-----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, KuDdznkoS4ePv+/VrfUoZu4aDz4e1lTJONZe6+QkKtBRwCL9tVKYlSXOiCzpyAp+ DTsmKG2jorBuY/WxdZ8OZQ== 0001019687-02-000514.txt : 20020415 0001019687-02-000514.hdr.sgml : 20020415 ACCESSION NUMBER: 0001019687-02-000514 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-25857 FILM NUMBER: 02597168 BUSINESS ADDRESS: STREET 1: 1720 SOUTH AMPHLETT BLVD., 3RD FLOOR CITY: SAN MATEO STATE: CA ZIP: 94402 BUSINESS PHONE: 6503417733 10-K 1 persistence_10k-123101.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-K --------------- (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR FISCAL YEAR ENDED DECEMBER 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT 1934 FROM 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 OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 1720 SOUTH AMPHLETT BLVD., THIRD FLOOR SAN MATEO, CALIFORNIA 94402 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (650) 372-3600 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK 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 than the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $17.2 million as of February 28, 2002 based upon the closing sale price on the Nasdaq National Market reported for such date of $1.09 per share. Shares of Common Stock held by each officer and director and by each person who owns 10% of more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. There were 20,095,160 shares of the registrant's Common Stock issued and outstanding as of February 28, 2002. DOCUMENTS INCORPORATED BY REFERENCE Part III incorporates information by reference from the definitive proxy statement for the 2002 Annual Meeting of Stockholders to be held on June 6, 2002. ================================================================================ We own or have rights to trademarks or trade names that we use in conjunction with the sale of our products and services. "Persistence," as well as the logo for "Live Object Cache," are registered trademarks owned by us. We have registrations pending for the use of our logo with "Persistence," as well as "PowerTier," "Dynamai," "EdgeXtend" and "The Engine for E-Commerce" are also trademarks of ours. This annual report on Form 10-K also makes reference to trademarks and trade names of other companies that belong to them. PART I ITEM 1. BUSINESS. COMPANY OVERVIEW Persistence Software solves data access problems for distributed and real-time systems. Persistence solutions help deliver better business visibility for applications which require current information about customers, products and suppliers. Persistence provides a suite of data management products that sit between existing databases - such as Oracle and DB/2 - and application servers - such as WebLogic and WebSphere. Developers can configure these products to structure and position business information with optimal efficiency, improving application server performance and simplifying application distribution while reducing database costs. By effectively managing enterprise data, users achieve the benefit of "business visibility" - the ability to manage their business in real time with data and applications where they need them, when they need them. By caching data, or moving information stored in back-end computer systems closer to users, our software dramatically reduces network traffic and data latency, resulting in both better application performance and faster transaction processing. POWERTIER application servers support both C++ and Sun Microsystems' full Java 2 Platform, Enterprise Edition (J2EE, formerly known as Enterprise Java Beans or EJB) standards to enable businesses to deploy sophisticated C++ or Java applications, which readily scale, and accommodate rapidly increasing numbers of users. Our EDGEXTEND data management infrastructure for J2EE application servers offers a data architecture for IBM's WebSphere and BEA's WebLogic application servers to support highly distributed and transaction-oriented applications both within data centers and in remote locations. Our DYNAMAI Web content accelerator improves the speed and scalability of electronic commerce Web sites that rely heavily on dynamically generated content using technologies such as Java Server Pages and Active Server Pages. Our major customers include AT&T, Cablevision, Cisco, FedEx, Instinet, Intershop, Lucent, Motorola, Nokia and Salomon Smith Barney. INDUSTRY BACKGROUND Today's IT managers are faced with many challenges as they attempt to scale their existing infrastructure to meet the ever increasing demands of their users. They are asked to support more users with better response times, but without a commensurate increase in resources, both people and money, to meet these challenges. The solutions of past years - replicated data centers - are no longer an option for most IT professionals. Consequently, they are looking for alternative technology strategies to meet the performance demands of their corporate enterprise systems and reduce the associated operating costs. As systems scale to meet growing demands, companies are finding that many of their systems are reaching their technological limitations. While network bandwidth can be a problem, more frequently the absence of real-time data being available to distributed users on the network is the real limitation on application performance resulting in: o SLOW RESPONSE TIMES: Many enterprise applications were not designed to scale to handle large numbers of concurrent users. Users accessing these systems often experience lengthy delays as the number of concurrent users increases. o SYSTEM FAILURES: Disaster recovery and fail-over capability are crucial for systems required to operate 24 hours a day, 7 days a week. Users accessing these systems at peak volume can experience frequent system crashes. 2 o LIMITED SCALABILITY: As applications are deployed to more and more remote users in a system, improving the productivity of those users, the need for a system to scale easily without the need and expense of additional data centers is essential. In large part, the problems facing enterprises today are derived from the continuing evolution and increasing sophistication of enterprise applications. Simple applications supporting back office systems typically had few users accessing limited amounts of data. As decision-making based on real-time, frequently changing data was moved farther out to the edge of the enterprise, the need for vital information to support these business-critical applications became paramount. In addition, the need to keep the cost of these systems to a minimum provided an additional challenge to the system architects. Traditional system architectures and approaches cannot completely solve the problem. A new distributed data infrastructure is required. The next generation of enterprise applications will require a fundamentally new data management infrastructure, which will allow application servers to scale, meeting the demands of an ever increasing user base, and to be deployed without the need for an expensive back end IT infrastructure. These platforms must provide: o REAL-TIME SCALABILITY: accommodate up to thousands of end users with consistent sub-second response times; o HIGH AVAILABILITY: handle system failures without interruption and without losing critical information for potentially thousands of concurrent users; o RAPID ADAPTABILITY: allow companies to continuously improve their business processing through automated development and management of differentiated business-critical applications; and o EDGE COMPUTING: enable businesses to extend their processing across organizational boundaries, support employees, remote users and even partners and customers. PERSISTENCE SOLUTION Our POWERTIER, EDGEXTEND and DYNAMAI family of products provide a data management infrastructure that is specifically designed to enable high volume, high performance, distributed applications. Our products, POWERTIER for J2EE, POWERTIER for C++, EDGEXTEND for J2EE and DYNAMAI, address the scalability, availability and adaptability demands that typically occur when delivering business solutions for high demand, globally distributed enterprise business applications. Our products offer the following key benefits: REAL-TIME RESPONSE FOR THOUSANDS OF CONCURRENT USERS. Our POWERTIER, EDGEXTEND and DYNAMAI products were designed specifically to accommodate high volume transaction processing and the data integrity requirements of distributed applications. POWERTIER, EDGEXTEND and DYNAMAI utilize caching technology. Caching is a process in which select data is pulled out of back-end systems and into the server cache, which allows the data to be shared and manipulated by multiple users. Replication between POWERTIER AND EDGEXTEND server caches using the POWERSYNC feature allows a cluster of application servers to provide highly scalable performance as the number of users increases. DYNAMAI is designed to use a similar clustering scheme to enable successful cooperation among multiple caches. This architecture helps reduce the work load on back-end systems and accelerates application performance. The effect of this architecture is to minimize unnecessary network traffic and thereby enable high performance and reliability even with significant transaction volumes. We believe that our POWERTIER, EDGEXTEND, and DYNAMAI products offer superior performance and scalability to support the deployment of large-scale distributed enterprise applications. DRAMATIC REDUCTIONS IN TIME-TO-MARKET FOR ENTERPRISE APPLICATIONS. Our POWERTIER AND EDGEXTEND products decrease time-to-market and development cycles for sophisticated applications due to our proprietary and patented object-to-relational mapping technology. This technology enables the automatic generation of software code, which minimizes basic, low-level programming tasks, such as security and database access. Both POWERTIER AND EDGEXTEND accelerate development by giving developers access to data in a familiar way, as software components, and provides application developers with a framework to rapidly build electronic commerce applications. Similarly, the DYNAMAI product enhances the performance and scalability of Web-based systems through a 3 relatively simple cache configuration process, which does not require costly re-architecture of existing back-end systems. PROTECTS AND LEVERAGES EXISTING INFORMATION TECHNOLOGY INVESTMENTS. POWERTIER and EDGEXTEND enable developers to build new enterprise applications while simultaneously integrating existing back-end systems. POWERTIER AND EDGEXTEND'S flexible architecture integrates with disparate database servers, web servers and multiple clients, while supporting multiple programming languages and computing platforms. POWERTIER and EDGEXTEND provide enhanced flexibility and inter-operability to link existing enterprise applications and systems, allowing businesses to leverage their investments in information technology and extend them to the edge of their enterprise and beyond. Similarly, the DYNAMAI product is designed to provide its benefits with minimal disruption of existing information technology investments. LEADERSHIP IN EMERGING STANDARDS. Customers are increasingly seeking open, standards-based technology solutions that enable them to develop and implement new applications rapidly. Both POWERTIER and EDGEXTEND provide for application server solutions that support the J2EE specification to enable businesses to deploy high performance, scalable Java applications for the enterprise. We worked with the Sun Microsystems consortium to define an industry-wide component standard to be used when building enterprise applications with the Java language. It is this standard upon which our POWERTIER and EDGEXTEND products are built, and we believe that this emerging platform has the potential to dramatically simplify the development of distributed, multi-tier enterprise applications. Sun Microsystems introduced the Java 2 Platform, Enterprise Edition (J2EE) in 1999, which is a suite of enterprise Java technology specifications. Persistence became one of Sun's first J2EE licensees, and we intend to continue to be a leading adopter and contributor to these technologies as they evolve. OPTIMIZED DISTRIBUTED DATA MANAGEMENT ARCHITECTURE. All our products are built on the core Persistence technologies of O/R Mapping, Dynamic Caching and Cache Synchronization. This expertise, called Distributed Dynamic Caching (DDC), allows for a distributed data management architecture which is highly scalable, suitable for high volume transaction oriented applications, and capable of supporting thousands of concurrent users. In addition, this architecture is designed to be implemented in a globally distributed enterprise environment without the need for an expensive back-end infrastructure. It provides for