-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RHYNIJZMk5l7c+XYgRPYeFPbFe67kx4tIPXcgeZ9qos0YsUP0kSOTjLlo/PcEjTq ZkQ6apGgYWLjNrgAkKnWqg== 0000891618-00-002804.txt : 20000516 0000891618-00-002804.hdr.sgml : 20000516 ACCESSION NUMBER: 0000891618-00-002804 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000331 FILED AS OF DATE: 20000515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PERSISTENCE SOFTWARE INC CENTRAL INDEX KEY: 0001084400 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 943138935 STATE OF INCORPORATION: CA FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-25857 FILM NUMBER: 630468 BUSINESS ADDRESS: STREET 1: 1720 SOUTH AMPHLETT BLVD., 3RD FLOOR CITY: SAN MATEO STATE: CA ZIP: 94402 BUSINESS PHONE: 6503417733 10-Q 1 FORM 10-Q 1 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 MARCH 31, 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 000-25857 ================================================================================ PERSISTENCE SOFTWARE, INC. (Exact name of registrant as specified in its charter) DELAWARE 94-3138935 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 1720 SOUTH AMPHLETT BLVD., THIRD FLOOR SAN MATEO, CALIFORNIA 94402 (Address of principal executive offices, including zip code) (650) 372-3600 (Registrant's telephone number, including area code) NOT APPLICABLE (Former name, former address and former fiscal year, if changed since last report) ================================================================================ 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 [ ] As of April 28, 2000, there were 19,510,773 shares of the registrant's Common Stock outstanding. 2 INDEX PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2000 AND DECEMBER 31, 1999. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ITEM 5. OTHER INFORMATION. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. SIGNATURES 2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. PERSISTENCE SOFTWARE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
AS OF ---------------------------- MARCH 31, DECEMBER 31, 2000 1999 -------- -------------- (UNAUDITED) (EXTRACTED)[1] Assets: Current assets: Cash and cash equivalents $ 19,529 $ 22,300 Short-term investments 5,819 7,352 Accounts receivable, net 5,681 5,685 Prepaids and other current assets 846 1,187 Total current assets 31,875 36,524 Property and equipment, net 1,243 1,051 Purchased intangibles, net 4,591 1,447 Deposits 86 70 -------- -------- Total assets $ 37,795 $ 39,092 ======== ======== Liabilities and Stockholders' Equity: Current liabilities: Accounts payable $ 1,308 $ 1,370 Accrued compensation and related benefits 2,760 1,804 Other accrued liabilities 1,518 1,194 Deferred revenues 1,986 2,015 Current portion of long-term obligations 304 337 -------- -------- Total current liabilities 7,876 6,720 Long-term obligations, net of current portion 307 354 -------- -------- Total liabilities 8,183 7,074 -------- -------- Stockholders' equity: Common stock 60,375 57,467 Unamortized deferred stock compensation (958) (1,206) Notes receivable from stockholders (161) (161) Accumulated deficit (29,634) (24,072) Accumulated other comprehensive loss (10) (10) -------- -------- Total stockholders' equity 29,612 32,018 -------- -------- Total liabilities and stockholders' equity $ 37,795 $ 39,092 ======== ========
[1] The condensed consolidated balance sheet as December 31, 1999 has been extracted from the consolidated financial statements as of that date, and does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. See notes to condensed consolidated financial statements. 3 4 PERSISTENCE SOFTWARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED ----------------------- MARCH 31, MARCH 31, 2000 1999 -------- -------- (UNAUDITED) Revenues: Licenses $ 2,881 $ 2,116 Service 1,329 747 -------- -------- Total revenues 4,210 2,863 -------- -------- Cost of revenues: Licenses 50 42 Service 715 580 -------- -------- Total cost of revenues 765 622 -------- -------- Gross profit 3,445 2,241 Operating expenses: Sales and marketing 5,998 2,015 Research and development, excluding amortization of purchased intangibles 2,013 1,806 General and administrative 867 383 Amortization of purchased intangibles 496 - -------- -------- Total operating expenses 9,374 4,204 -------- -------- Loss from operations (5,929) (1,963) Interest income 380 63 Interest and other expense (13) (15) -------- -------- Net loss $ (5,562) $ (1,915) ======== ======== Basic and diluted net loss per share $ (0.29) $ (0.27) ======== ======== Shares used in calculating basic and diluted net loss per share 18,968 7,044 ======== ========
See notes to condensed consolidated financial statements. 4 5 PERSISTENCE SOFTWARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
THREE MONTHS ENDED MARCH 31, MARCH 31, 2000 1999 -------- -------- (UNAUDITED) Cash flows from operating activities: Net loss $ (5,562) $ (1,915) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 272 141 Amortization of deferred stock compensation 99 504 Change in allowance for doubtful accounts 324 - Changes in operating assets and liabilities: Accounts receivable (320) (439) Prepaids and other currents 341 (9) Accounts payable (62) (77) Accrued compensation and benefits 956 1 Other accrued liabilities 324 362 Deferred revenues (29) (253) Deferred rent - (24) -------- -------- Net cash used in operating activities (3,657) (1,709) -------- -------- Cash flows from investing activities: Change in short-term investments 1,533 - Property and equipment additions (372) (94) Purchased intangibles additions (173) - Deposits (16) (2) -------- -------- Net cash provided by (used in) investing activities 972 (96) -------- -------- Cash flows from financing activities: Sale of convertible preferred stock, net - 4,142 Sale of common stock, net of repurchases (6) 156 Repayment of capital lease obligations (80) (45) -------- -------- Net cash provided by (used in) financing activities (86) 4,253 -------- -------- Net increase (decrease) in cash and cash equivalents (2,771) 2,448 Cash and cash equivalents - beginning of period 22,300 4,938 -------- -------- Cash and cash equivalents - end of period $ 19,529 $ 7,386 ======== ======== Noncash investing and financing activities: Common stock issued for purchased intangibles $ 3,063 $- ======== ========
See notes to condensed consolidated financial statements. 5 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS Persistence Software, Inc. and subsidiary (the Company) develops and markets transactional application server and dynamic caching software products that comprise the Internet software infrastructure for high-volume, high-performance electronic commerce applications. 2. BASIS OF PRESENTATION The condensed consolidated financial statements included in this filing on Form 10-Q as of March 31, 2000 and for the three month periods ended March 31, 2000 and 1999 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial statements. Certain information and footnote disclosures normally included in complete financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The December 31, 1999 balance sheet was extracted from audited financial statements as of and for the year ended that date, but does not include all disclosures required by generally accepted accounting principles for complete financial statements. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the annual consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K as of and for year ended December 31, 1999 filed with the Securities and Exchange Commission. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the Company's condensed consolidated financial position as of March 31, 2000, its condensed consolidated results of operations for the three month periods ended March 31, 2000 and 1999, and its cash flows for the three month periods ended March 31, 2000 and 1999, have been made. The results of operations and cash flows for any interim period are not necessarily indicative of the operating results and cash flows for any future interim or annual periods. 3. NET LOSS PER SHARE Basic net loss per common share excludes dilution and is computed by dividing net loss by the weighted average number of common shares outstanding for the period (excluding shares subject to repurchase). Diluted net loss per common share was the same as basic net loss per common share for all periods presented since the effect of any potentially dilutive securities is excluded as they are anti-dilutive because of the Company's net losses. The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per share (in thousands, except per share amounts):
THREE MONTHS ENDED MARCH 31, ----------------------- 2000 1999 -------- -------- Net loss (numerator), basic and diluted .......................... $ (5,562) $ (1,915) ======== ======== Shares (denominator): Weighted average common shares outstanding ................... 19,336 7,688 Weighted average common shares outstanding subject to repurchase .................... (368) (644) -------- -------- Shares used in computation, basic and diluted ............. 18,968 7,044 ======== ======== Net loss per share, basic and diluted .......................... $ (0.29) $ (0.27) ======== ========
6 7 As of March 31, 2000 and 1999, the Company had securities outstanding which could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net loss per share in the periods presented, as their effect would have been anti-dilutive. Such outstanding securities consist of the following (in thousands):
