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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, 1997
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 (I.R.S. Employer
of organization) 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 11, 1997, there were 6,906,557 shares of Common Stock, no par
value, outstanding.
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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, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Operations --
For the three months and nine months ended
September 30, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows --
For the nine months ended September 30, 1997 and 1996 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
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SOFTWARE ARTISTRY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
September 30, December 31,
1997 1996
------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $11,270 $15,606
Marketable securities 65 2,216
Trade account receivables, net of allowance
for doubtful accounts of $655 in 1997
and $480 in 1996 14,416 12,036
Accrued accounts receivable 2,718 1,749
Other receivables 17 366
Prepaid and other assets 1,363 870
Deferred income taxes 344 262
------- -------
Total current assets 30,193 33,105
Property and equipment, net 6,077 5,676
Capitalized software development costs, net 1,757 1,245
Goodwill and other intangible assets, net 1,250 --
Other assets 75 51
------- -------
Total assets $39,352 $40,077
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 2,042 $ 2,556
Accrued compensation and related expenses 950 1,898
Income taxes payable 494 874
Deferred revenue 10,099 7,560
------- -------
Total current liabilities 13,585 12,888
Deferred income taxes (411) 737
------- -------
Total liabilities 13,174 13,625
------- -------
Stockholders' equity:
Common stock, no par value; 10,000,000 shares
authorized, 7,085,433 and 6,985,708 shares
outstanding at September 30, 1997 and
December 31, 1996, respectively 24,391 24,091
Treasury stock; 182,983 shares at September 30,
1997 and 242,500 shares at December 31, 1996 (1,799) (2,028)
Accumulated translation adjustments 79 (83)
Retained earnings 3,507 4,472
------- -------
Total stockholders' equity 26,178 26,452
------- -------
Total liabilities and stockholders' equity $39,352 $40,077
------- -------
------- -------
See accompanying notes.
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SOFTWARE ARTISTRY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine months Ended
September 30, September 30,
1997 1996 1997 1996
------- ------ ------- -------
<S> <C> <C> <C> <C>
Revenues:
Initial license fees $ 6,781 $5,418 $18,600 $13,869
Renewal license fees and services 5,062 2,843 12,647 7,990
------- ------ ------- -------
Total revenues 11,843 8,261 31,247 21,859
------- ------ ------- -------
Operating expenses:
Costs of license fees 596 475 1,628 1,283
Costs of renewal license fees and services 1,970 1,786 5,524 4,458
Sales and marketing 4,962 3,515 14,135 10,195
Product development 1,481 1,413 4,144 3,581
General and administrative 1,798 806 3,626 2,326
Non-recurring charge 4,100 -- 4,100 207
------- ------ ------- -------
Total operating expenses 14,907 7,995 33,157 22,050
------- ------ ------- -------
Operating (loss) income (3,064) 266 (1,910) (191)
Interest income, net 143 204 531 567
------- ------ ------- -------
Income (loss) before income taxes (2,921) 470 (1,379) 376
Provision (benefit) for income taxes (938) 160 (414) 128
------- ------ ------- -------
Net (loss) income $(1,983) $ 310 $ (965) $ 248
------- ------ ------- -------
------- ------ ------- -------
Primary:
Net (loss) income per share $ (0.25) $ 0.04 $ (0.12) $ 0.03
------- ------ ------- -------
------- ------ ------- -------
Shares used in computing net (loss) income per share 7,941 7,413 7,769 7,499
------- ------ ------- -------
------- ------ ------- -------
</TABLE>
See accompanying notes.
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SOFTWARE ARTISTRY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine months Ended
September 30,
------------------
1997 1996
-------- --------
Operating activities:
Net (loss) income $ (965) $ 248
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Write-off of acquired research and development costs 4,100 --
Depreciation and amortization of property and equipment 1,398 1,083
Amortization of software development costs 520 284
Amortization of goodwill and other intangible assets 59 --
Change in allowance for doubtful accounts (175) (118)
Loss on sale of furniture and equipment 55 --
Changes in assets and liabilities:
Trade accounts receivable (2,825) 2,588
Prepaid and other current assets (493) (122)
Accounts payable and accrued liabilities (986) 175
Accrued compensation and related expenses (948) (541)
Income taxes payable (380) (241)
Deferred revenue 2,471 494
Deferred income taxes (1,230) --
------- --------
Net cash provided by operating activities 601 3,850
------- --------
Investing activities:
Sale (purchase) of marketable securities, net 2,151 (8,009)
Purchase of property and equipment (1,598) (2,289)
Capitalization of software development costs (1,032) (608)
Acquisition of Sirius Systems, Inc. (5,125) --
Increase in other non-current assets (24) (1)
------- --------
Net cash provided (used) by investing activities (5,628) (10,907)
------- --------
Financing activities:
Proceeds from exercise of stock options 529 307
Purchase of treasury stock -- (2,028)
Principal payments on equipment obligations -- (18)
------- --------
Net cash provided (used) by financing activities 529 (1,736)
Accumulated translation adjustments 162 --
------- --------
Change in cash and cash equivalents (4,336) (8,796)
Cash and cash equivalents, beginning of period 15,606 15,816
------- --------
Cash and cash equivalents, end of period $11,270 $ 7,020
------- --------
------- --------
Supplemental disclosures:
Cash paid for:
Interest expense $ 22 $ 4
Income taxes 413 369
See accompanying notes.