data center type performance without the need for replicated data centers. PERSISTENCE STRATEGY Our goal is to fundamentally restructure how companies extend and leverage their vital business information by enabling a distributed data management infrastructure. To achieve this goal, we intend to: INCREASE PARTNERSHIPS WITH INDEPENDENT SOFTWARE VENDORS (ISVS). We intend to continue to develop and expand relationships with ISVs, in particular IBM WebSphere and BEA WebLogic. Through our EDGEXTEND product for WebSphere and EDGEXTEND for WebLogic we now offer a complementary J2EE product, which leverages the unique data management capability of Persistence's technologies. As part of the IBM and BEA partner programs, we believe that these relationships will provide additional marketing and sales channels for our products and facilitate the successful deployment of customer applications. CONTINUE TO EXPAND OUR GROWING OEM BUSINESS. We intend to become a market leader in providing data management infrastructure software to enable sophisticated enterprise applications. We have worked with several customers who have successfully built their global enterprise applications on core Persistence technologies and are deploying these applications to their customers. We will continue to collaborate with our innovative and advanced customers to develop and deliver product features that address their needs. We believe that this collaboration focuses our overall product development effort and speeds our time-to-market. EXTEND TECHNOLOGY LEADERSHIP POSITION IN STANDARDS-BASED PLATFORMS FOR NEXT GENERATION ENTERPRISE APPLICATIONS. We intend to extend our technology leadership in distributed data management for the transactional application server and dynamic Web content acceleration markets by enhancing our underlying technology to offer real-time scalability, high availability and rapid adaptability for the next generation of enterprise business applications. To achieve this objective, we will continue to make investments in our research and development organization. In addition, we intend to be a leader in the definition and adoption of emerging technology standards, such as J2EE, which we believe have the potential to dramatically simplify the development of distributed, multi-tier applications. We have been a pioneer in the areas of 4 caching and object-relational mapping, and hold several patents on core technologies. We intend to continue to innovate and create new enabling technologies for distributed data management. EXPAND PRODUCT PLATFORM TO OFFER COMPLEMENTARY SOLUTIONS. In addition to extending our technology leadership, we intend to broaden and enhance our product platform to incorporate complementary solutions for developing and deploying sophisticated enterprise applications. We will continue to make investments in our research and development organization for many of these product initiatives. We will also consider, from time to time, bolstering these internal efforts with strategic acquisitions, and partnerships with software vendors who have complementary product offerings. The addition of these complementary technologies will enable us to offer a more complete platform for our customers. LEVERAGE INSTALLED CUSTOMER BASE. We believe there are significant opportunities to expand the use of our products throughout our current customer base. This is particularly true for customers who have adopted our technology for a particular part of their business, but who have standardized on IBM's WebSphere or BEA's WebLogic for their mainstream applications. We now have the opportunity to re-engage with those customers on a broader basis as they deploy their applications throughout their enterprise. Through Persistence's distributed data management architecture we can enable our customers to scale and deploy applications without the need for replicated data centers in some cases saving them millions of dollars. MAINTAIN OUR INTERNATIONAL PRESENCE. We believe there are significant international opportunities for our products and services, in particular, in Europe and Asia. Currently, we have established direct sales operations in the United Kingdom, Germany, and Hong Kong. In addition to our direct sales operations, we also distribute our products throughout Europe and Asia with distributors and systems integrators. We intend to extend these international third-party distributor and systems integrator relationships. PRODUCTS Our POWERTIER platform is a family of transactional application server products that deliver scalability, high availability and rapid adaptability for high volume, high performance, distributed enterprise applications. Our current product line consists of POWERTIER for J2EE and POWERTIER for C++. The following table describes the major features and benefits of our POWERTIER platform.
PRODUCT FEATURES BENEFITS - ------- -------- -------- POWERTIER FOR J2EE Shared transactional object cache Enables real-time scalability by reducing database traffic Application server cache synchronization Allows cooperative processing across organizational boundaries Application server failover Delivers high availability by replicating information across clusters of application server caches Integrated end-to-end systems, including: Delivers out of box productivity and an end-to-end development and deployment platform o XML server o EJB server J2EE 1.2 - compliant security encription Simplifies developer inclusion of encryption Certified for the J2EE 1.2 standard Protects customers' IT investments as a result of open solution POWERTIER FOR C++ Shared transactional object cache Enables real-time scalability by reducing database traffic Application server cache synchronization Allows cooperative processing across organizational boundaries Application server failover Delivers high availability by replicating information across clusters of application server caches Support for CORBA standard Protects customers' IT investments as a result of open solution
5 POWERTIER for J2EE Our POWERTIER for J2EE application server platform incorporates our patented technologies into a J2EE-based transactional application server. The J2EE standard, as defined by the Java Software division of Sun Microsystems, is gaining rapid acceptance as a programming language for complex enterprise applications. J2EE provides a consistent way to program and integrate services for companies building distributed business-to-business applications with the Java programming language. The J2EE standard specifies container-managed persistent objects, which automate the mapping between EJB components and relational database tables. This feature allows programmers to build complex applications quickly by making relational data look like software components, which can be easily manipulated. We worked with the Sun Microsystems consortium to help define the initial EJB standard, and we continue to contribute to new versions of the J2EE standard. Our POWERTIER for J2EE platform now runs on the Windows NT and multiple varieties of the Unix operating systems. Our latest version of POWERTIER for J2EE, POWERTIER 7 with POWERPAGE, is designed to simplify the complex task of developing high performance, scalable web applications and eliminate the need to compromise between powerful application servers and simplicity of web page creation. The POWERTIER 7 application server is designed to have an end-to-end J2EE development platform that enhances development team productivity and allows scalable, flexible applications to be rolled out at internet speed. POWERTIER 7 also: o Is designed to be security compliant with Sun Microsystems' J2EE 1.2 specification, providing integrated and comprehensive authorization, authentication and encryption capability for new applications o Includes an enterprise class Servlet Engine tightly integrated with POWERTIER 7, with support for Java servlets and JSPs. The Servlet Engine is designed to be scalable and fault tolerant. POWERTIER for C++ Our POWERTIER for C++ product is a high-performance transactional application server, which is based on our patented technologies and the Common Object Request Broker Architecture, or CORBA, standard for communication between distributed applications. The CORBA standard is managed by an industry group called the Object Management Group, of which we are a contributing member. We are also one of the authors, along with Oracle, IBM and others, of an emerging component of the overall CORBA standard, called the Persistent State Service specification. Our POWERTIER for C++ platform runs on the Windows NT and Unix operating systems. We have licensed the J2EE platform and are a contributor to the Java standard. Other features and benefits include: o PATENTED TECHNOLOGY PLATFORM. Our application server cache software architecture and cache replication technology have been designed to serve as the foundation for a variety of scalable electronic commerce applications. o SHARED CACHING. Our cache technology is the foundation for the high performance characteristics of our transactional application server. To maximize performance, dynamic information such as product inventory data is retrieved from a database into the application server cache. This in-memory information may be accessed simultaneously by multiple users, saving each user from having to access a disk-based database for that information. This feature reduces network traffic between the application server and the database, which we believe results in higher performance. o TRANSACTIONAL CACHING. To enable users to get a consistent view of information within the shared cache, our technology prevents one user from seeing uncommitted changes made by another user. The ability of our 6 shared application server cache to isolate users from dynamic changes to component information, such as inventory data, differentiates our application server cache from other caching technologies, which can only manage static information, such as web pages. This feature allows high performance caching of dynamic or transactional information. o CACHE REPLICATION. Our cache replication technology provides the foundation for the scalability, stateful availability and fault tolerance of our transactional application server. We define stateful availability as a system that can transfer a user in the middle of a complex business operation, such as a portfolio valuation, from one application server to another without interruption or losing business state, such as the user's portfolio information. To provide stateful scalability, information from one application server cache can be synchronized with information in one or more other application server caches. Companies can deploy additional replicated application server caches to increase their ability to support more users, allowing them to use several smaller computers to do the work of one larger and more expensive computer. Users' requests are automatically routed to the application server with the most free capacity, enabling high performance, notwithstanding increases in user volumes. In the event of an application server failure, that application server's responsibilities are automatically reassigned to another application server, improving system availability. o CLUSTER MANAGEMENT. We have developed complementary, proprietary administration software, which enables remote administration for clusters of application servers, reducing both administrative costs and the possibility of error. This management software also enables centralized monitoring, via a standard Web browser, of the cluster through any individual application server. This feature contributes to greater system availability and reduced administrative costs. o DEVELOPMENT AUTOMATION. Our POWERTIER development environment includes frameworks to automate or eliminate many development tasks. The proprietary and patented object-relational mapping feature, ObjectBuilder, automatically generates the software code to translate software components into relational databases. This feature reduces the programming time required to build enterprise applications. The POWERTIER application server includes pre-built software services for data management, transaction management and communications, relieving the developer from having to build these services from scratch. o STANDARDS-BASED. The POWERTIER application server platform uses an open architecture that is based on industry standards such as Java, C++, CORBA, Windows NT, UNIX, SQL, J2EE, EJB and others. DYNAMAI Our DYNAMAI Web content accelerator improves the speed and scalability of electronic commerce Web sites that rely heavily on dynamically generated content using technologies such as Java Server Pages and Active Server Pages. The DYNAMAI product was released in 2000. The following table describes the major features and benefits of DYNAMAI.