MARCH 31, MARCH 31, 2000 1999 ----- ----- Convertible preferred stock -- 7,698 Shares of common stock subject to repurchase 337 657 Outstanding options 3,475 1,388 Outstanding warrants -- 81 ----- ----- Total 3,812 9,824 ----- -----
4. COMPREHENSIVE INCOME For all periods presented, the Company had no comprehensive income items other than net loss. 5. ACQUISITION In March 2000, the Company acquired 10BaseJ, Inc. for 140,000 shares of common stock valued at the stock's fair market value on the acquisition date of $3.1 million. The acquisition was accounted for using the purchase method of accounting. The acquisition cost is included in purchased intangibles and is being amortized over the estimated useful life of three years. 6. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires companies to record derivatives on the balance sheet as assets or liabilities measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 will be effective for the Company's year ending December 31, 2001. The Company is currently evaluating the impact of SFAS No. 133 on its financial statements and related disclosures. 7 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements as of December 31, 1999 and 1998 and for each of the years ended December 31, 1999, 1998, and 1997, included in our Annual Report on Form 10-K as of and for year ended December 31, 1999 filed with the Securities and Exchange Commission. In addition, this Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Words such as "anticipates," "believes, "plans," "expects," "future," "intends, and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed or forecasted. Factors that might cause such a difference include, but are not limited to, those discussed in the section entitled "Additional Factors That May Affect Future Results" and those appearing elsewhere in this Form 10-Q and our Annual Report on Form 10-K as of and for year ended December 31, 1999 filed with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements. OVERVIEW We are a leading provider of transactional application server software products that comprise the Internet software infrastructure for high volume, high performance electronic commerce applications. We were incorporated and began operations in 1991. Our first products incorporated patented object-to-relational mapping and caching technologies, which have since become the foundation for our PowerTier product family. From 1992 to 1996, we introduced a variety of enhancements to these products, including a patented data transformation technology for mapping objects to database tables, and caching capabilities. In 1996, we developed our PowerTier transactional application server, which integrates all of the previously released Persistence products with new shared transactional caching technologies, which enable multiple users to simultaneously access the same cached data. We first shipped our PowerTier for C++ transactional application server in 1997. Sales of PowerTier for C++ accounted for the majority of our revenues in 1997, 1998, and 1999, during which years we added a professional services staff to enable our customers to implement PowerTier more rapidly. We were one of the first companies to adopt and implement the EJB specification. In 1998, we introduced PowerTier for EJB, which customers have frequently purchased together with PowerTier for C++. Our most recent version of PowerTier for EJB is currently in use by several major customers and was commercially released in March 2000. We currently plan to continue to focus product development efforts on enhancements to both the PowerTier for C++ and the PowerTier for EJB products. Our revenues, which consist of software license revenues and service revenues, totaled $4.2 million in the three months ended March 31, 2000 and $2.9 million in the three months ended March 31, 1999. License revenues consist of licenses of our software products, which generally are priced based on the number of users or servers. Service revenues consist of professional services consulting, customer support and training. Because we only commenced selling application servers in 1997, we have a limited operating history in the application server market. We expect that, as a percentage of total revenues, sales of PowerTier for EJB transaction servers will increase and sales of PowerTier for C++ will decrease in the future. We market our software and services primarily through our direct sales organizations in the United States, the United Kingdom, France, Germany, Hong Kong and Shanghai. Revenues from PowerTier licenses and services to customers outside the United States represented $1.4 million, or 33% of total revenues, in the three months ended March 31, 2000, $4.1 million, or 28% of total revenues, in 1999 and $2.9 million, or 29% of total revenues, in 1998. Our future success will depend, in part, on our successful development of international markets for our products. Historically, we have received a substantial portion of our revenues from product sales to a limited number of customers. Sales of products to our top five customers accounted for 44% of total revenues in the three months ended March 31, 2000, 35% of total revenues in 1999, and 55% of total revenues in 1998. In the future, it is possible that a relatively few large customers could continue to account for a relatively large proportion of our revenues. To date, we have sold our products primarily through our direct sales force, and we will need to continue to hire many more sales people in order to meet our sales goals. In addition, our ability to achieve significant revenue growth will depend in large part on our success in establishing and leveraging relationships with systems integrators and other third parties. 8 9 For 1997 and prior years, we recognized revenues in accordance with the American Institute of Certified Public Accountants Statement of Position 91-1. Commencing in 1998, we began recognizing revenues in accordance with the American Institute of Certified Public Accountants Statement of Position 97-2, "Software Revenue Recognition," as amended by Statements of Position 98-4 and 98-9. Our adoption of these new standards has not to date had a material effect on our revenue recognition. Future implementation guidance relating to these standards may result in unanticipated changes in our revenue recognition practices, and these changes could affect our future revenues and earnings. We recognize license revenues upon shipment of the software if collection of the resulting receivable is probable, an executed agreement has been signed, the fee is fixed or determinable and vendor-specific objective evidence exists to allocate a portion of the total fee to any undelivered elements of the arrangement. Undelivered elements in these arrangements typically consist of services. For sales made through distributors, revenue is recognized upon shipment. Distributors have no right of return. We recognize revenues from customer training, support and consulting services as the services are performed. We generally recognize support revenues ratably over the term of the support contract. If support or professional services are included in an arrangement that includes a license agreement, amounts related to support or professional services are allocated based on vendor-specific objective evidence. Vendor-specific objective evidence for support and professional services is based on the price when such elements are sold separately, or, when not sold separately, the price established by management having the relevant authority. Arrangements which require significant modification or customization of software are recognized under the percentage of completion method. Since inception, we have incurred substantial research and development costs and have invested heavily in the expansion of our sales, marketing and professional services organizations to build an infrastructure to support our long-term growth strategy. The number of our employees increased from 81 as of March 31, 1999 to 137 as of March 31, 2000, representing an increase of 69%. As a result of investments in our infrastructure, we have incurred net losses in each fiscal quarter since 1996 and, as of March 31, 2000, had an accumulated deficit of $29.6 million. We anticipate that our operating expenses will increase substantially for the foreseeable future as we expand our product development, sales and marketing and other staff. In addition, we expect to incur substantial expenses associated with sales personnel, referral fees, marketing programs and increased administrative expenses associated with being a public company. Accordingly, we expect to incur net losses for the foreseeable future. We believe that period-to-period comparisons of our operating results are not meaningful and should not be relied upon as indicative of future performance. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in early stages of development, particularly companies in new and rapidly evolving markets. We may not achieve or maintain profitability in the future. Our success depends significantly upon broad market acceptance of our PowerTier for EJB application server. Because Sun Microsystems controls the EJB standard, we need to maintain a good working relationship with them to develop future versions of PowerTier for EJB, as well as additional products using the EJB standard. Our performance will also depend on the growth and widespread adoption of the market for business-to-business electronic commerce over the Internet. RESULTS OF OPERATIONS POTENTIAL QUARTERLY VARIABILITY Our quarterly operating results have fluctuated significantly in the past, and may continue to fluctuate in the future, as a result of a number of factors, many of which are outside our control. These factors include: - our ability to close relatively large sales on schedule; - delays or deferrals of customer orders or deployments; - delays in shipment of scheduled software releases; - demand for and market acceptance of our PowerTier for C++ and PowerTier for EJB products; - the possible loss of sales people; - introduction of new products or services by us or our competitors; 9 10 - annual or quarterly budget cycles of our customers; - the level of product and price competition in the application server market; - our lengthy sales cycle; - our success in expanding our direct sales force and indirect distribution channels; - the mix of direct sales versus indirect distribution channel sales; - the mix of products and services licensed or sold; - the mix of domestic and international sales; and - our success in penetrating international markets and general economic conditions in these markets. The typical sales cycle of our products is long and unpredictable, and is affected by seasonal fluctuations as a result of our customers' fiscal year budgeting cycles and slow summer purchasing patterns in Europe. We typically receive a substantial portion of our orders in the last two weeks of each quarter because our customers often delay purchases of our products to the end of the quarter to gain price concessions. Because a substantial portion of our costs are relatively fixed and based on anticipated revenues, a failure to book an expected order in a given quarter would not be offset by a corresponding reduction in costs and could adversely affect our operating results. Our license revenues in the first quarter of 2000 were lower than those in the fourth quarter of 1999 and our license revenues in the first quarter of 1999 were lower than those in the fourth quarter of 1998. In the future, we expect this trend to continue, with the fourth quarter of each year accounting for the greatest percentage of total revenues for the year and with an absolute decline in revenues from the fourth quarter to the first quarter of the next year. The results of operations and cash flows for any interim period are not necessarily indicative of the operating results and cash flows for any future interim or annual periods. THREE MONTHS ENDED MARCH 31, 2000 AND 1999 Revenues Our revenues were $4.2 million for the three months ended March 31, 2000 and $2.9 million for the three months ended March 31, 1999, representing an increase of 47%. International revenues were $1.4 million for the three months ended March 31, 2000 and $626,000 for the three months ended March 31, 1999. In the three months ended March 31, 2000, sales of software licenses to Cisco accounted for 12% of total revenues. License Revenues. License revenues were $2.9 million for the three months ended March 31, 2000 and $2.1 million for the three months ended March 31, 1999, representing an increase of 36%. License revenues represented 68% of total revenues for the three months ended March 31, 2000 and 74% of total revenues for the three months ended March 31, 1999. The increase in software license revenues was primarily due to sales of our new PowerTier for EJB application server and the increased size and productivity of our sales team. Service Revenues. Our service revenues were $1.3 million for the three months ended March 31, 2000 and $747,000 for the three months ended March 31, 1999, representing an increase of 78%. The increase in service revenues was primarily due to an increase in customer support fees related to increased sales of our PowerTier platform. Service revenues represented 32% of total revenues the three months ended March 31, 2000 and 26% of total revenues for the three months ended March 31, 1999. 10 11 Cost of Revenues Cost of License Revenues. Cost of license revenues consists of packaging, documentation and associated shipping costs. Our cost of license revenues was $50,000 for the three months ended March 31, 2000 and $42,000 for the three months ended March 31, 1999. As a percentage of license revenues, cost of license revenues were 2% for each of the three months ended March 31, 2000 and 1999. Cost of Service Revenues. Cost of service revenues consists of personnel and other costs related to professional services, technical support and training. Our cost of service revenues was $715,000 for the three months ended March 31, 2000 and $580,000 for the three months ended March 31, 1999, representing an increase of 23%. This increase was primarily due to increased staffing in our support organization to support a greater installed base of customers. As a percentage of service revenues, cost of service revenues were 54% for the three months ended March 31, 2000 and 78% for the three months ended March 31, 1999. In particular, cost of service revenues as a percentage of service revenues may vary between periods due to our use of third party professional services. Operating Expenses Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, travel and entertainment, and promotional expenses. Our sales and marketing expenses were $6.0 million for the three months ended March 31, 2000 and $2.0 million for the three months ended March 31, 1999, representing an increase of 198%. This increase was primarily due to our investment in our sales and marketing infrastructure, which included significant personnel-related costs to recruit and hire sales people and sales engineers, their compensation, including sales commissions, advertising and travel expenses, additional sales office costs, professional services and trade show expenses. Sales and marketing expenses represented 143% of total revenues for the three months ended March 31, 2000 and 70% of total revenues for the three months ended March 31, 1999. We believe that a continued increase in our sales and marketing efforts is essential for us to maintain our market position and further increase acceptance of our products. Accordingly, we anticipate we will continue to invest in sales and marketing for the foreseeable future, and sales and marketing expenses will increase in future periods. Research and Development. Research and development expenses consist primarily of salaries and benefits for software developers, product managers and quality assurance personnel and payments to outside software developers. Our research and development expenses were $2.0 million for the three months ended March 31, 2000 and $1.8 million for the three months ended March 31, 1999, representing an increase of 11%. This increase was primarily related to an increase in employee and consultant software developers and program management and documentation personnel hired to support product development. Research and development expenses for the three months ended March 31, 1999 also include a one-time $303,000 compensation charge associated with the issuance of common stock to an investor at a price which was less than the deemed fair value for accounting purposes. Research and development expenses represented 48% of total revenues for the three months ended March 31, 2000 and 63% of total revenues for the three months ended March 31, 1999. We believe that a continued increase in our research and development investment is essential for us to maintain our market position, to continue to expand our product line and to enhance our technology. Accordingly, we anticipate that we will continue to invest in product research and development for the foreseeable future, and research and development expenses are likely to increase in future periods. General and Administrative. General and administrative expenses consist primarily of salaries, benefits and related costs for our finance, administrative and general management personnel. Our general and administrative expenses were $867,000 for the three months ended March 31, 2000 and $383,000 for the three months ended March 31, 1999, representing an increase of 126%. This increase was primarily the result of the hiring of additional finance and administrative personnel, additional professional services and insurance costs associated with being a public company. General and administrative expenses represented 21% of total revenues for the three months ended March 31, 2000 and 13% of total revenues for the three months ended March 31, 1999. We believe that our general and administrative expenses will continue to increase as a result of the expenses associated with our growth and being a public company, including annual and other public reporting costs, directors' and officers' liability insurance, investor relations programs and accounting and legal expenses. Amortization of Purchased Intangibles. Amortization of purchased intangibles was $496,000 for the three months ended March 31, 2000 and none for the three months ended March 31, 1999. Net Interest Income. Net interest income consists primarily of earnings on our cash, cash equivalent and short-term investment balances, offset by interest expense related to obligations under capital leases and other borrowings. Net interest income was $367,000 for the three months ended March 31, 2000 and $48,000 for the three months ended March 31, 1999, representing an increase of $319,000. This increase was earned on the net proceeds received from our initial public offering of common stock on June 24, 1999. We expect that net interest income will decrease as we continue to use our net proceeds from our initial public offering. 