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SOFTWARE ARTISTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Software Artistry, Inc. (the "Company") develops, 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 customers continue
to increase as a percentage of revenues. 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 the
licensing and support of the Company's EXPERTISE-TM- suite of products for
Enterprise Support Management solutions, a complete problem management system
designed to proactively manage and improve the organization's processes for
help desk, network management, asset and change management, and end-user
empowerment; and the EXPERTISE-TM- suite of products for Customer Relationship
Management solutions, a complete problem management system designed to
address customer support and satisfaction.
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 1996 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, 1997 or December 31, 1996.
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
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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.
Capitalized software development costs consists of the following amounts
(in thousands):
September 30, December 31,
1997 1996
------------- ------------
(Unaudited)
Capitalized costs $ 2,870 $ 1,838
Less accumulated amortization 1,113 593
------------- ------------
$ 1,757 $ 1,245
------------- ------------
------------- ------------
4. NET INCOME PER SHARE
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. Common equivalent shares are included in the per share calculation
using the modified 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 December 31, 1997. At that time, the
Company will be required to change the method currently used to compute
earnings per share and to restate all prior periods. Under the new
requirements for calculating basic earnings per share, the dilutive effect
of stock options will be excluded. The Company has not yet determined what
the impact of Statement No. 128 will be on the calculation of earnings per
share.
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. ACQUISITION
On August 12, 1997, the Company acquired certain assets and liabilities
of Sirius Systems, Inc. (Sirius), an Atlanta-based sales management software
developer. The purchase price consisted of a $5,125,000 initial cash
payment and a contingent earnout of up to $2,000,000 if certain future
revenue levels are attained. Of the total purchase price, $4.1 million was
allocated to acquired research and development related to projects which had
not yet attained technological feasibility. This amount is reflected as a
non-recurring charge in the Company's third quarter operating results. The
remaining purchase price has been allocated to the assets and liabilities of
Sirius based upon their estimated respective fair values. This amount
exceeded the fair value of Sirius's net assets by approximately $1,309,000
which was assigned to goodwill and other intangible assets.
This acquisition was accounted for as a purchase and the net assets and
results of operations are included in the Company's consolidated financial
statements from the date of purchase.
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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 1996 Annual
Report to Shareholders and Form 10-K for the year ended December 31, 1996,
that could cause actual results to differ materially from historical results
or those anticipated.
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 months and nine months ended September 30, 1997 and
1996.
<TABLE>
<CAPTION>
Period to Period Change
Three Months Ended Nine months Ended -----------------------------
September 30, September 30, Three Months Nine months
------------------ ------------------ 1997 Compared 1997 Compared
1997 1996 1997 1996 to 1996 to 1996
------ ------ ------ ------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Initial license fees 57% 66% 60% 63% 25% 34%
Renewal license fees and services 43 34 40 37 78 58
------ ------ ------ ------
Total revenues 100 100 100 100 43 43
------ ------ ------ ------
Operating expenses:
Costs of license fees 5 6 5 6 25 27
Costs of renewal license fees and services 17 22 18 20 10 24
Sales and marketing 42 42 45 47 41 39
Product development 12 17 13 16 5 16
General and administrative 15 10 12 11 123 56
Non-recurring charge 35 -- 13 1 * *
------ ------ ------ ------
Total operating expenses 126 97 106 101 86 50
------ ------ ------ ------
Income (loss) from operations (26) 3 (6) (1) * *
Interest income, net 1 3 2 3 (30) (6)
------ ------ ------ ------
Income before income taxes 25 6 (4) 2 * *
Provision for income taxes (8) 2 (1) 1 * *
------ ------ ------ ------
Net income (17)% 4% (3)% 1% * *
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
- ----------------------------------
* Not a meaningful percentage
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 educational services. 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.
