Product Development
The following table sets forth information regarding product development
costs (dollar amounts in thousands):
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1996 1995 1996 1995
------- ------ ------- -------
<S> <C> <C> <C> <C>
Total product development costs $1,625 $ 928 $4,189 $2,430
Costs capitalized 212 176 608 450
------- ------ ------- -------
Product development expense $1,413 $ 752 $3,581 $1,980
======= ====== ======= =======
Amortization of capitalized software
development costs (included in costs
of license fees) $ 118 $ 42 $ 284 $ 121
Percentage of costs capitalized 13% 19% 14% 19%
Percentage of costs capitalized,
net of amortization 6% 15% 7% 14%
</TABLE>
Product development expenses were 17% and 12% of total revenues in the
third quarter of 1996 and 1995, respectively. For the nine month periods
ended September 30, 1996 and 1995, product development expenses were 16% and
12% of total revenues, respectively. The increase in dollar amounts was due
primarily to the growth of the product development staff. The Company plans to
hold development costs steady in the fourth quarter of 1996 relative to the
third quarter of 1996.
The Company capitalized software development costs in accordance with
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased or Otherwise Marketed." The amounts
capitalized are dependent on the specific activities that the development
staff is engaged in during each year. Capitalized software development costs
are amortized over the estimated life of the related products (up to three
years) and amounts amortized are included in the costs of license fees.
General and Administrative
General and administrative expenses include the costs of finance, human
resources, information systems, and administrative departments of the Company.
General and administrative represented 10% and 9% of total revenue for the
third quarters of 1996 and 1995, respectively. For the nine month periods
ended September 30, 1996 and 1995, general and administrative expenses were
11% and 9% of total revenues, respectively. The dollar increase resulted
primarily from additional personnel and other costs incurred to support the
growth of the Company's operations.
Severance Charge
Severance charge amounts include the compensation and benefits expense
resulting from certain management separations during the second quarter of
1996.
Interest Income, Net
Interest income, net was $204,000 and $224,000 in the third quarters of
1996 and 1995, respectively. This decrease was primarily attributable to 1996
stock repurchases, which have totaled $2.0 million. For the first nine months
of 1996, interest income increased to $567,000 from $491,000 for the
comparable 1995 period. This increase was due to interest earned on the
proceeds of the Company's initial public offering in March 1995.
In January 1996, the Company announced a stock repurchase plan of up to
500,000 shares of its common stock. To the extent that the Company repurchases
common stock as authorized, interest rates change, cash is generated or used
by operations, and cash is used to purchase property and equipment, interest
income will be affected.
LIQUIDITY AND CAPITAL RESOURCES
In March 1995, the Company completed the sale of equity securities
through the initial public offering of its common stock. As a result of this
offering, the Company recorded proceeds of $19.7 million, net of related
underwriting discount and offering expenses. The Company generated $3.9
million and $1.8 million of cash from operations for the nine months ended
September 30, 1996 and 1995, respectively. For 1996, this amount is due
primarily to a decrease in account receivables and non-cash expenses. In
1995, the amount was due primarily to net income.
Account receivables decreased to $10.0 million from $12.4 million and
deferred revenues increased to $6.4 million from $5.9 million at September 30,
1996 from December 31, 1995, respectively. The decrease in accounts
receivable is primarily attributable to the lower amount of initial license
fee revenues in the third quarter of 1996 compared to the fourth quarter of
1995. The Company calculates days sales outstanding as (i) the amount of
accounts receivable at quarter end (ii) divided by the sum of quarterly
revenues and the change in deferred revenues (iii) multiplied by 90. The
Company believes this calculation to be relevant because deferred revenues (in
addition to recognized revenues) are typically billable, and therefore
contribute to the increase in account receivable each period.
Days sales outstanding were 107 days as of September 30, 1996 and 102
days as of September 30, 1995. These nearly equivalent amounts are
attributable to the similar concentration of licensing activity at the end of
the third quarters of 1996 and 1995. This 1996 amount is also due in part to
a substantially greater percentage of 1996 contracts with customers outside of
North America (see Initial License Fees discussion). Payments from these
customers take longer, on average, to collect. Also, a number of the
Company's contracts are billable over an extended period of time, generally
four to six months. Given the expected continuing concentration of licensing
activity at the end of each period, increasing international revenue and
certain extended billing terms, the Company expects that accounts receivable
and days sales outstanding may continue to be substantial in the foreseeable
future.
The Company used $10.9 million and $12.6 million for investment
activities in the first three quarters of 1996 and 1995, respectively. This
decrease is due primarily to a lower amount of marketable securities purchased
in the first nine months of 1996 compared to the same time period in 1995. In
the first nine months of 1996 and 1995, the Company expended $2.3 million and
$1.2 million, respectively, for purchases of property and equipment. Due to
planned business expansion, additions to property and equipment are expected
to continue, including the purchase of equipment for new employees, upgrading
equipment for existing employees, and potential expansion of Company
facilities. As of September 30, 1996, the Company had no material commitments
for capital expenditures.