11 12 Stock-Based Compensation. Some options granted and common stock issued during the years ended December 31, 1999 and 1998 and during 1997 have been considered to be compensatory, as the estimated fair value for accounting purposes was greater than the stock price as determined by the board of directors on the date of grant or issuance. Total deferred stock compensation associated with equity transactions as of March 31, 2000 was $958,000, net of amortization. Deferred stock compensation is being amortized ratably over the vesting periods of these securities. Amortization expense was $99,000 in the three months ended March 31, 2000 and $504,000 in 1999. Provision for Income Taxes. Since inception, we have incurred net operating losses for federal and state tax purposes and have not recognized any tax provision or benefit. We have placed a full valuation allowance against our net deferred tax assets due to the uncertainty surrounding the realization of these assets. We evaluate on a quarterly basis the recoverability of the net deferred tax assets and the level of the valuation allowance. If and when we determine that it is more likely than not that the deferred tax assets are realizable, the valuation allowance will be reduced. LIQUIDITY AND CAPITAL RESOURCES Since inception, we have financed our business primarily through our initial public offering of common stock in June 1999, which totaled $34.1 million in aggregate net proceeds, and private sales of convertible preferred stock, which totaled $19.9 million in aggregate net proceeds, through March 31, 2000. We have also financed our business through a loan in the principal amount of $800,000 and capitalized leases. As of March 31, 2000, we had $25.3 million of cash, cash equivalents and short-term investments and $24.0 million of working capital. Net cash used for operating activities was $3.7 million in the three months ended March 31, 2000 and $1.7 million for the three months ended March 31, 1999. For each of the three months ended March 31, 2000 and 1999, cash used for operating activities was attributable primarily to net losses and increases in accounts receivable. Those increases were primarily offset by depreciation and amortization, amortization of deferred stock compensation and deferred revenues, and for the three months ended March 31, 2000, a decrease in the allowance for doubtful accounts and an increase in accrued compensation and benefits. Net cash provided by (used in) investing activities was $972,000 for the three months ended March 31, 2000 and $(96,000) for the three months ended March 31, 1999. For the three months ended March 31, 2000, cash was provided by investing activities through the conversion of short-term investments into cash and cash equivalents. For each of the three month periods, cash used in investing activities primarily reflected investments in property and equipment and deposits. For the three months ended March 31, 2000, cash used in investing activities also consisted of additions of purchased intangibles. Net cash provided by (used in) financing activities was $(86,000) for the three months ended March 31, 2000 and $4.3 million for the three months ended March 31, 1999. Cash provided by financing activities during the three months ended March 31, 1999 was primarily attributable to proceeds from the issuance of preferred stock. We have credit facilities with Comerica Bank. Under those credit facilities, the Company has a $5.0 million revolving line of credit facility available through August 15, 2000 and a second equipment financing facility for an amount up to $1,000,000 under which drawdowns are available through July 15, 2000. As of March 31, 2000 we had no borrowings outstanding under the revolving line of credit facility or the second equipment financing facility. As of March 31, 2000, we had a promissory note in favor of Comerica, under which $534,000 out of an original $800,000 was outstanding. We are required to make principal payments of $22,222 per month plus interest of 7.75% per annum on the unpaid principal balance, payable in 24 monthly installments. The credit facilities with Comerica Bank are collateralized by substantially all of our assets, including our patents and intellectual property. Although we have no material commitments for capital expenditures, we anticipate a substantial increase in capital expenditures and lease commitments consistent with our anticipated growth in operations, infrastructure and personnel. We also may increase our capital expenditures as we expand into additional international markets. We believe that the our current cash, cash equivalents and short-term investments, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next year. If cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain a credit facility. If additional funds are raised through the issuance of debt securities, these securities could have rights, preferences and privileges senior to holders of 12 13 common stock, and the term of this debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders, and we may not be able to obtain additional financing on acceptable terms, if at all. If we are unable to obtain this additional financing, we may be required to reduce the scope of our planned product development and marketing efforts, which could harm our business. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board issued accounting statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement requires companies to record derivatives on the balance sheet as assets or liabilities measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 will be effective for us beginning in 2001. We are currently evaluating the impact of SFAS No. 133 on our financial statements and related disclosures. ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS You should carefully consider the following risks in addition to the other information contained in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K as of and for the year ended December 31, 1999 filed with the Securities and Exchange Commission. The risks and uncertainties described below are intended to be the ones that are specific to our company or industry and that we deem to be material, but are not the only ones that we face. We Have A Limited Operating History In The Application Server Market. Because we only commenced selling application servers in 1997, we have a limited operating history in the application server market. We thus face the risks, expenses and difficulties frequently encountered by companies in early stages of development, particularly companies in the rapidly changing software industry. These risks include: 13 14 - our substantial dependence for revenue from our PowerTier for C++ product, which was first introduced in 1997 and has achieved only limited market acceptance; - our substantial dependence for revenue from our PowerTier for EJB product, which was first introduced in 1998 and has achieved only limited market acceptance; - our need to expand our distribution capability through both a direct sales organization and third party distributors and systems integrators; - our unproven ability to anticipate and respond to technological and competitive developments in the rapidly changing market for application servers; - our unproven ability to compete in a highly competitive market; - uncertainty as to the growth rate in the electronic commerce market and, in particular, the business-to-business electronic commerce market; - our dependence on Enterprise JavaBeans, commonly known as EJB, becoming a widely accepted standard in the transactional application server market; and - our dependence upon key personnel. Because We Have A History Of Losses And Negative Cash Flow, We May Never Become Or Remain Profitable. Our revenues may not continue to grow and we may not be able to achieve or maintain profitability in the future. We have incurred net losses each year since 1996. In particular, we incurred losses of $4.7 million in 1997, $4.1 million in 1998 and $11.3 million in 1999, and $5.6 million in the three months ended March 31, 2000. As of March 31, 2000, we had an accumulated deficit of approximately $29.6 million. In addition, while we are unable to predict accurately our future operating expenses, we currently expect these expenses to increase, potentially substantially, as we continue to expand our product development and sales and marketing efforts and assume the increased administrative duties associated with our public company status. Thus, we will need to increase our revenues to become profitable. Because our product market is new and evolving, we cannot accurately predict either the future growth rate, if any, or the ultimate size of the market for our products. We Have Financed Our Business Through The Sale Of Stock And Not Through Cash Generated By Our Operations. Since inception, we have generally had negative cash flow from operations. To date, we have financed our business primarily through sales of common stock and convertible preferred stock and not through cash generated by our operations. We expect to continue to have negative cash flow from operations. We May Need To Raise Additional Capital In The Future. Although we believe that our current cash, cash equivalents and short-term investment balances will be sufficient to meet our anticipated operating cash needs for the next 12 months, we may need to raise additional funds prior to that time. We face several risks in connection with this possible need to raise additional capital: - the issuance of additional securities could result in: - debt securities with rights senior to the common stock; - dilution to existing stockholders as a result of issuing additional equity or convertible debt securities; - debt securities with restrictive covenants that could restrict our ability to run our business as desired; or - securities issued on disadvantageous financial terms. 