PRODUCT FEATURES BENEFITS - ------- -------- -------- Dynamai Dynamic Web object cache Enables real-time scalability by reducing application server and database workload Event-based content invalidation Supports maintenance of "fresh" information in cache Automatic cache clustering Delivers high availability by replicating information across clusters of application server caches On-the-fly content adaption Allows caching of personalized content
EDGEXTEND Our EDGEXTEND for WebSphere and EDGEXTEND for WebLogic products are designed to make the performance and reliability of Persistence's patented DDC technology available to applications running on IBM's WebSphere and BEA's WebLogic 7 application servers. EDGEXTEND provides a new distributed data management architecture, which complements J2EE compliant application servers. Through the J2EE Connector Architecture the data access layer is replaced by EDGEXTEND, allowing the application servers to have the benefits of DDC without changing their existing business and presentation logic. In addition, with this distributed data architecture, WebSphere and WebLogic application servers can operate outside of a data center in a "virtual data center" without the requirement of an expensive relational database infrastructure. Our EDGEXTEND for WebSphere product is scheduled to be released on a generally available basis by the end of March 2002. Our EDGEXTEND FOR WebLogic product is scheduled to be released on a generally available basis by the end of June 2002. The following table describes the major features and benefits of EDGEXTEND:
PRODUCT FEATURES BENEFITS - ------- -------- -------- EDGEXTEND for Shared transactional object Enables real-time scalability by reducing IBM WebSphere(R) cache database traffic Object-relational mapping that Speeds application development by managing provides abstraction to database details for developer database representation Optimized usage of native Improves application capacity by efficiently database libraries using database resources Application server cache Improves application capacity by caching EDGEXTEND for synchronization unpredictably changing data BEA WebLogic(R) Application server failover Delivers high availability by replicating information across clusters of application server cache Shared transactional object Enables real-time scalability by reducing cache database traffic Object-relational mapping that Speeds application development by managing provides abstraction to database details for developer database representation Optimized usage of native Improves application capacity by efficiently database libraries using database resources Application server cache Improves application capacity by caching synchronization unpredictably changing data Application server failover Delivers high availability by replicating information across clusters of application server caches
We believe that research and product development will be a key to our success as a leader in providing distributed data management software in the application server and dynamic Web content acceleration markets. Our research and development expenditures totaled $5.6 million for 2001, $8.1 million for 2000 and $6.4 million for 1999. CUSTOMERS Our software products are licensed to customers worldwide for use in a wide range of enterprise and electronic commerce applications, including real-time electronic trading, supply chain management, network management, application outsourcing and logistics management. Our services consist of professional consulting services, technical support and training. The following table lists a selection of customers who have purchased a significant amount of our products or services in 2001 or 2000 (defined as purchases of approximately 1% or more of our total revenues in either year.) 8 E-COMMERCE/INTERNET FINANCIAL SERVICES/EXCHANGES Cisco Systems Chase JP Morgan/Accordia i2/Rightworks CNP Assurances Intershop Credit Suisse First Boston Network Appliance Instinet Nexus Limited Corp Kinetech Services Salomon Smith Barney COMMUNICATIONS Zurich Arippina Gruppe 4T Solutions AT&T CSC Holdings (Cablevision) TRANSPORTATION & LOGISTICS Lucent Technologies Effix Motorola Hekimian Laboratories Nokia Sabre Group Holdings (American Airlines) Sprint WorldRes.com MANUFACTURING & DISTRIBUTION OTHER Hewlett Packard Applied Biosystems Nippon Steel Bundesanstalt fur Arbeit Convergys Information Infron Technologies Refco Group In 2001, sales of products and services to Salomon Smith Barney accounted for 15% of our total revenues and sales to Cablevision accounted for 11% of our total revenues. In 2000, sales of products and services to Salomon Smith Barney accounted for 16% of our total revenues. In 1999, sales of products and services to Cisco accounted for 13% of our total revenues. The following case studies illustrate how selected customers have used our products to address their electronic commerce and core business application needs. These case studies are based on information supplied by these customers, however, we believe the information is accurate in all material respects. Reuters, the parent of Instinet, and Cisco are both stockholders in our company. REAL-TIME ELECTRONIC TRADING NETWORK INSTINET CORPORATION. Instinet is the world's largest electronic agency broker in equity securities. Historically, trading in fixed income securities occurred almost exclusively over the telephone. Instinet revolutionized this telephone-based fixed income trading with a global electronic broker trading service for fixed income dealers that can accommodate up to 1,000 transactions per second. It has designed a system based on the use of hundreds of replicated POWERTIER application servers, operating in concert, to meet the performance and scalability requirements of its electronic fixed income broker service. INTRANET SUPPLY CHAIN MANAGEMENT FEDERAL EXPRESS CORPORATION. The world's largest express transportation company, FedEx transports more than three million items to over 200 countries each business day, using a fleet of more than 620 aircraft and 44,000 vehicles. In its effort to improve on-time deliveries, FedEx has built a global operations center to monitor and control the movement of shipments worldwide. The global operations center functions as the nerve center of the FedEx transportation system, handling daily occurrences including changing flight schedules, emergency maintenance, inclement weather and excess package volumes. Because the company's existing mainframe systems lacked the required flexibility and performance, FedEx turned to us for help in building a high performance intranet system. By managing complex flight schedule information from multiple data sources within a POWERTIER application server cache, the global operations center can provide real-time contingency plans, enabling FedEx to provide consistently high on-time package delivery rates and superior customer service. FedEx estimates that, using the POWERTIER development environment, it has been able to significantly reduce development time for new system functionality compared to development in its traditional mainframe environment. 9 INTERNET SERVICE PROVIDER NETWORK MANAGEMENT CISCO SYSTEMS, INC. A worldwide leader in networking for the Internet, Cisco Systems is committed to delivering hardware and software solutions that enable service providers to meet the rapid growth of the Internet. The Cisco Service Management System, or CSM, gives Service Providers sophisticated tools to automate time-consuming network management tasks. For this system, Cisco required a highly scalable, standards-based application server platform for deploying network management applications for managed business services such as virtual private networks, Internet telephony and electronic commerce. To meet these requirements, Cisco chose the POWERTIER platform. For the Cisco IP Manager product within the CSM system, POWERTIER application server caching enables real-time simulation of network configuration changes, preventing costly network outages. The POWERTIER development environment also enables Cisco to create a common component framework that can be reused to reduce development time for future CSM network services. APPLICATION OUTSOURCING OVER THE INTERNET CELERA GENOMICS. Celera provides gene discovery and characterization services for drug discovery and development. Celera's GeneTag technology is a novel gene expression analysis method that enables pharmaceutical companies to develop new and potentially life-saving drugs by discovering and monitoring genes involved in disease. Celera's BioScope software application allows customers to access their data securely and remotely over the Internet. To allow clients to quickly analyze and view the GeneTag results, Celera needed a sophisticated software platform that could process hundreds of thousands of gene expression comparisons while avoiding data bottlenecks. Celera selected POWERTIER to achieve these goals. The BioScope application utilizes the POWERTIER application server cache for high volume data analysis. With the POWERTIER development environment, Celera has been able to use both the Java and C++ languages to deliver the BioScope software application in only four months. SALES AND MARKETING We sell our products through both a direct sales force and third party distributors. As of December 31, 2001, we had 40 people in our sales and marketing organization, of which 25 were in the United States, 14 were in European offices, and 1 was in our Asian office. We intend to increase the size of our direct sales force as well as focusing on indirect distribution channels. While our overall 2002 sales and marketing expense compared to 2001 is expected to decrease, reductions in non-personnel related programs are expected to offset expenses for new hirings. Our sales cycle is relatively long, 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 pilot program to establish a technical fit. We have engaged in, and may continue to engage in, a variety of targeted marketing activities, including focused advertising, public relations, seminars, trade shows and customer-oriented web site management. We have also made substantial marketing investments in education and training for the J2EE and C++ markets. We hold periodic seminars in order to train developers. We intend to continue to develop and expand relationships with OEMs, consultants, system integrators and independent software vendors (ISVs). We believe these third parties can effectively market our products, particularly EDGEXTEND, through their existing relationships with our target market customers. We believe that these relationships will provide additional marketing and sales channels for our products and facilitate the successful deployment of customer applications. We are currently working with multiple consultants, system integrators and ISV partners, including IBM and BEA, with whom we announced partner agreements in 2001. In international markets, we plan to expand our sales through indirect channels, such as distributors and OEMs. As of December 31, 2001, we were represented by 2 international distributors, both of whom sell our products in Asia. 10 COMPETITION 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: o performance, including scalability, integrity and availability; o ability to provide a complete software platform; o flexibility; o use of standards-based technology (e.g. J2EE); o ease of integration with customers' existing enterprise systems; o ease and speed of implementation; o quality of support and service; o security; o company reputation; and o price. Our competitors for POWERTIER include both publicly and privately-held enterprises, including BEA Systems (WebLogic), Secant Technologies, IBM (WebSphere), Oracle (OAS) and Sun Microsystems (iPlanet). Many customers may not be willing to purchase our POWERTIER, EDGEXTEND or DYNAMAI products because they have already invested heavily in databases and other enterprise software components offered by these competing companies. Many of these competitors have pre-existing 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 considered competitors. Further, dozens of companies have announced their intention to support EJB/J2EE 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. See also "Risk Factors -- Because we compete with Sun Microsystems, who controls the EJB/J2EE standard, we face the risk that they may develop this standard to favor their own products" and "-- Microsoft has established a competing application server standard, which could diminish the market potential for our products if it gains widespread acceptance." 