In January 1996 the Company announced that the Board of Directors
authorized the Company to purchase up to 500,000 of the Company's common
stock. During the three months ended September 30, 1996, the Company purchased
102,500 shares at a cost of $775,000 and for the first nine months of 1996,
the Company purchased 242,500 shares at a cost of $2.0 million.
As of September 30, 1996, the Company had $7.0 million of cash and cash
equivalents, $10.3 million of short-term investments, and working capital of
$18.9 million. In addition, at September 30, 1996 the Company had a working
capital line of credit of $2.0 million. Management believes that existing
cash balances and marketable securities, cash flow from operations, and the
line of credit commitment will be sufficient to meet the Company's currently
anticipated working capital and capital expenditure requirements at least
through the next twelve months.
In October 1996 the Company signed a lease for a new corporate office facility
in the same vicinity as its current corporate office. The expected occupancy
date is January 1998. The new facility is considered necessary to meet the
expected growth in company staff. The lease commitment is substantially
greater than the current lease, but is relatively comparable in cost per
square foot. In connection with this relocation, there may be capital costs
incurred by the company for leasehold improvements and other equipment. In
connection with the Company's decision to remain in Indiana, state and city
tax credits are available which could aggregate more than $10 million over a
ten year period beginning in 1998.
OTHER CONSIDERATIONS
In addition to the other information set forth in this report, there are
certain risks that should be considered with regard to the Company and its
Common Stock. The following section lists some, but not all, of these risks
and uncertainties which may cause a significant impact on the Company's future
results of operations. This section should be read in conjunction with the
Company's 1995 Annual Report to Shareholders and Form 10-K for the year ended
December 31, 1995.
The Company may experience significant fluctuations in operating results
depending upon many factors, including, among others, the timing of new
application announcements and releases by the Company and its competitors,
budgeting cycles of its customers, demand for the Company's products, the size
and timing of customer orders, changes in the proportion of revenues
attributable to license fees versus renewal fees and services, changes in the
level of operating expenses, and general economic conditions. As a result, the
Company believes that period-to-period comparisons are not necessarily
meaningful and should not be relied upon as an indication of future
performance.
Although the Company has experienced rapid growth in recent periods, such
growth rates may not be sustainable and may not be indicative of future
operating results. The Company's continued growth will depend in part upon its
ability to enhance existing applications and develop and introduce new
applications that are technologically advanced, respond to evolving customer
requirements, respond to competitive products or announcements, and achieve
market acceptance of its products.
The Company's quarterly operating results fluctuate from quarter to quarter
with the fourth quarter historically having the highest total revenues and
operating income. The Company believes that this pattern will repeat in the
future.
The trading price of the Company's Common Stock could be subject to wide
fluctuations in response to quarterly variations in the Company's operating
results, announcements of new products or technological innovations by the
Company or its competitors, as well as other events or factors. Changes in
earnings estimates made by brokerage firms and industry analysts relating to
the market in which Software Artistry does business, or relating to Software
Artistry specifically, have in the past resulted and could in the future
result in an immediate and adverse effect on the market price of the Company's
Common Stock. In addition, the stock market has from time to time experienced
extreme price and volume fluctuations, which have particularly affected the
market prices of securities of many high-technology companies and which have
often been unrelated to the operating performance of these companies. The
broad market fluctuations may adversely affect the market price of the
Company's Common Stock.
The Company currently derives substantially all of its revenue from SA-Expert
Advisor and related products and services and expects this concentration to
continue for the foreseeable future. As a result, any factor adversely
affecting the demand for, or pricing of SA-Expert Advisor and related products
and services would have a material adverse effect on the Company's business
and results of operations. The Company's future financial performance will
depend significantly on the successful development and customer acceptance of
new and enhanced versions of SA-Expert Advisor and other products.
The Company believes that its future success will depend upon its ability to
attract, motivate, and retain qualified personnel, including key members of
senior management and members of the Company's sales force and development
staff. Competition for such personnel is intense. The inability to hire and
retain qualified personnel could have a material adverse effect on the
Company's business or results of operations. In addition, the rapid growth in
the Company's customer base and expansion of its applications have placed, and
are expected to continue to place, a strain on the Company's management and
other resources. The Company's future performance will depend in part on its
ability to implement and improve its operational, financial, and management
information systems and to hire, train, and manage its employees.
In conjunction with the license of its applications, the Company markets a
proprietary application development environment, including its own fourth
generation language. In the event that the Company's proprietary application
development environment does not keep pace with the technological changes
required by its customers, there can be no assurance that the Company would be
able to modify its proprietary application development environment or rewrite
its applications, and the inability or delays in doing so could have a
material adverse effect on the Company's business or results of operations.
Because the Company provides its licensees with the source code to certain
Company licensed applications, licensees have the ability to customize such
applications. However, there can be no assurance that all licensees will
appropriately isolate their customizations. As a result, the Company, while
not contractually obligated, may incur additional costs for services in excess
of those that would ordinarily be required, and customer satisfaction could
diminish substantially, resulting in a material adverse effect on the
Company's business or results of operations.