14 15 - the failure to procure needed funding could result in: - a reduction in scope in our planned product development or marketing efforts; or - an inability to respond to competitive pressures or take advantage of market opportunities, which could adversely affect our ability to achieve profitability or positive cash flow. The Unpredictability Of Our Quarterly Results May Adversely Affect The Price Of Our Common Stock. Our operating results have fluctuated significantly in the past and may fluctuate significantly in the future as a result of a variety of factors, many of which are outside our control. In particular, the fourth quarter of each year has in the past tended to account for the greatest percentage of total revenues for the year, and we have often experienced an absolute decline in revenues from the fourth quarter to the first quarter of the next year. If our future quarterly operating results are below the expectations of securities analysts or investors, the price of our common stock would likely decline. The factors that may cause fluctuations of our operating results include the following: - our ability to close relatively large sales on schedule; - delays or deferrals of customer orders or deployments; - delays in shipment of scheduled software releases; - demand for and market acceptance of our PowerTier for C++ and PowerTier for EJB products; - the possible loss of sales people; - introduction of new products or services by us or our competitors; - annual or quarterly budget cycles of our customers; - the level of product and price competition in the application server market; - our lengthy sales cycle; - our success in expanding our direct sales force and indirect distribution channels; - the mix of direct sales versus indirect distribution channel sales; - the mix of products and services licensed or sold; - the mix of domestic and international sales; and - our success in penetrating international markets and general economic conditions in these markets. We typically receive a substantial portion of our orders in the last two weeks of each fiscal quarter because our customers often delay purchases of our products to the end of the quarter to gain price concessions. Because a substantial portion of our costs are relatively fixed and based on anticipated revenues, a failure to book an expected order in a given quarter would not be offset by a corresponding reduction in costs and could adversely affect our operating results. Our Sales Cycle Is Long, Unpredictable And Subject To Seasonal Fluctuations, So It Is Difficult To Forecast Our Revenues. Any delay in sales of our products or services could cause our quarterly revenues and operating results to fluctuate. The typical sales cycle of our products is long and unpredictable and requires both a significant capital investment decision by our customers and our education of potential customers regarding the use and benefits of our products. Our sales cycle is generally between three and nine months. A successful sales cycle typically includes presentations to both business and technical decision makers, as well as a limited 15 16 pilot program to establish technical fit. Our products typically are purchased as part of a significant enhancement to a customer's information technology system. The implementation of our products involves a significant commitment of resources by prospective customers. Accordingly, a purchase decision for a potential customer typically requires the approval of several senior decision makers. Our sales cycle is affected by the business conditions of each prospective customer. Due to the relative importance of many of our product sales, a lost or delayed sale could adversely affect our quarterly operating results. Our sales cycle is affected by seasonal fluctuations as a result of our customers' fiscal year budgeting cycles and slow summer purchasing patterns in Europe. We Depend On A Relatively Small Number Of Significant Customers, And The Loss Of One Or More Of These Customers Could Result In A Decrease In Our Revenues. Historically, we have received a substantial portion of our revenues from product sales to a limited number of customers. In the three months ended March 31, 2000, sales of products and services to Cisco accounted for 12% of our total revenues and sales of products and services to our top five customers accounted for 44% of our total revenues. In 1999, sales of products and services to Cisco accounted for 13% of our total revenues, and sales of products and services to our top five customers accounted for 35% of total revenues. In 1998, sales of products and services to Cisco accounted for 14% of our total revenues, sales of products and services to Instinet accounted for 17% of our total revenues, and sales of products and services to our top five customers accounted for 55% of total revenues. In 1997, sales of products and services to Lucent accounted for 11% of our total revenues, and sales of products and services to our top five customers accounted for 15% of our total revenues. In addition, the identity of our top five customers has changed from year to year. If we lose a significant customer, or fail to increase product sales to an existing customer as planned, we may not be able to replace the lost revenues with sales to other customers. In addition, because our marketing strategy is to concentrate on selling products to industry leaders, any loss of a customer could harm our reputation within the industry and make it harder for us to sell our products to other companies in that industry. The loss of, or a reduction in sales to, one or more significant customers would likely result in a decrease in our revenues. We Depend On The Java Programming Language, The Enterprise JavaBeans Standard And The Emerging Market For Distributed Object Computing, And If These Technologies Fail To Gain Acceptance, Our Business Could Suffer. We are focusing significant marketing efforts on our PowerTier for EJB application server, which is based on three relatively new technologies, none of which has been widely adopted by companies. These three technologies are a distributed object computing architecture, Sun Microsystems' Java programming language and Enterprise JavaBeans, or EJB. Distributed object computing combines the use of software modules, or objects, communicating across a computer network to software applications, such as our PowerTier application server. EJB is the Java programming standard for use in an application server. In 1998, we launched our PowerTier for EJB product, which is a transactional application server that uses Java and conforms to the EJB standard. Sun Microsystems released the EJB standard in 1998, and thus far EJB has had limited market acceptance. Since our PowerTier for EJB product depends upon the specialized EJB standard, we face a limited market compared to competitors who may offer application servers based on more widely accepted standards, including the Java programming language. We expect a substantial portion of our future revenues will come from sales of products based on the EJB standard. Thus, our success depends significantly upon broad market acceptance of distributed object computing in general, and Java application servers in particular. If EJB does not become a widespread programming standard for application servers, our revenues and business could suffer. If We Do Not Deliver Products That Meet Rapidly Changing Technology Standards And Customer Demands, We Will Lose Market Share To Our Competitors. The market for our products and services is characterized by rapid technological change, dynamic customer demands and frequent new product introductions and enhancements. Customer requirements for products can change rapidly as a result of innovation in software applications and hardware configurations and the emergence or adoption of new industry standards, including Internet technology standards. We need to increase our research and development investment to maintain our technological leadership. Our future success depends on our ability to continue to enhance our current products and to continue to develop and introduce new products that keep pace with competitive product introductions and technological developments. For example, as Sun Microsystems introduces new EJB specifications, we will need to introduce new versions of PowerTier for EJB designed to support these new specifications to remain competitive. If we do not bring enhancements and new versions of our products to market in a timely manner, our market share and revenues could decrease and our reputation could suffer. If we fail to anticipate or respond adequately to changes in technology and customer needs, or if there are any significant delays in product development or introduction, our revenues and business could suffer. 