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. In the DYNAMAI market, similar dynamic Web content acceleration technology is available from a variety of sources, including but not limited to internal development, application server vendors such as Oracle, electronic commerce software vendors such as Intershop and ATG, content delivery networks such as Akamai and epicRealm, and emerging software and hardware appliance vendors such as Chutney and Cachier, who are directly targeting DYNAMAI'S market. In the EDGEXTEND market, similar technology is available from a variety of sources, including the potential for internal development. Company vendors such as Versant, webGain and Excelon are middleware vendors that offer alternative data management solutions that directly target EDGEXTEND's market. Because we enhance standard J2EE application servers, we face the risk that they may develop similar functionality within their own products. 11 INTELLECTUAL PROPERTY RIGHTS Our performance may depend on our ability to protect our proprietary rights to the technologies used in our principal products. If we are not adequately protected, our competitors could use the intellectual property that we have developed to enhance their products and services, which would harm our business. We rely on a combination of patents, copyright and trademark laws, trade secrets, confidentiality provisions and other contractual provisions to protect our proprietary rights, but these legal means afford only limited protection. As of February 28, 2002, we had five issued United States patents and two pending United States patent applications with allowable subject matter. Despite any measures taken to protect our intellectual property, 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 as fully as do the laws of the United States. Thus, the measures we are taking to protect our intellectual property rights in the United States and abroad may not be adequate. Finally, our competitors may independently develop similar technologies. 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 entrants into our market increases, the possibility of an intellectual property claim against us grows. For example, we may be inadvertently infringing 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 issues in the future. To address these patent infringement 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 of product infringement against us, and our failure to license the infringed or similar technology, would harm our business. In addition, any infringement claims, with or without merit, would be time-consuming and expensive to litigate or settle and would divert management attention from administering our core business. 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 competing products that would, in the absence of this license agreement, infringe our patents. Under this agreement, Sun Microsystems made a one-time payment to us. Neither Sun Microsystems nor we can transfer the license without the consent of the other party. In January 2001, we entered into a license agreement with both webGain and Secant to manufacture and sell products under three of our patents. Under this agreement, both webGain and Secant made a one-time payment to us. EMPLOYEES As of December 31, 2001, we had 81 full-time employees, including 40 in sales and marketing, 28 in research and development and technical services, and 13 in general and administrative functions. Our relationships with our employees are generally good. From time to time, we also employ independent contractors to support our sales and marketing, research and development, professional services and administrative organizations. 12 EXECUTIVE OFFICERS The following table sets forth specific information regarding our executive officers as of February 28, 2002: NAME AGE POSITION ---- --- -------- Christopher T. Keene.......41 Chief Executive Officer Christine Russell..........52 Chief Financial Officer and Secretary Derek Henninger............39 Vice President of Customer Care and CIO Keith Zaky.................43 Vice President of Worldwide Field Operations Ed Murrer..................52 Vice President of Marketing Vivek Singhal..............33 Vice President of Engineering Each executive officer serves at the sole discretion of the Board of Directors. CHRISTOPHER T. KEENE co-founded Persistence and has served as Chief Executive Officer and a director since June 1991 and as Chairman of the Board since April 1999. From June 1991 to April 1999, Mr. Keene also served as President. Before founding Persistence, Mr. Keene worked at McKinsey & Company, Ashton-Tate and Hewlett-Packard. Mr. Keene holds a B.S. degree in Mathematical Sciences with honors from Stanford University and an M.B.A. degree from The Wharton School at the University of Pennsylvania. CHRISTINE RUSSELL joined Persistence in October 1997 and has served as Chief Financial Officer and Secretary since December 1997. From October 1995 to October 1997, she served as Chief Financial Officer for Cygnus Solutions, an open source platform software company. Previously, Mrs. Russell was CFO of Valence Technology and served in various senior financial positions with Shugart Corporation, a subsidiary of Xerox. She holds a B.A. degree in English Literature and an M.B.A. degree from Santa Clara University. DEREK HENNINGER co-founded Persistence and served as Vice President of Engineering from June 1991 until January 2002 when he became Vice President of Customer Care and CIO. Previously, Mr. Henninger worked in the Data Interpretation Division of Metaphor Corporation, a software and hardware company, from September 1990 to June 1991. Mr. Henninger holds a B.A. degree in Economics and a B.S. degree in computer Science and Mathematics from the University of California at Davis. KEITH ZAKY joined Persistence in October 2001 as Vice President, Worldwide Field Operations. From June 1985 to December 1999, he worked in the Octel Messaging Division of Lucent Technologies, a major networking company, most recently as Vice President and General Manager of Asia Pacific. Mr. Zaky took a planned sabbatical from December 1999 until August 2000. From August 2000 until he joined Persistence, Mr. Zaky was Executive Vice President of Worldwide Field Operations at AppGenesys. ED MURRER joined Persistence in July 2001 as Vice President, Marketing. Mr. Murrer was the Senior Vice President of Sales and Marketing at Xcert International, an enterprise security software company, from March 2000 to March 2001 when Xcert was sold to RSA Security. From July 1997 to March 2000, Mr. Murrer was Vice President, Business Development at Veridicom, a biometrics security software company. VIVEK SINGHAL joined Persistence in April 1995 as a Software Engineer. In January 2002, he was promoted to Vice President, Engineering. He holds a B.S. degree in Computer Science from the Massachusetts Institute of Technology and a Ph.D. in Computer Science from the University of Texas at Austin. 13 ITEM 2. PROPERTIES. We are headquartered in San Mateo, California, where we lease approximately 17,000 square feet of office space under a lease expiring on December 31, 2004. We have an engineering staff facility in San Diego, where we lease approximately 6,000 square feet of office space under a lease expiring on August 31, 2004. We also maintain sales offices in other U.S. states, the United Kingdom, Germany, and Hong Kong. We believe that our existing facilities are adequate to meet our current and foreseeable requirements or that suitable additional or substitute space will be available as needed. ITEM 3. LEGAL PROCEEDINGS. We are not currently subject to any material legal proceedings. We may, however, from time to time become a party to various legal proceedings that arise in the ordinary course of business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 14 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. PRICE RANGE OF COMMON STOCK. Our common stock has been traded on the Nasdaq National Market under the symbol PRSW since the effective date of our initial public offering on June 24, 1999. Prior to the initial public offering, no public market existed for our common stock. The price per share reflected in the table below represents the range of low and high closing sale prices for our common stock as reported in the Nasdaq National Market for the periods indicated. HIGH LOW -------- -------- For The Year Ended December 31, 1999: Second Quarter from June 24, 1999........................ $ 13.81 $ 11.00 Third Quarter............................................ $ 28.88 $ 12.63 Fourth Quarter........................................... $ 26.06 $ 8.25 For The Year Ended December 31, 2000: First Quarter............................................ $ 23.63 $ 15.81 Second Quarter........................................... $ 21.38 $ 10.13 Third Quarter............................................ $ 20.75 $ 9.91 Fourth Quarter........................................... $ 12.00 $ 3.38 For The Year Ended December 31, 2001: First Quarter............................................ $ 4.50 $ 1.00 Second Quarter........................................... $ 1.25 $ 0.48 Third Quarter............................................ $ 0.99 $ 0.15 Fourth Quarter........................................... $ 1.35 $ 0.19 We had 170 stockholders of record as of February 28, 2002, including several holders who are nominees for an undetermined number of beneficial owners. DIVIDEND POLICY. We have never paid dividends on our common stock or preferred stock. We currently intend to retain any future earnings to fund the development of our business. Therefore, we do not currently anticipate declaring or paying dividends in the foreseeable future. In addition, our line of credit agreement prohibits us from paying dividends. USE OF PROCEEDS FROM SALES OF REGISTERED SECURITIES. Our registration statement on Form S-1, SEC File No. 333-76867, for our initial public offering of common stock became effective on June 24, 1999. We registered and sold an aggregate of 3,450,000 shares of common stock under the registration statement at a per share price of $11.00. Our underwriters were BancBoston Robertson Stephens, U.S. Bancorp Piper Jaffray, and Soundview Technology Group. Offering proceeds, net of aggregate underwriting commissions and discounts of $2.7 million and other offering transaction expenses of $1.1 million, were $34.1 million. None of the underwriting commissions and discounts or other offering transaction expenses were direct or indirect payments to our directors, officers, or holders of 10% or more of our stock. From June 24, 1999 through December 31, 2001, we have used the net offering proceeds as follows: Working capital expenditures $21.5 million Acquiring property and equipment 2.3 million Acquiring technologies 2.9 million ------------- 26.7 million Cash and cash equivalents 7.4 million ------------- $34.1 million Each of the above amounts represents our best estimate of our use of the net proceeds. None of the net offering proceeds were paid directly or indirectly to our directors, officers, or holders of 10% or more of our common stock. 15 ITEM 6. SELECTED FINANCIAL DATA. The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations," which are included elsewhere in this report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 2001, 2000, and 1999 and the consolidated balance sheet data at December 31, 2001 and 2000, are derived from audited consolidated financial statements included elsewhere in this report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 1998 and 1997, and the consolidated balance sheet data as of December 31, 1999, 1998 and 1997 are derived from audited financial statements not included in this report on Form 10-K.