The market for the Company's applications is characterized by rapid
technological advances, changes in customer requirements and frequent new
product introductions and enhancements. The Company's growth and future
financial performance will depend in part upon its ability to enhance existing
applications and to develop and introduce new applications that meet
technological advances, respond to evolving customer requirements, respond to
competitive products or announcements, and achieve market acceptance. There
can be no assurance that the Company will be successful in developing and
marketing new applications or enhancements to existing applications on a
timely basis, or that its enhancements and new applications will adequately
address the changing needs of the marketplace and achieve market acceptance.
Any such failure could have a material adverse effect on the Company's
business or results of operations. Furthermore, programs as complex as those
offered by the Company may contain a number of undetected errors or bugs when
they are first introduced or as new versions are released. There can be no
assurance that, despite testing by the Company and by third-party test sites,
errors will not be found in future applications or enhancements, with the
possible result of delay in or loss of market acceptance and a material
adverse effect on the Company's business or results of operations.
The competitive factors affecting the market for the Company's software and
services include: vendor and product reputation, availability of products on
"popular" computer and communications platforms, scalability, integration with
other enterprise applications, functionality and features, ease-of-use,
product quality, performance, price, quality of support, documentation, and
training. The relative importance of each of these factors depends upon the
market segment. The inability to compete effectively with respect to these
factors could have a material adverse effect on the Company's business or
results of operations.
The Company is not aware that its products, trademarks, or other proprietary
rights significantly infringe the property rights of third parties. However,
there can be no assurance that third parties will not assert infringement
claims against the Company in the future with respect to current or future
products or that any such assertion may not require the Company to enter into
royalty arrangements or result in costly litigation. As the number of
software products in the industry increases and the functionality of these
products further overlap, the Company believes that software developers may
become increasingly subject to infringement claims. Any such claims, with or
without merit, can be time consuming and expensive to defend.
Despite the high credit ratings on the Company's marketable securities, there
is no assurance such agencies will not default on their obligations which
could result in losses of principal and accrued interest to the Company.
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11 -- Statement re: Computation of Earnings Per Share
Exhibit 27 -- Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the current period.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: November 13, 1996
SOFTWARE ARTISTRY, INC.
/s/ W. Scott Webber
W. Scott Webber
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Stephen R. Head
Stephen R. Head
Vice President, Finance and Administration,
Chief Financial Officer,
Secretary and Treasurer
(Principal Financial Officer and
Principal Accounting Officer)
<TABLE>
<CAPTION>
Software Artistry, Inc.
Exhibit 11 -- Statement Re: Computation of Earnings Per Share
(Dollars in thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Primary:
Average shares outstanding 6,728,010 6,729,683 6,751,194 5,683,086
Add common shares issued upon conversion
of Series A Redeemable Preferred Stock -- -- -- 280,931
Net effect of dilutive stock options 684,743 994,977 747,428 1,005,082
--------- --------- --------- ----------
Total 7,412,753 7,724,660 7,498,622 6,969,099
========= ========= ========= =========
Net income $ 310 $ 911 $ 248 $ 2,067
Deduct dividends on Series B, C, and D
Redeemable Preferred Stock -- -- -- (31)
--------- --------- --------- ----------
Adjusted net income $ 310 $ 911 $ 248 $ 2,036
========= ========= ========= ==========
Per share amount $ 0.04 $ 0.12 $ 0.03 $ 0.29
========= ========= ========= ==========
Fully diluted:
Average shares outstanding 6,728,010 6,729,683 6,751,194 5,683,086
Add common shares issued upon conversion
of Series A Redeemable Preferred Stock -- -- -- 771,635
Net effect of dilutive stock options 684,816 994,977 747,428 1,005,218
--------- --------- --------- ---------
Total 7,412,826 7,724,660 7,498,622 7,459,939
========= ========= ========= =========
Net income $ 310 $ 911 $ 248 $ 2,067
Deduct dividends on Series D
Redeemable Preferred Stock -- -- -- (7)
--------- --------- --------- ----------
Adjusted net income $ 310 $ 911 $ 248 $ 2,060
========= ========= ========= ==========
Per share amount $ 0.04 $ 0.12 $ 0.03 $ 0.28
========= ========= ========= ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
EXHIBIT 27
FINANCIAL DATA SCHEDULE
This schedule contains summary financial information extracted from the
condensed financial statements included in the Company's Form 10-Q and is
qualified in its entirety by reference to such condensed financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 7,020
<SECURITIES> 10,272
<RECEIVABLES> 10,248
<ALLOWANCES> 276
<INVENTORY> 0
<CURRENT-ASSETS> 28,161
<PP&E> 6,751
<DEPRECIATION> 2,227
<TOTAL-ASSETS> 33,890
<CURRENT-LIABILITIES> 9,263
<BONDS> 0
0
0
<COMMON> 21,382
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 33,890
<SALES> 8,261
<TOTAL-REVENUES> 8,261
<CGS> 2,261
<TOTAL-COSTS> 2,261
<OTHER-EXPENSES> 5,734
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4
<INCOME-PRETAX> 470
<INCOME-TAX> 160
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 310
<EPS-PRIMARY> 0.04
<EPS-DILUTED> 0.04
</TABLE>