Total revenues increased 43% to $11.8 million for the quarter ended September
30, 1997, from $8.3 million for the quarter ended September 30, 1996. For the
nine month period ended September 30, 1997, total revenues increased by 43% to
$31.2 million from $21.9 million for the comparable period 1996 period.
International revenues accounted for approximately 28% and 27% of the
Company's total revenues for the three months ended September 30, 1997 and 1996,
respectively. International revenues accounted for approximately 27% and 21% of
the Company's total revenues for the nine months ended September 30, 1997 and
1996, respectively.
8
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INITIAL LICENSE FEES
Initial license fee revenues increased 25% to $6.8 million for the quarter
ended September 30, 1997, from $5.4 million for the quarter ended September 30,
1996. For the nine month period ended September 30, 1997, initial license fee
revenues increased 34% to $18.6 million from $13.9 million for the comparable
1996 period. The increase in initial license fees was primarily due to increased
world-wide acceptance throughout the industry of the Company's move to
integrated applications suites verses single product sales.
North American initial license fees increased $740,000 (22%) to $4.2
million in the third quarter of 1997 compared to $3.4 million in the third
quarter of 1996. For the nine month period ended September 30, 1997, North
American initial license fees increased $1.5 million (15%) to $11.3 million
compared to $9.9 million for the comparable 1996 period. The increase in
North American license fees is primarily due to additional salespersons hired
during 1997.
Initial license fees from outside North America increased $0.6 million
(31%) to $2.6 million, or 38% of total initial license fees revenue for the
third quarter of 1997, from $2.0 million or 37% for the quarter ended
September 30, 1996. For the nine month period ended September 30, 1997,
initial license fees from outside North America increased by $3.3 million
(82%) to $7.3 million, or 39% of total license fees revenue, compared to $4.0
million or 29% for the comparable 1996 period. The increase in initial
license fees outside North America is primarily the result of increased
acceptance of the Company's move to integrated applications suites verses
single product sales both in Europe and the Asia-Pacific regions.
As both the European and Asia-Pacific operations continue to mature, the
Company believes that initial license fees from outside North America will
continue to increase as a percentage of total revenues.
The initial license fees for products are based on the number of seats a
licensee contracts to use.
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 52% to $2.6 million
in the three months ended September 30, 1997 from $1.7 million for the
comparable period in 1996. For the nine month period ended September 30,
1997, renewal license fee revenues increased 39% to $6.9 million from $4.9
million for the comparable 1996 period. The increase is due to an expanded
user base as a result of an increased number of product installations and
license expansions.
Services revenues increased 119% to $2.4 million in the third quarter of
1997 from $1.1 million in the third quarter of 1996. For the nine month
period ended September 30, 1997, service revenues increased 90% to $5.8
million from $3.1 million for the comparable 1996 period. This increase is
attributable to the increase in revenues from the initial licensing of the
SA-EXPERTISE-TM- products and the Company's commitment to being a total
solutions provider of products, services and training to existing customers.
COSTS OF LICENSE FEES
Costs of license fees consist primarily of third party royalties, product
media, documentation, duplication, shipment, and amortization of capitalized
software costs. Costs of license fees increased 25% to $596,000 in the third
quarter of 1997 from $475,000 in the third quarter of 1996. For the nine month
period ended September 30, 1997, costs of license fees increased 27% to $1.6
million from $1.3 million for the comparable 1996 period. Costs of license fees
represented 5% and 6% of total revenues for the three months ended September 30,
1997, and 1996, respectively. For the nine month period ended September 30,
1997, costs of license fees represented 5% of total revenues compared to 6% for
the comparable 1996 period. The Company expects these costs to remain a similar
percentage of total revenues for the remainder of 1997.
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 17% and
22% of total revenues and 39% and 63% of renewal license fees and services
revenue in the third quarters of 1997 and 1996, respectively. Costs of
renewal license fees and services constituted 18% and 20% of total revenues
and 44% and 56% of renewal license fees and services revenue in the first
nine months of 1997 and 1996, respectively. The increase was due primarily
to the growth in the Company's installed customer base.
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SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, commissions,
incentives and travel expenses of sales and marketing personnel, as well as
promotional expenses. Sales and marketing expenses were 42% of total
revenues in the third quarters of 1997 and 1996, respectively. For the nine
month periods ended September 30, 1997 and 1996, sales and marketing expenses
were 45% and 47% of total revenues, respectively. The amount of spending on
sales and marketing increased primarily due to the development and staffing
of the channel marketing department. The percentage change actually
decreased due to costs being spread over a larger revenue base.