YEARS ENDED DECEMBER 31, --------------------------------------------------------- 2001 2000 1999 1998 1997 --------- --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Revenues: License ......................................... $ 10,561 $ 17,684 $ 10,890 $ 7,478 $ 3,546 Service ......................................... 8,810 7,593 3,553 2,682 1,867 --------- --------- --------- --------- --------- Total revenues .......................... 19,371 25,277 14,443 10,160 5,413 Loss from operations .............................. (15,391) (17,857) (12,165) (4,090) (4,686) Net loss .......................................... $(15,132) $(16,726) $(11,306) $ (4,089) $ (4,674) ========= ========= ========= ========= ========= Basic and diluted net loss per share(1) ........... $ (0.76) $ (0.87) $ (0.86) $ (0.59) $ (0.73) ========= ========= ========= ========= ========= Shares used in basic and diluted net loss per share calculation ....................................... 19,919 19,330 13,091 6,879 6,366 ========= ========= ========= ========= ========= AS OF DECEMBER 31, --------------------------------------------------------- 2001 2000 1999 1998 1997 --------- --------- --------- --------- --------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash, cash equivalents and short-term investments . $ 7,411 $ 19,490 $ 29,652 $ 4,938 $ 2,610 Working capital ................................... 6,783 17,289 29,582 3,384 1,604 Total assets ...................................... 13,755 33,641 39,092 7,064 5,447 Long-term obligations ............................. 421 932 354 714 419 Total stockholders' equity ........................ 7,944 22,556 32,018 3,422 2,057
- ---------- (1) 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. ITEM 7. 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, 2001 and 2000 and for each of the years ended December 31, 2001, 2000, and 1999, included elsewhere in this annual report on Form 10-K. In addition, this Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this annual report on Form 10-K contain forward-looking statements that involve risks and uncertainties. Words such as "anticipates," "believes," "plans," "targets," "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 differences 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 annual report on Form 10-K. 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 Persistence Software solves data access problems for distributed and real-time systems. Persistence solutions help deliver better business visibility for applications which require current information about customers, products and 16 suppliers. Persistence provides a suite of data management products that sit between existing databases - such as Oracle and DB/2 - and/or application servers - such as WebLogic and WebSphere. Developers can configure these products to structure and position business information with optimal efficiency, improving application server performance and simplifying application distribution while reducing database costs. Persistence is a leading provider of software for the management of distributed data throughout an enterprise without the need for replicated data centers. By effectively managing enterprise data, users achieve the benefit of "business visibility" - the ability to manage their businesses in real time with data and applications where they need them, when they need them. We were incorporated and began operations in 1991. Our products incorporate patented object-to-relational mapping and caching technologies. We have continually enhanced our 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 J2EE (formerly known as EJB) specification. In 1998, we introduced POWERTIER for EJB (now J2EE), which customers have frequently purchased together with POWERTIER for C++. Our most recent version of POWERTIER for J2EE is currently in use by several major customers and was commercially released in September 2001. We currently plan to continue to focus product development efforts on enhancements to both the POWERTIER for C++ and the POWERTIER for J2EE products, as well as our EDGEXTEND product. Our revenues, which consist of software license revenues and service revenues, totaled $19.4 million in 2001, $25.3 million in 2000 and $14.4 million in 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 J2EE and EDGEXTEND products 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, Germany, and Hong Kong. Revenues from licenses and services to customers outside the United States were $7.4 million in 2001, $7.2 million in 2000 and $4.1 million in 1999 which represented approximately 38% of total revenues for 2001, 28% for 2000 and 28% for 1999. 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 45% of total revenues in 2001, 40% of total revenues in 2000 and 35% of total revenues in 1999. In addition, the identity of our top five customers has changed from year to year. In the future, it is likely 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. We plan to hire sales people, in particular those with expertise in channel sales, 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 OEM partners and other resellers. We recognize revenues in accordance with the American Institute of Certified Public Accountants Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended. Future implementation guidance relating to these standards or any future standards may result in unanticipated changes in our revenue recognition practices, and these changes could affect our future revenues and earnings. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 provided guidance on the recognition, presentation and disclosure of revenue in the financial statements. SAB No. 101 outlines basic criteria that must be met to recognize revenue and provides 17 guidance for disclosure related to revenue recognition policies. The company implemented SAB No. 101 in the fourth quarter of the year ended December 31, 2000. The provisions of SAB No. 101 did not have a material impact on the company's consolidated financial position or results of operations. 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 to make such decision. Arrangements that 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 decreased from 152 as of December 31, 2000 to 81 as of December 31, 2001, representing a decrease of 47%. We have incurred net losses in each quarter since 1996 and, as of December 31, 2001, had an accumulated deficit of $55.9 million. We are currently targeting that sales and marketing expenses, research and development expenses, and general and administrative expenses, will remain below the levels incurred during 2001. We expect to achieve a modest net profit on a GAAP basis for 2002. 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 J2EE application server and our more recently introduced caching products, DYNAMAI and EDGEXTEND. Because Sun Microsystems controls the J2EE standard, we need to maintain a good working relationship with them to develop future versions of POWERTIER for J2EE, as well as additional products using the J2EE standard. Our performance will also depend on the level of capital spending in our target market of customers and on the growth and widespread adoption of the market for business-to-business electronic commerce over the Internet. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, bad debts, intangible assets, income taxes, restructuring costs, and contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. - - REVENUE RECOGNITION. Our revenue recognition policy is significant because our revenue is a key component of our results of operations. In addition, our revenue recognition determines the timing of certain expenses, such as commissions. We follow specific and detailed guidelines in measuring and recognizing revenue. Revenue results are difficult to forecast, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses. 18 - - BAD DEBTS. Our bad debt policy requires that we maintain a specific allowance for certain doubtful accounts and a general allowance for the majority of the non-specifically reserved accounts. These allowances provide for estimated losses resulting from the inability or refusal of our customers to make required payments. If the financial condition of the company's customers were to deteriorate further, additional allowances would generally be required. - - PURCHASED TECHNOLOGY AND INTANGIBLES. Our business acquisitions typically resulted in goodwill and other intangible assets, which affect the amount of future period amortization expense and possible impairment expense that we will incur. The determination of the value of such intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements and operating results. Accordingly in 2001, the company took an impairment charge of $2.0 million. - - INCOME TAXES. Our income tax policy records the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying consolidated balance sheets, as well as operating loss and tax credit carry-forwards. We follow specific and detailed guidelines regarding the recoverability of any tax assets recorded on the balance sheet and provide any necessary allowances as required. RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2001 AND 2000 REVENUES Our revenues were $19.4 million for 2001 and $25.3 million for 2000 representing a decrease of 23%. International revenues were $7.4 million for 2001 and $7.2 million for 2000, representing an increase of 3%. For 2001, sales to Salomon Smith Barney accounted for 15% of total revenues, sales to Cablevision accounted for 11% of total revenues, and sales to our top five customers accounted for 45% of total revenues. For 2000, sales to Salomon Smith Barney accounted for 16% of total revenues and sales to our top five customers accounted for 40% of total revenues. LICENSE REVENUES. License revenues were $10.6 million for 2001 and $17.7 million for 2000, representing a decrease of 40%. License revenues represented 55% of total revenues for 2001 and 70% of total revenues for 2000. The decrease in software license revenues was primarily due to a general reduction in information technology spending for 2001, as compared to the more buoyant levels experienced in 2000. This was particularly noticeable within our domestic markets. SERVICE REVENUES. Our service revenues were $8.8 million for 2001 and $7.6 million for 2000, representing an increase of 16%. The increase in service revenues was primarily due to our focus upon significant consulting engagements with Salomon Smith Barney and other key customers. Service revenues represented 45% of total revenues for 2001 and 30% of total revenues for 2000. COST OF REVENUES COST OF LICENSE REVENUES. Cost of license revenues consists of royalties, packaging, documentation and associated shipping costs. Our cost of license revenues was $14,000 for 2001 and $304,000 for 2000. The cost of license revenues for 2000 included significant royalties that did not continue in 2001. COST OF SERVICE REVENUES. Cost of service revenues consists of personnel, contractors and other costs related to the provision of professional services, technical support and training. Our cost of service revenues was $4.0 million for 2001 and $3.6 million for 2000, representing an increase of 11%. This increase was primarily due to the higher technical support revenues experienced in 2001. As a percentage of service revenues, cost of service revenues were 45% for 2001 and 47% for 2000. This decrease was due in part to the increase in our technical support revenues. Cost of service revenues as a percentage of service revenues may vary between periods due to our use of third party professional services. 