16 17 Because Our Direct Sales Team Is Currently Our Most Critical Sales Channel, Any Failure To Build And Train This Team May Result In Lower Revenues. We must expand our direct sales team to generate increased revenue. In 1998, we hired several new salespeople, replacing most of our preexisting sales force. In 1999 and 2000, we continued to hire new salespeople. In order to meet our future sales goals, we will need to hire many more salespeople within the next two years for both our domestic and international sales efforts. In the past, newly hired employees have required training and approximately six to nine months experience to achieve full productivity. Because our entire sales team is relatively new, they may not meet our sales goals. In addition, our recently hired employees may not become productive, and we may not be able to hire enough qualified individuals in the future. Because Our Future Revenue Goals Are Based On Our Development Of A Strong Sales Channel Through Systems Integrators And Other Third Parties, Any Failure To Develop This Channel May Result In Lower Revenues. To date, we have sold our products primarily through our direct sales force, but our ability to achieve significant revenue growth in the future will depend in large part on our success in establishing and leveraging relationships with systems integrators and other third parties. It may be difficult for us to establish these relationships, and, even if we establish these relationships, we will then depend on the systems integrators' and other third parties' sales efforts. In addition, because these relationships are nonexclusive, systems integrators may choose to use application servers or other alternative solutions offered by our competitors, and not our products. If we fail to successfully build our third-party distribution channels or if our systems integrator and other third party partners do not perform as expected, our business could be harmed. Because Our Products Are Often Incorporated Into Enterprise-Wide System Deployments, Any Delays In These Projects May Result In Lower Revenues. Because our products are often incorporated into multi-million dollar enterprise projects, we depend on the successful and timely completion of these enormous projects to fully deploy our products and achieve our revenue goals. These enterprise projects often take many years to complete and can be delayed by a variety of factors, including general or industry-specific economic downturns, our customers' budget constraints, other customer-specific delays, problems with other system components or delays caused by the systems integrators who may be managing the system deployment. If our customers cannot successfully implement large-scale deployments, or they determine for any reason that our products cannot accommodate large-scale deployments or that our products are not appropriate for widespread use, our business could suffer. In addition, if a systems integrator fails to complete a project utilizing our product for a customer in a timely manner, our revenues or business reputation could suffer. Because We Compete With Sun Microsystems, Who Controls The EJB Application Server Standard, We Face The Risk That They May Develop This Standard To Favor Their Own Products. Our success depends on achieving widespread market acceptance of our PowerTier for EJB application server. Because Sun Microsystems controls the EJB standard, we need to maintain a good working relationship with Sun Microsystems to develop future versions of PowerTier for EJB, as well as additional products using EJB, that will gain market acceptance. In March 1998, we entered into a license agreement with Sun Microsystems, pursuant to which we granted Sun Microsystems rights to manufacture and sell, by itself and not jointly with others, products under a number of our patents and Sun Microsystems granted us rights to manufacture and sell, by ourselves and not jointly with others, products under a number of Sun Microsystems' patents. As a result, Sun Microsystems may develop and sell some competing products that would, in the absence of this license agreement, infringe our patents. Because Sun Microsystems controls the EJB standard, it could develop the EJB standard in a more proprietary way to favor a product offered by its subsidiary, iPlanet, or a third party, which could make it much harder for us to compete in the EJB application server market. Microsoft Has Established A Competing Application Server Standard, Which Could Diminish The Market Potential For Our Products If It Gains Widespread Acceptance. Microsoft has established a competing standard for distributed computing, COM, which includes an application server product. If this standard gains widespread market acceptance over the EJB or CORBA standards, on which our products are based, our business would suffer. Because of Microsoft's resources and commanding position with respect to other markets and technologies, Microsoft's entry into the application server market may cause our potential customers to delay purchasing decisions. We expect that Microsoft's presence in the application server market will increase competitive pressure in this market. 17 18 We Face Significant Competition From Companies With Greater Resources Than We Have And May Face Additional Competition In The Future. The market for our products is intensely competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. We believe that the principal competitive factors in our market are: - performance, including scalability, integrity and availability; - ability to provide a complete software platform; - flexibility; - use of standards-based technology; - ease of integration with customers' existing enterprise systems; - ease and speed of implementation; - quality of support and service; - security; - company reputation; and - price. Our competitors include both publicly and privately-held enterprises, including BEA Systems (WebLogic), Secant Technologies, IBM (WebSphere), Inprise, Iona Technologies, Oracle (OAS) and i-Planet (Sun Microsystems). Many customers may not be willing to purchase our PowerTier platform because they have already invested heavily in databases and other enterprise software components offered by these competing companies. Many of these competitors have preexisting customer relationships, longer operating histories, greater financial, technical, marketing and other resources, greater name recognition and larger installed bases of customers than we do. In addition, some competitors offer products that are less complex than our PowerTier products and require less customization to implement with potential customers' existing systems. Thus, potential customers engaged in simpler business-to-business e-commerce transactions may prefer these "plug-and-play" products to our more complex offerings. Moreover, there are other very large and established companies, including Microsoft, who offer alternative solutions and are thus indirect competitors. Further, dozens of companies, such as Allaire, have announced their intention to support EJB and may compete against us in the future. These competitors and potential competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we can. In addition, in the PowerTier for C++ market, many potential customers build their own custom application servers, so we effectively compete against our potential customers' internal information technology departments. If The Market For Business-To-Business Electronic Commerce Over The Internet Does Not Develop As We Currently Envision, Our Business Model Could Fail And Our Revenues Could Decline. Our performance and future success will depend on the growth and widespread adoption of the market for business-to-business electronic commerce over the Internet. If business-to-business electronic commerce does not develop in the manner currently envisioned, our business could be harmed. Moreover, critical issues concerning the commercial use of the Internet, including security, cost, accessibility and quality of network service, remain unresolved and may negatively affect the growth of the Internet as a platform for conducting business-to-business electronic commerce. In addition, the Internet could lose its viability due to delays in the development or adoption of new standards and protocols to handle increased activity or due to increased government regulation and taxation of Internet commerce. 