PRODUCT DEVELOPMENT
The following table sets forth information regarding product development
costs (dollar amounts in thousands):
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
1997 1996 1997 1996
--------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
Total product development costs $ 1,876 $ 1,625 $ 5,176 $ 4,189
Costs capitalized 395 212 1,032 608
-------- -------- -------- --------
Product development expense $ 1,481 $ 1,413 $ 4,144 $ 3.581
-------- -------- -------- --------
-------- -------- -------- --------
Amortization of capitalized software
development costs (included in costs
of license fees) $ 168 $ 118 $ 521 $ 284
Percentage of costs capitalized 21% 13% 20% 14%
Percentage of costs capitalized,
net of amortization 12% 6% 10% 7%
</TABLE>
Product development expenses were 12% and 17% of total revenues in the
third quarters of 1997 and 1996, respectively. For the nine month periods
ended September 30, 1997 and 1996, product development expenses were 13% and
16% of total revenues, respectively. The increase in dollar amounts was due
primarily to the acquisition of Sirius Systems, Inc. ("Sirius"). The
decrease in percentage of revenue is due primarily to the increase in costs
capitalized which have increased due to additional resources being dedicated
to unreleased products.
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 expenses represented 15% and 10% of total revenue for
the third quarters of 1997 and 1996, respectively. For the nine month periods
ended September 30, 1997 and 1996, general and administrative expenses were 12%
and 11% of total revenues, respectively. The increase is due primarily to a
write-off of a specific account receivable totaling approximately $400,000 and
an increase in the bad debt allowance due to the increase in sales.
NON-RECURRING CHARGE
During the third quarter of 1997, the Company recorded a non-recurring charge
of $4.1 million for the write-off of acquired research and development costs
associated with the acquisition of Sirius Systems, Inc. ("Sirius").
INTEREST INCOME, NET
Interest income, net, was $143,000 and $204,000 for the three months ended
September 30, 1997 and 1996, respectively. For the nine month period ended
September 30, 1997, interest income decreased to $0.5 from $0.6 million for the
nine month period ended September 30, 1996. The decrease in net interest income
is due to the reduction of the Company's investment portfolio, primarily
resulting from the acquisition of Sirius.
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LIQUIDITY AND CAPITAL RESOURCES
The Company generated $601,000 and $3.9 million of cash from operations for
the nine months ended September 30, 1997 and 1996, respectively. The 1997
decrease is due primarily to the an increase in accounts receivable offset by
an increase in deferred revenue.
Account receivables increased to $17.1 million from $13.8 million and deferred
revenues increased to $10.1 million from $7.6 million at September 30, 1997 from
December 31, 1996, respectively. The increase in accounts receivable is
primarily attributable to third quarter sales being more heavily weighted toward
the end of the quarter than other quarters.
The Company used $5.6 million for investment activities in the first three
quarters of 1997 and $10.9 million for investment activities for the same period
in 1996. In the first nine months of 1997 and 1996, the Company used $1.6
million and $2.3 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 expansion of Company facilities.
As of September 30, 1997, the Company had no material commitments for capital
expenditures other than those related to the Company's relocation to a new
corporate office facility.
As of September 30, 1997, the Company had $11.3 million of cash and cash
equivalents and marketable securities, and working capital of $16.6 million. In
addition, at September 30, 1997 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 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 1997.
OUTLOOK
In this report, the words "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.
In 1995, the Company began marketing the SA-EXPERTISE-TM- name as an
umbrella for its evolving product suite for Enterprise Support Management
(ESM). The EXPERTISE suite for Enterprise Support Management provides
organizations with an integrated solution for internal support for employees
and end users. In 1996, the Company began using the SA-EXPERTISE-TM- suite
designation for its Customer Relationship Management (CRM) products for
external customer support. At the end of the first quarter of 1997, the
Company released SA-EXPERTISE-TM- for CUSTOMER RELATIONSHIP MANAGEMENT (CRM).
On August 12, 1997, the Company acquired substantially all of the assets of
Sirius Systems, Inc., a sales management organization that has been providing
sales and marketing solutions on a global basis since 1991. The acquisition,
which fulfilled a key component of the company's strategy for the customer
relationship management market, provides the company's customers with a
unified source of acquiring, developing and maintaining customer
relationships. This acquisition was neutral to earnings in the third quarter
(exclusive of the non-recurring charge to earnings of $4.1 million)
and is expected to be modestly dilutive to earnings in the fourth quarter.