19 OPERATING EXPENSES SALES AND MARKETING. Sales and marketing expenses consist primarily of salaries, benefits, commissions and bonuses earned by sales and marketing personnel, travel and entertainment, and promotional expenses. Our sales and marketing expenses were $14.4 million for 2001 and $22.8 million for 2000, representing a decrease of 37%. This decrease was primarily due to a general reduction in marketing programs, a reduction in staff and lower commissions based on lower sales revenues. Sales and marketing expenses represented 74% of total revenues for 2001 and 90% of total revenues for 2000. We are presently targeting that 2002 sales and marketing expense levels will be lower than comparable 2001 expense levels. RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of salaries and benefits for software developers, technical managers and quality assurance personnel as well as payments to external software consultants. Our research and development expenses were $5.6 million for 2001 and $8.1 million for 2000, representing a decrease of 31%. This decrease was primarily related to a reduction in staff and a reduction in the use of external consultants. Research and development expenses represented 29% of total revenues for 2001 and 32% of total revenues for 2000. We are presently targeting that 2002 research and development expense levels will be lower than comparable 2001 expense levels. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of salaries, benefits and related costs for our finance, administrative and executive management personnel, legal costs, bad debt write-offs and various costs associated with our status as a public company. Our general and administrative expenses were $5.5 million for 2001 and $5.4 million for 2000, representing an increase of 2%. This increase was primarily the result of patent litigation and settlement costs, offset by a reduction in personnel expenses. General and administrative expenses represented 29% of total revenues for 2001 and 21% of total revenues for 2000. We are presently targeting that 2002 general and administrative expense levels will be lower than comparable 2001 expense levels. AMORTIZATION AND WRITE-DOWN OF PURCHASED INTANGIBLES. Amortization of purchased intangibles was $3.6 million for 2001 and $2.9 million for 2000 representing an increase of 24%. The increase in amortization was primarily due to write-off of intangibles and goodwill of $2.0 million in June 2001. RESTRUCTURING COSTS. The Company restructured several functions within its operations in 2001. This resulted in one-time charges of $1.7 million. The majority of these charges related to severance and other employee related benefit costs. INTEREST AND OTHER INCOME (EXPENSE). Interest and other income (expense) consists primarily of earnings on our cash, cash equivalents and short-term investment balances, offset by interest expense related to obligations under capital leases and other borrowings, and various miscellaneous state and foreign taxes, and other expenses. Interest and other income (expense) was $259,000 for 2001 and $1.1 million for 2000, representing a decrease of 76%. This decrease was primarily due to a reduction in our short-term investment balances and a general reduction in market interest rates. We expect that interest and other income (expense) will decrease as we continue to use our net proceeds from our initial public offering and may become a net expense in 2002. STOCK-BASED COMPENSATION. Some options granted and common stock issued in the past have been considered to be compensatory, as the estimated fair value of the stock price for accounting purposes was greater than the fair market value of the stock as determined by the Board of Directors on the date of grant or issuance. Total deferred stock compensation associated with equity transactions as of December 31, 2001 was $119,000, net of amortization. Deferred stock compensation is being amortized ratably over the vesting periods of these securities. Amortization expense, which is included in operating expenses, was $245,000 in 2001 and $416,000 in 2000. We expect to record amortization expense related to these securities of approximately $120,000 in 2002. 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. As of December 31, 2001, we had $48.4 million of federal and $9.5 million of state net operating loss carryforwards available to offset future taxable income. The federal net operating loss carryforwards expire through 2020, while the state net operating loss carryforwards expire through 2011. The net operating loss carryforwards for state tax purposes are substantially less than for federal tax purposes, primarily because only 50% of state net operating loss 20 carryforwards can be utilized to offset future state taxable income and because state net operating loss carryforwards generated in earlier years have already expired. The Tax Reform Act of 1986 limits the use of net operating loss carryforwards in situations where changes occur in the stock ownership of a company. If we should be acquired or otherwise have an ownership change, as defined in the Tax Reform Act of 1986, our utilization of these carryforwards could be restricted. As of December 31, 2001, the Company also had research and development tax credit carryforwards of $1.5 million and $1.4 million available to offset future federal and state income taxes, respectively. The federal credit carryforward expires in 2021, while the state credit carryforward has no expiration. 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. YEARS ENDED DECEMBER 31, 2000 AND 1999 REVENUES Our revenues were $25.3 million for 2000 and $14.4 million for 1999 representing an increase of 75%. International revenues were $7.2 million for 2000 and $4.1 million for 1999, representing an increase of 76%. For 2000, sales to Salomon Smith Barney accounted for 16% of total revenues and sales to our top five customers accounted for 40% of total revenues. For 1999, sales of products and services to Cisco (a stockholder) accounted for 13% of our total revenues, and sales of products and services to our top five customers accounted for 35% of total revenues. LICENSE REVENUES. License revenues were $17.7 million for 2000 and $10.9 million for 1999, representing an increase of 62%. License revenues represented 70% of total revenues for 2000 and 75% of total revenues for 1999. The increase in software license revenues was primarily due to an increase in sales of our POWERTIER for EJB application server and the increased size and productivity of our sales team. SERVICE REVENUES. Our service revenues were $7.6 million for 2000 and $3.6 million for 1999, representing an increase of 114%. The increase in service revenues was primarily due to an increase in customer support fees related to increased sales of our POWERTIER platform and an increase in our professional services fees. Service revenues represented 30% of total revenues for 2000 and 25% of total revenues for 1999. COST OF REVENUES COST OF LICENSE REVENUES. Our cost of license revenues was $304,000 for 2000 and $170,000 for 1999. As a percentage of license revenues, cost of license revenues remained flat at 2% for each of 2000 and 1999. COST OF SERVICE REVENUES. Our cost of service revenues was $3.6 million for 2000 and $2.6 million for 1999, representing an increase of 36%. This increase was primarily due to increased staffing, and occupancy costs. As a percentage of service revenues, cost of service revenues were 47% for 2000 and 74% for 1999. OPERATING EXPENSES SALES AND MARKETING. Our sales and marketing expenses were $22.8 million for 2000 and $14.1 million for 1999, representing an increase of 62%. This increase was primarily due to our investment in our sales and marketing infrastructure, which included increases in staff related costs, sales commissions and advertising and promotional events. Sales and marketing expenses represented 90% of total revenues for 2000 and 97% of total revenues for 1999. RESEARCH AND DEVELOPMENT. Our research and development expenses were $8.1 million for 2000 and $6.4 million for 1999, representing an increase of 28%. This increase was primarily related to increases in staff related costs and occupancy costs. Research and development expenses for 1999 also included a one-time $303,000 compensation charge associated with the issuance of common 21 stock to an investor at a price which was less than the deemed fair value for accounting purposes. Research and development expenses represented 32% of total revenues for 2000 and 44% of total revenues for 1999. GENERAL AND ADMINISTRATIVE. Our general and administrative expenses were $5.4 million for 2000 and $2.8 million for 1999, representing an increase of 93%. This increase was primarily the result of staff related costs, professional service providers, and bad debt reserves. This increase was primarily offset by a decrease in occupancy costs. General and administrative expenses represented 21% of total revenues for 2000 and 20% of total revenues for 1999. AMORTIZATION OF PURCHASED INTANGIBLES. Amortization of purchased intangibles was $2.9 million for 2000 and $576,000 for 1999. The increase in amortization was due to the increased level of purchased intangibles, primarily resulting from our acquisition of additional purchased technology during 2000. INTEREST AND OTHER INCOME (EXPENSE). Interest and other income (expense) was $1.1 million for 2000 and $859,000 for 1999, representing an increase of 32%. STOCK-BASED COMPENSATION. Total deferred stock compensation associated with equity transactions as of December 31, 2000 was $592,000, net of amortization. Deferred stock compensation is being amortized ratably over the vesting periods of these securities. Amortization expense, which is included in operating expenses, was $416,000 in 2000 and $971,000 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. 22 QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited consolidated statement of operations data for each of the twelve quarters in the three-year period ended December 31, 2001. This financial data is also expressed as a percentage of our total revenues for the periods indicated. This data has been derived from our unaudited consolidated financial statements, which have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information when read in conjunction with the consolidated financial statements and notes thereto. Our quarterly results have been in the past, and may be in the future, subject to significant fluctuations. As a result, we believe that results of operations for interim periods should not be relied upon as any indication of the results to be expected in any future period. 23
QUARTER ENDED ------------------------------------------------------------------------------------------------------- MAR. 31, JUN. 30, SEP. 30, DEC. 31, MAR. 31, JUN. 30, SEP. 30, DEC. 31, MAR. 31, JUN. 30, 1999 1999 1999 1999 2000 2000 2000 2000 2001 2001 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PERCENTAGE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA Revenues: License................ $ 2,116 $ 3,463 $ 1,747 $ 3,564 $ 2,881 $ 4,402 $ 5,356 $ 5,045 $ 2,131 $ 2,538 Service................ 747 784 878 1,144 1,329 1,556 1,728 2,980 2,735 2,213 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Total revenues....... 2,863 4,247 2,625 4,708 4,210 5,958 7,084 8,025 4,866 4,751 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Cost of revenues: License................ 42 56 19 53 50 16 207 31 5 1 Service................ 580 695 490 868 715 902 857 1,118 1,173 1,189 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Total cost of revenues 622 751 509 921 765 918 1,064 1,149 1,178 1,190 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Gross profit............ 2,241 3,496 2,116 3,787 3,445 5,040 6,020 6,876 3,688 3,561 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Operating expenses: Sales and marketing.... 2,015 2,956 4,057 5,024 5,998 5,255 5,234 6,268 4,349 3,819 Research and development 1,806 1,305 1,533 1,713 2,013 2,213 2,042 1,859 1,748 1,583 General and administrative 383 538 1,146 753 867 1,492 1,649 1,423 1,374 1,394 Amortization of purchased intangibles.......... -- 63 188 325 496 771 799 859 718 2,458 Restructuring costs.... -- -- -- -- -- -- -- -- 785 688 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Total operating expenses........... 4,204 4,862 6,924 7,815 9,374 9,731 9,724 10,409 8,974 9,942 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Loss from operations.... (1,963) (1,366) (4,808) (4,028) (5,929) (4,691) (3,704) (3,533) (5,286) (6,381) Interest income (expense), net................... 48 42 410 358 367 290 299 175 177 97 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Net loss................ $(1,915) $(1,324) $(4,398) $(3,670) $(5,562) $(4,401) $(3,405) $(3,358) $(5,109) $(6,284) ======== ======== ======== ========= ======== ======== ======== ======== ======== ======== Shares used in calculating basic and diluted net loss per share.......... 7,044 7,860 18,449 18,739 18,968 19,148 19,418 19,667 19,791 19,916 ======== ======== ======== ========= ======== ======== ======== ======== ======== ======== Basic and diluted net loss per share.......... $ (0.27) $ (0.17) $ (0.24) $ (0.20) $ (0.29) $ (0.23) $ (0.18) $ (0.17) $ (0.26) $ (0.32) ======== ======== ======== ========= ======== ======== ======== ======== ======== ======== AS A PERCENTAGE OF TOTAL REVENUES: Revenues: License................ 73.9% 81.5% 66.6% 75.7% 68.4% 73.9% 75.6% 62.9% 43.8% 53.4% Service................ 26.1 18.5 33.4 24.3 31.6 26.1 24.4 37.1 56.2% 46.6% -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Total revenues....... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0% 100.0% -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Cost of revenues: License................ 1.5 1.3 0.7 1.1 1.2 0.3 2.9 0.4 0.1 0.0 Service................ 20.3 16.4 18.7 18.4 17.0 15.1 12.1 13.9 24.1 25.0 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Total cost of revenues 21.7 17.7 19.4 19.6 18.2 15.4 15.0 14.3 24.2 25.0 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Gross margin............ 78.3 82.3 80.6 80.4 81.8 84.6 85.0 85.7 75.8 75.0 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Operating expenses: Sales and marketing.... 70.4 69.6 154.6 106.7 142.5 88.2 73.9 78.1 89.4 80.4 Research and development 63.1 30.7 58.4 38.0 47.8 37.1 28.8 23.2 35.9 33.3 General and administrative....... 13.4 12.7 43.7 16.0 20.6 25.0 23.3 17.7 28.2 29.3 Amortization of purchased intangibles.......... -- 1.5 7.2 5.2 11.8 12.9 11.3 10.7 14.8 51.7 Restructuring costs.... -- -- -- -- -- -- -- -- 16.1 14.5 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Total operating 146.8 114.5 263.8 166.0 222.7 163.3 137.3 129.7 184.4 209.3 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- expenses................ Loss from operations.... (68.6) (32.2) (183.2) (85.6) (140.8) (78.7) (52.3) (44.0) (108.6) (134.3) Interest income (expense), net.................... 1.7 1.0 15.6 7.6 8.7 4.9 4.2 2.2 3.6 2.0 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Net loss................ (66.9)% (31.2)% (167.5)% (78.0)% (132.4)% (73.9)% (48.1)% (41.8)% (105.0)% (132.3) ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== (CONTINUED BELOW) 24 QUARTER ENDED ------------------- SEP. 30, DEC. 31, 2001 2001 -------- -------- CONSOLIDATED STATEMENT OF OPERATIONS DATA Revenues: License................ $ 3,114 $ 2,778 Service................ 2,056 1,806 -------- -------- Total revenues....... 5,170 4,584 -------- -------- Cost of revenues: License................ 1 7 Service................ 975 636 -------- -------- Total cost of revenues 976 643 -------- -------- Gross profit............ 4,194 3,941 -------- -------- Operating expenses: Sales and marketing.... 3,739 2,464 Research and development 1,229 1,018 General and administrative 1,464 1,287 Amortization of purchased intangibles.......... 245 213 Restructuring costs.... 200 -- -------- -------- Total operating expenses........... 6,877 4,982 -------- -------- Loss from operations.... (2,683) (1,041) Interest income (expense), net................... 14 (29) -------- -------- Net loss................ $(2,669) $(1,070) ======== ======== Shares used in calculating basic and diluted net loss per share.......... 19,971 20,012 ======== ======== Basic and diluted net loss per share.......... $ (0.13) $ (0.05) ======== ======== AS A PERCENTAGE OF TOTAL REVENUES: Revenues: License................ 60.2% 60.6% Service................ 39.8% 39.4% -------- -------- Total revenues....... 100.0% 100.0% -------- -------- Cost of revenues: License................ 0.0 0.1 Service................ 18.9 13.9 -------- -------- Total cost of revenues 18.9 14.0 -------- -------- Gross margin............ 81.1 86.0 -------- -------- Operating expenses: Sales and marketing.... 72.3 53.8 Research and development 23.8 22.2 General and administrative....... 28.3 28.1 Amortization of purchased intangibles.......... 4.7 4.6 Restructuring costs.... 3.9 0.0 -------- -------- Total operating 133.0 108.7 -------- -------- expenses................ Loss from operations.... (51.9) (22.7) Interest income (expense), net.................... 0.2 (0.6) -------- -------- Net loss................ (51.7)% (23.3)% ======== ========
Our quarterly operating results have fluctuated significantly in the past, and may continue to fluctuate significantly in the future, as a result of a number of factors, many of which are outside our control. These factors include: o our ability to close relatively large sales on schedule; o delays or deferrals of customer orders or deployments; o delays in shipment of scheduled software releases; o demand for and market acceptance of our POWERTIER products and our newer DYNAMAI and EDGEXTEND products; o introduction of new products or services by us or our competitors; o annual or quarterly budget cycles of our customers; o the level of product and price competition in the application server and distributed dynamic caching markets; o our lengthy sales cycle; o our success in maintaining our direct sales force and expanding indirect distribution channels; o the mix of direct sales versus indirect distribution channel sales; o the mix of products and services licensed or sold; o the mix of domestic and international sales; and o our success in 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. 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. We have also financed our business through equipment-related loans in the maximum principal amount of $800,000, a second equipment related loan in the amount of $655,000 and capitalized leases. As of December 31, 2001, we had $7.4 million of cash and cash equivalents and $6.8 million of working capital. Net cash used in operating activities was $11.6 million for 2001, $11.7 million for 2000, and $10.9 million for 1999. For each of 2001, 2000 and 1999, cash used for operating activities was attributable primarily to net operating losses. These losses were offset by depreciation and amortization expenses. Net cash provided by investing activities was $5.4 million for 2001. Net cash used in investing activities was $108,000 for 2000, and $10.0 million for 1999. For 2001, cash provided by investing activities consisted primarily of the sale of short-term investments. For 2000, cash used in investing activities consisted of purchases of property and equipment and purchased intangibles, offset by the sale of short-term investments. For 1999, cash used in investing activities consisted primarily of purchases of short-term investments, purchased intangibles and property and equipment. 25 Net cash used in financing activities was $500,000 for 2001. Net cash provided by financing activities was $3.6 million for 2000 and $38.2 million for 1999. Net cash used in financing activities during 2001 consisted primarily of repayments of capital leases and loan agreements offset by the sale of common stock. Net cash provided by financing activities during 2000 and 1999 was primarily attributable to the sale of common stock. For 2001 and 2000, net cash was also provided from borrowings under an equipment financing facility, offset by repayments of loan agreements. 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 April 30, 2003, an $800,000 equipment term loan, and a second equipment term loan of $655,000. As of December 31, 2001 we had no borrowings outstanding under the revolving line of credit facility. As of December 31, 2001, we had a promissory note in favor of Comerica Bank related to our first equipment term loan, under which $67,000 out of an original $800,000 was outstanding. We are required to make principal payments of $22,222 per month plus interest at 7.75% per annum on the unpaid principal balance, payable in 36 monthly installments. As of December 31, 2001 we had $502,000 outstanding under the second equipment term loan. We are required to make principal payments of $21,843 per month, plus interest at the bank's base rate plus 0.5% per annum payable in 30 monthly installments. The bank's credit facilities require the Company, among other things, to maintain a minimum tangible net worth of $7 million and a minimum quick ratio (current assets not including inventory less current liabilities) of 2 to 1. As of both June 30, 2001 and September 30, 2001, the Company's tangible net worth fell below the minimum tangible net worth ratio then in effect, and the bank waived both of those previous events. As of December 31, 2001, we were in compliance with our debt covenants. Borrowings under the facilities are collateralized by substantially all of the Company's assets. We believe that our current cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through at least 2002. 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 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 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. The Company adopted SFAS No. 142 for the fiscal year beginning January 1, 2002. The impact of adopting this standard is not expected to be material to our financial statements as the Company does not currently carry any goodwill or intangible assets with indefinite lives. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 requires that one accounting model be used for long-lived assets to be disposed of by sale whether previously held and used or newly acquired, and broadened the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 will be effective for fiscal years beginning after December 15, 2001 and the Company adopted the provisions of SFAS No. 144 as of January 1, 2002 but does not expect SFAS No. 144 to have a material effect on the Company's financial position or results of operations. 26 ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS You should carefully consider the following risks in addition to the other information contained in this annual report on Form 10-K as well as in our quarterly reports on Form 10-Q. 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: o the timing and magnitude of capital expenditures by our customers and prospective customers; o our substantial dependence for revenue from our POWERTIER for C++ product, which was first introduced in 1997 and has achieved only limited market acceptance; o our substantial dependence for revenue from our POWERTIER for EJB/J2EE product, which was first introduced in 1998 and has achieved only limited market acceptance; o our need to expand our distribution capability through various sales channels, including a direct sales organization, original equipment manufacturers, third party distributors and systems integrators; o our unproven ability to anticipate and respond to technological and competitive developments in the rapidly changing market for application servers; o our unproven ability to compete in a highly competitive market; o uncertainty as to the growth rate in the software infrastructure market; o our need to achieve market acceptance for our new product introductions, including DYNAMAI and EDGEXTEND; o our dependence on Enterprise JavaBeans, commonly known as EJB/J2EE, becoming a widely accepted standard in the transactional application server market; and o our dependence upon key personnel. BECAUSE WE HAVE A HISTORY OF LOSSES AND NEGATIVE CASH FLOW, WE MAY NEVER BECOME OR REMAIN PROFITABLE. We may not achieve our targeted revenues 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 $15.1 million in 2001, $16.7 million in 2000, $11.3 million in 1999, $4.1 million in 1998 and $4.7 million in 1997. As of December 31, 2001, we had an accumulated deficit of $55.9 million. While we are currently targeting decreases in sales and marketing, research and development, and general and administrative expenses for 2002 as compared to such 2001 expenses, we will still need to achieve our revenue targets to become profitable. Because our product markets are 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. 