18 19 Our Failure To Manage Growth Could Impair Our Business. Achieving our planned revenue growth and other financial objectives will place significant demands on our management and other resources. We anticipate increasing our headcount significantly over the next two years. Our ability to manage this growth effectively will require us to continue to develop and improve our operational, financial and other internal systems and controls, as well as our business development capabilities, and to train, motivate and manage our employees. If we are unable to manage our growth effectively, we may not be able to retain key personnel and the quality of our services and products may suffer. Our Business Could Suffer If We Cannot Attract And Retain The Services Of Key Employees. Our future success depends on the ability of our management to operate effectively, both individually and as a group. We are substantially dependent upon the continued service of our existing executive personnel, especially Christopher T. Keene, our Chief Executive Officer and Chairman of the Board. We do not have a key person life insurance policy covering Mr. Keene or any other officer or key employee. Our success will depend in large part upon our ability to attract and retain highly-skilled employees, particularly sales personnel and software engineers. There is significant competition for skilled employees, especially for people who have experience in both the software and Internet industries. If we are not successful in attracting and retaining these skilled employees, our sales and product development efforts would suffer. In addition, if one or more of our key employees resigns to join a competitor or to form a competing company, the loss of that employee and any resulting loss of existing or potential customers to a competitor could harm our business. If we lose any key personnel, we may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by those former employees. Our Software Products May Contain Defects Or Errors, And Shipments Of Our Software May Be Delayed. Complex software products often contain errors or defects, particularly when first introduced or when new versions or enhancements are released. Our products have in the past contained and may in the future contain errors and defects, which may be serious or difficult to correct and which may cause delays in subsequent product releases. Delays in shipment of scheduled software releases or serious defects or errors could result in lost revenues or a delay in market acceptance, which could have a material adverse effect on our revenues and reputation. We May Be Sued By Our Customers For Product Liability Claims As A Result Of Failures In Their Critical Business Systems. Because our customers use our products for important business applications, errors, defects or other performance problems could result in financial or other damages to our customers. They could pursue claims for damages, which, if successful, could result in our having to make substantial payments. Although our purchase agreements typically contain provisions designed to limit our exposure to product liability claims, existing or future laws or unfavorable judicial decisions could negate these limitation of liability provisions. A product liability claim brought against us, even if meritless, would likely be time consuming and costly for us to litigate or settle. A Portion Of Our Revenues Is Derived From International Sales, Which Could Decline As A Result Of Legal, Business And Economic Risks Specific To International Operations. Our future success will depend, in part, on our successful development of international markets for our products. Approximately 33% of our revenues came from sales of products and services outside of the United States in the three months ended March 31, 2000. Approximately 28% of our revenues came from sales of products and services outside the United States during 1999, and approximately 29% of our revenues came from sales of products and services outside the United States during 1998. We expect international revenues to continue to represent a significant portion of our total revenues. To date, almost all of our international revenues have resulted from our direct sales efforts. In international markets, however, we expect that we will depend more heavily on third party distributors to sell our products in the future. The success of our international strategy will depend on our ability to develop and maintain productive relationships with these third parties. The failure to develop key international markets for our products could cause a reduction in our revenues. Additional risks related to our international expansion and operation include: - difficulties of staffing and managing foreign operations; - our dependence on the sales efforts of our third party distributors; - longer payment cycles typically associated with international sales; 19 20 - tariffs and other trade barriers; - failure to comply with a wide variety of complex foreign laws and changing regulations; - exposure to political instability and economic downturns; - failure to localize our products for foreign markets; - restrictions on the export of technologies; - potentially adverse tax consequences; - reduced protection of intellectual property rights in some countries; and - currency fluctuations. We sell products outside the United States in U.S. dollars. We do not currently engage in any hedging transactions to reduce our exposure to currency fluctuations as a result of our foreign operations. We are not currently ISO 9000 compliant, nor are we attempting to meet all foreign technical standards that may apply to our products. Our failure to develop our international sales channel as planned could cause a decline in our revenues. If We Do Not Protect Our Intellectual Property Rights, Our Competitive Position May Be Impaired. Our success may depend on our ability to protect our proprietary rights to the technologies used in our products, and yet the measures we are taking to protect these rights may not be adequate. If we are not adequately protected, our competitors could use the intellectual property that we have developed to enhance their products, which could harm our business. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure and other contractual restrictions to protect our proprietary technology, but these legal means afford only limited protection. Unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States. We have commenced patent infringement actions against two competitors -- See "Part II, Other Information, Item 1, Legal Proceedings." Further litigation may be necessary to enforce our intellectual property rights, which could result in substantial costs and diversion of management attention and resources. We May Be Sued For Patent Infringement. The software industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement and the violation of other intellectual property rights. As the number of competitors in the application server market grows and the functionality of products in different market segments overlaps, the possibility of an intellectual property claim against us increases. For example, we may inadvertently infringe a patent of which we are unaware. In addition, because patent applications can take many years to issue, there may be a patent application now pending of which we are unaware, which will cause us to be infringing when it is issued in the future. To address these patent infringement or other intellectual property claims, we may have to enter into royalty or licensing agreements on disadvantageous commercial terms. Alternatively, we may be unable to obtain a necessary license. A successful claim against us, and our failure to license the infringed or similar technology, would harm our business. In addition, any infringement or other intellectual property claims, with or without merit, which are brought against us could be time consuming and expensive to litigate or settle and could divert management attention from administering our core business. Future Sales Of Our Common Stock May Depress Our Stock Price. If our current stockholders sell substantial amounts of common stock, including shares issued upon the exercise of outstanding options and warrants, in the public market, the market price of our common stock could fall. In addition, these sales of common stock could impede our ability to raise funds at an advantageous price through the sale of securities. As of March 31, 2000, we had 19.5 million shares of common stock outstanding. Beginning in December 1999, approximately 14.4 million shares of restricted common stock held by our stockholders became eligible for sale in the public market. Approximately 7 million of these restricted shares are subject to volume and other restrictions under Rule 144. 20 21 Our Stock Price Has Been, And May Continue To Be, Volatile. Our common stock has only been available in the public market since June 24, 1999. An active public market for our common stock may not completely develop or be sustained in the future. To date, the market price of our common stock has been highly volatile and may rise or fall in the future as a result of many factors, such as: - variations in our quarterly results; - announcements of technological innovations by us or our competitors; - introductions of new products by us or our competitors; - acquisitions or strategic alliances by us or our competitors; - hiring or departure of key personnel; - the gain or loss of a significant customer or order; - changes in estimates of our financial performance or changes in recommendations by securities analysts; - market conditions in the software industry and in our customers' industries; and - adoption of new accounting standards affecting the software industry. The stock market in general has experienced extreme price and volume fluctuations, which could adversely affect the market price of our stock. In particular, the market prices of the common stock of many companies in the software and Internet industries have experienced this volatility, which has often been unrelated to these companies' operating performance. In the past, securities class action litigation has often been brought against a company after a period of volatility in the market price of its stock. We