During the third quarter of 1997, the Company released SA-Expert
Discovery-TM-, a dynamic application that leverages an organization's
investment in support technology. Expert Discovery improves customer
satisfaction and support center effectiveness by transforming support center
data into meaningful information. Expert
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Discovery also offers the ability to integrate with data from network and
systems management platforms as well as enterprise resource planning
applications, allowing executive decision makers to gain insight into actual
service level performance. The Company believes it is the only one in the
industry with this type of application. The company expects that sales of
this product will add to fourth quarter 1997 and full year 1998 results.
During the third quarter of 1997, the Company expanded its Expert
Partners-TM- program, which is currently composed of over 50 organizations
including MicroAge The Corporate Center, XLConnect Solutions, Inc., Global
Management Systems Incorporated (GMSI), and Coopers & Lybrand. As part of
the company's channel marketing division formed in March of this year, Expert
Partners provides the infrastructure, programs and processes to accelerate
the growth of strategic relationships with industry-leading systems
integrators, value-added resellers (VARs), and service and technology
organizations that can add value to the company's offerings.
Additionally, the company added two international distributors: NextWare
Limited in Japan and PooRun Information Systems and Engineering Company
(PRISE) in Korea. These distributors have begun to actively market, resell
and support all company software application suites, which are fully
double-byte enabled to support languages in these key Asian markets. The
company also signed a development partnership with Computer Associates
International, Inc. (CA), a $35 billion organization providing enterprise
management solutions to nearly 100% of Fortune 500 companies. The
partnership allows users of the company's SA-Expertise for Enterprise Support
Management (ESM) application suite to perform proactive management for
enterprises managed by CA's Unicenter TNG. Results from these partnerships
are expected in the first half of 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 1996 Annual Report to Shareholders and Form 10-K for the
year ended December 31, 1996.
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 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 significant 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 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 the Company does business, or relating to the Company
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.
12
<PAGE>
The Company currently derives substantially all of its revenue from the
SA-EXPERTISE-TM- suite of products and related services and expects this
concentration to continue for the foreseeable future. As a result, any
factor adversely affecting the demand for, or pricing of the SA-EXPERTISE-TM-
suite of 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 the SA-EXPERTISE-TM-
suite and other products. At the end of the first quarter the company
released SA-EXPERTISE-TM- for CUSTOMER RELATIONSHIP MANAGEMENT (CRM), a suite
of applications to address external customer support and satisfaction.
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 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
13
<PAGE>
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 marketable securities in the Company's
investment portfolio, 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.
14
<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, 1997
SOFTWARE ARTISTRY, INC.
/s/ W. Scott Webber /s/ Thomas E. Vanneman
- ------------------------------------ ------------------------------------
W. Scott Webber Thomas E. Vanneman
President, Chief Executive Officer Vice President, Finance
and Director and Administration,
(Principal Executive Officer) Chief Financial Officer,
Secretary and Treasurer
(Principal Financial Officer)
15
<PAGE>
Software Artistry, Inc.
Exhibit 11 -- Statement Re: Computation of Earnings Per Share
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine months Ended
September 30, September 30,
------------------------ ------------------------
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Primary:
Average shares outstanding 6,880,933 6,728,010 6,832,978 6,751,194
Net effect of dilutive stock options 1,060,198 684,743 935,635 747,428
---------- ---------- ---------- ----------
Total 7,941,131 7,412,753 7,768,613 7,498,622
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income (loss) $ (1,983) $ 310 $ (965) $ 248
Per share amount $ (0.25) $ 0.04 $ (0.12) $ 0.03
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Fully diluted:
Average shares outstanding 6,880,933 6,728,010 6,832,978 6,751,194
Net effect of dilutive stock options 1,060,087 684,816 1,044,192 747,428
---------- ---------- ---------- ----------
Total 7,941,020 7,412,826 7,877,170 7,498,622
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income (loss) $ (1,983) $ 310 $ (965) $ 248
Per share amount $ (0.25) $ 0.04 $ (0.12) $ 0.03
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ITEM 1 OF
FORM 10-Q FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 11,270
<SECURITIES> 65
<RECEIVABLES> 15,071
<ALLOWANCES> 655
<INVENTORY> 0
<CURRENT-ASSETS> 30,193
<PP&E> 9,973
<DEPRECIATION> 3,896
<TOTAL-ASSETS> 39,352
<CURRENT-LIABILITIES> 13,585
<BONDS> 0
0
0
<COMMON> 24,391
<OTHER-SE> 1,787
<TOTAL-LIABILITY-AND-EQUITY> 39,352
<SALES> 6,781
<TOTAL-REVENUES> 11,843
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,921)
<INCOME-TAX> (938)
<INCOME-CONTINUING> (1,983)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,983)
<EPS-PRIMARY> (.25)
<EPS-DILUTED> (.25)
</TABLE>