may in the future be a target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources, which could harm our business. Our Executive Officers And Directors Own A Large Percentage Of Our Voting Stock And Could Exert Significant Influence Over Matters Requiring Stockholder Approval. As of March 31, 2000, executive officers and directors, and entities affiliated with them, own approximately 45% of our outstanding common stock. Accordingly, these stockholders may, as a practical matter, continue to control the election of a majority of the directors and the determination of all corporate actions. This concentration of voting control could have the effect of delaying or preventing a merger or other change in control, even if it would benefit our other stockholders. The Antitakeover Provisions In Our Charter Documents And Under Delaware Law Could Discourage A Takeover. Provisions in our certificate of incorporation, bylaws and Delaware law may discourage, delay or prevent a merger or other change in control that a stockholder may consider favorable. These provisions may also discourage proxy contests or make it more difficult for stockholders to take corporate action. These provisions include the following: - establishing a classified board in which only a portion of the total board members will be elected at each annual meeting; - authorizing the board to issue preferred stock; - prohibiting cumulative voting in the election of directors; - limiting the persons who may call special meetings of stockholders; - prohibiting stockholder action by written consent; and 21 22 - establishing advance notice requirements for nominations for election of the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings. We May Engage In Future Acquisitions That Could Disrupt Our Business And Dilute Our Stockholders. As part of our business strategy, we expect to review acquisition prospects that we believe would be advantageous to the development of our business. For example, we have recently acquired object request broker technology and servlet engine technology. While we have no current agreements or negotiations underway with respect to any major acquisitions, we may make acquisitions of businesses, products or technologies in the future. If we make any acquisitions, we could take any or all of the following actions, any of which could materially and adversely affect our financial results and the price of our common stock: - issue equity securities that would dilute existing stockholders' percentage ownership; - incur substantial debt; - assume contingent liabilities; or - take substantial charges in connection with the amortization of goodwill and other intangible assets. Acquisitions also entail numerous risks, including: - difficulties in assimilating acquired operations, products and personnel with our pre-existing business; - unanticipated costs; - diversion of management's attention from other business concerns; - adverse effects on existing business relationships with suppliers and customers; - risks of entering markets in which we have limited or no prior experience; and - potential loss of key employees from either our preexisting business or the acquired organization. We may not be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future, and our failure to do so could harm our business. We Have Not Designated Any Specific Use For The Net Proceeds Of The Company's Initial Public Offering Of Common Stock, And Thus May Use The Remaining Net Proceeds To Fund Operating Losses, For Acquisitions Or For Other Corporate Purposes. We have not designated any specific use for the net proceeds of our initial public offering of common stock. As a result, our management and board of directors has broad discretion in spending the remaining net proceeds of that offering. We currently expect to use the remaining net proceeds primarily for working capital and general corporate purposes, funding product development and expanding our sales and marketing organization. In addition, we may use a portion of the remaining net proceeds for further development of our product lines through acquisitions of products, technologies and businesses. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK. Interest Rate Sensitivity. Our operating results are sensitive to changes in the general level of U.S. interest rates, particularly because most of our cash equivalents are invested in short-term debt instruments. If market interest rates were to change immediately and uniformly by ten percent from levels at March 31, 2000, the fair value of our cash equivalents and short-term investments would change by approximately $150,000. Foreign Currency Fluctuations. We have not had any significant transactions in foreign currencies, nor did we have any significant balances that are due or payable in foreign currencies at March 31, 2000. Therefore, a hypothetical ten percent change in foreign 22 23 currency rates would have an insignificant impact on our financial position or results of operations. We do not hedge any of our foreign currency exposure. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On December 6, 1999, the Company filed a patent infringement action in the United States District Court for the Northern District of California against The Object People Inc. and The Object People (U.S.) Inc. (collectively, "TOP"), Persistence Software, Inc. v The Object People Inc., et al., Case No. C 99-5182 MMC (N.D. Cal.). On December 14, 1999, the Company filed a similar action against Secant Technologies, Inc. ("Secant"), Persistence Software, Inc. v. Secant Technologies, Inc., Case No. C 00-20210 SW (N.D. Cal.). A motion is pending to consolidate the two actions into one lawsuit. The Company alleges in both cases that TOP and Secant's software products infringe three of the Company's patents, and TOP and Secant have contributed to the infringement of, and induced the infringement of, the Company's patents by third parties (i.e., their respective customers). The three patents owned by the Company that are at issue in these actions are U.S. Patent No. 5,499,371, No. 5,615,362, and No. 5,706,506. The Company also has asserted claims against TOP and Secant for unfair business practices under California Business and Professions Code Sections 17200 et seq. ("Section 17200"). On December 22, 1999, TOP filed its Answer to the Company's Complaint and asserted counterclaims for declaratory relief that the Company's patents are invalid and unenforceable, as well as counterclaims that allege that the Company's filing of the lawsuit itself constitutes a violation of the Lanham Act and unfair business practices under Section 17200. On January 31, 2000, Secant filed its Answer to the Company's Complaint and asserted only counterclaims for declaratory relief that the Company's patents are invalid and unenforceable. Both suits are in the early stages, and discovery has not been completed. While management believes that the Company's claims are valid, that the counterclaims asserted by TOP and Secant are without merit, and that any potential liability that the Company might incur to TOP or Secant is immaterial as the only counterclaims alleging damages are TOP's claims under the Lanham Act and Section 17200, it is not possible at this time to determine the ultimate outcome of these actions. Except as described above, the Company is not currently subject to any material legal proceedings, though it may from time to time become a party to various legal proceedings that arise in the ordinary course of business. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. (c) Sales of Unregistered Securities The Company made the following unregistered sales of Common Stock in the quarter ended March 31, 2000:
Persons or Class of Persons to Name of Whom the Amount of Underwriter or Consideration Securities Were Transaction Date Securities Sold Placement Agent Received Sold ---------------- --------------- --------------- ------------- ----------------- 03/02/00 140,000 Shares None (1) 10BaseJ, Inc.
(1) On March 2, 2000, the Company issued 140,000 shares of Common Stock to 10BaseJ, Inc. in exchange for substantially all of the assets of 10BaseJ, Inc. This issuance was deemed to be exempt from the registration requirements the Securities Act of 1933, as amended, in reliance on Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering. These securities have not been registered for resale. 23 24 ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS: 27.1 Financial Data Schedule (b) REPORTS ON FORM 8-K: None. 24 25 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. PERSISTENCE SOFTWARE, INC. By: /s/ CHRISTINE RUSSELL --------------------------------------- CHRISTINE RUSSELL CHIEF FINANCIAL OFFICER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER) Date: May 15, 2000 25 26 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION ------- ----------- 27.1 Financial Data Schedule
26 EX-27.1 2 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONDENSED CONSOLIDATED BALANCE SHEET AND CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS INCLUDED IN THE COMPANY'S FORM 10-Q AS OF AND FOR THE THREE MONTH PERIOD ENDED MARCH 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-2000 JAN-01-2000 MAR-30-2000 19,529 5,819 6,337 657 0 31,875 3,644 2,401 37,795 7,876 307 0 0 59,256 (29,644) 37,795 2,881 4,210 50 765 9,374 0 367 (5,562) 0 (5,562) 0 0 0 (5,562) (0.29) (0.29)
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