27 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 MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE. Based upon our current forecasts and estimates, we are targeting that our current cash and cash equivalents will be sufficient to meet our anticipated operating cash needs through at least December 31, 2002. However, 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: o the issuance of additional securities could result in: o debt securities with rights senior to the common stock; o dilution to existing stockholders as a result of issuing additional equity or convertible debt securities; o debt securities with restrictive covenants that could restrict our ability to run our business as desired; or o securities issued on disadvantageous financial terms. o the failure to procure needed funding could result in: o a dramatic reduction in scope in our planned product development or marketing efforts; or o an inability to respond to competitive pressures or take advantage of market opportunities. If we are unable to obtain additional financing as and when needed and on acceptable terms, we may be required to reduce the scope of our planned product development and marketing efforts, which could jeopardize our business. THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK. Our quarterly operating results have fluctuated significantly in the past and may continue to fluctuate significantly in the future as a result of a number of factors, many of which are outside our control. In prior years, 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: o our ability to close relatively large sales on schedule; o delays or deferrals of customer orders or deployments; o delays in shipment of scheduled software releases; o demand for and market acceptance of our POWERTIER products and our newer DYNAMAI and EDGEXTEND products; o the possible loss of sales people; o introduction of new products or services by us or our competitors; o annual or quarterly budget cycles of our customers; 28 o the level of product and price competition in the application server and distributed dynamic caching markets; o our lengthy sales cycle; o our success in maintaining our direct sales force and expanding indirect distribution channels; o the mix of direct sales versus indirect distribution channel sales; o the mix of products and services licensed or sold; o the mix of domestic and international sales; and o 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 pilot program to establish a 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, as well as the overall economic climate for technology-related capital expenditures. 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 sales to a limited number of customers. In the year ended December 31, 2001, sales to our top five customers accounted for 45% of total revenues. Sales to Salomon Smith Barney accounted for 15% of total revenues and sales to Cablevision accounted for 11% of total revenues. In year ended December 31, 2000, sales to Salomon Smith Barney accounted for 16% of total revenues and sales to our top five customers accounted for 40% of total revenues. In year ended December 31, 1999, sales to Cisco accounted for 13% of our total revenues, and sales to our top five customers accounted for 35% of total revenues. In year ended December 31, 1998, sales to Cisco accounted for 14% of our total revenues, sales to Instinet accounted for 17% of our total revenues, and sales to our top five customers accounted for 55% of 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 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 sales to industry leaders, any loss of a customer could harm our reputation within the industry and make it harder for us to sell 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. 29 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 certain portions of our marketing efforts on our POWERTIER for J2EE application server, which is based on three relatively new technologies, which have not been widely adopted by a large number of companies. These three technologies are a distributed object computing architecture, Sun Microsystems' Java programming language and J2EE (formerly 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. J2EE 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 conformed 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 J2EE product depends upon the specialized J2EE 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 material portion of our future revenues will come from sales of products based on the J2EE standard. Thus, our success depends significantly upon broad market acceptance of distributed object computing in general, and Java application servers in particular. If J2EE 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 may 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 J2EE specifications, we will need to introduce new versions of POWERTIER for J2EE 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. Our EDGEXTEND products are currently in beta testing. Any delays in releasing these products on a generally available basis may materially affect our future revenues. EDGEXTEND for WebSphere is scheduled to be released in March 2002. EDGEXTEND for WebLogic is scheduled to be released in June 2002. WE ARE CURRENTLY TARGETING THAT SOME PORTION OF OUR REVENUES WILL BE DERIVED FROM SALES OF OUR NEWEST PRODUCT, EDGEXTEND, HOWEVER THERE ARE TECHNICAL AND MARKET RISKS ASSOCIATED WITH NEW PRODUCTS. We are currently targeting that sales of our EDGEXTEND products will represent some percentage of our revenues. New products, like EDGEXTEND, often contain errors or defects, particularly when first introduced. Any errors or defects could be serious or difficult to correct and could result in a delay of product adoption resulting in lost revenues or a delay in gaining market share, which could harm our revenues and reputation. In addition, market adoption is often slower for newer products, like EDGEXTEND, than for existing products. BECAUSE OUR DIRECT SALES TEAM IS CURRENTLY OUR MOST CRITICAL SALES CHANNEL, ANY FAILURE TO BUILD AND TRAIN AND MAINTAIN THIS TEAM MAY RESULT IN LOWER REVENUES. We must maintain a strong direct sales team to generate revenues. In the last several years, we have experienced significant turnover in our sales team, and in the third quarter of 2001, we implemented a reduction in force and substantially reorganized our sales team. In order to meet our future sales goals, we may need to hire more salespeople for both our domestic and international sales efforts. In the past, newly hired employees have required 30 training and approximately six to nine months experience to achieve full productivity. Like many companies in the software industry, we are likely to continue to experience turnover in our sales force. As a result of our recent restructuring, a number of our sales people are relatively new and we 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 OEM PARTNERS AND OTHER RESELLERS, 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 OEM partners and 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 sales efforts of these third parties. In addition, because these relationships are nonexclusive, these third parties may choose to sell 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 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 large 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 OEM or other third-party partners 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 an OEM or other third-party partner 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/J2EE APPLICATION SERVER STANDARD, WE FACE THE RISK THAT IT MAY DEVELOP THIS STANDARD TO FAVOR ITS OWN PRODUCTS. Our success depends on achieving widespread market acceptance of our POWERTIER for J2EE application server. Because Sun Microsystems controls the J2EE standard, we need to maintain a good working relationship with Sun Microsystems to develop future versions of POWERTIER for J2EE, as well as additional products using J2EE, 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 J2EE standard, it could develop the J2EE standard in a more proprietary way to favor a product offered by its subsidiary, i-Planet, or a third party, which could make it much harder for us to compete in the J2EE 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 J2EE 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 or change purchasing decisions. We expect that Microsoft's presence in the application server market will increase competitive pressure in this market. 31 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: o performance, including scalability, integrity and availability; o ability to provide a complete software platform; o flexibility; o use of standards-based technology (e.g. J2EE); o ease of integration with customers' existing enterprise systems; o ease and speed of implementation; o quality of support and service; o security; o company reputation; and o price. Our competitors for POWERTIER, DYNAMAI and EDGEXTEND include both publicly and privately-held enterprises, including BEA Systems (WebLogic), Secant Technologies, IBM (WebSphere), 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 have already supported, or have announced their intention to support J2EE, 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. In the DYNAMAI market, similar dynamic Web content acceleration technology is available from a variety of sources, including but not limited to internal development, application server vendors such as Oracle, electronic commerce software vendors such as Intershop and ATG, content delivery networks such as Akamai and epicRealm, and emerging software and hardware appliance vendors such as Chutney and Cachier, who are directly targeting Dynamai's market. In the EDGEXTEND market, similar technology is available from a variety of sources, including the potential for internal development. Company vendors such as Versant, webGain and Excelon are middleware vendors that offer alternative data management solutions that directly target EDGEXTEND's market. Because we enhance standard J2EE application servers, we face the risk that they may develop similar functionality within their own products. 32 IF THE MARKET FOR INFRASTRUCTURE SOFTWARE FOR NETWORKS AND WEB-BASED PRODUCTS AND SERVICES 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 infrastructure software for networks and web-based products and services. If this market does not develop in the manner we currently envision, 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 various forms of 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. OUR FAILURE TO MANAGE OUR RESOURCES COULD IMPAIR OUR BUSINESS. Achieving our planned revenue targets and other financial objectives will place significant demands on our management and other resources. Our ability to manage our resources 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 resources 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. 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. We have experienced significant turnover among sales personnel in recent years, which makes retention more challenging, in particular as a result of our recent restructurings. 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 SIGNIFICANT 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. 33 Our future success will depend, in part, on our successful development of international markets for our products. Approximately 40% of our total revenues came from sales of products and services outside of the United States for the three months ended December 31, 2001, and approximately 38% of our total revenues came from sales of products and services outside of the United States for the fiscal year 2001. 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: o difficulties of staffing, funding and managing foreign operations; o future dependence on the sales efforts of third party distributors to expand business; o longer payment cycles typically associated with international sales; o tariffs and other trade barriers; o failure to comply with a wide variety of complex foreign laws and changing regulations; o exposure to political instability and economic downturns; o failure to localize our products for foreign markets; o restrictions under U.S. law on the export of technologies; o potentially adverse tax consequences; o reduced protection of intellectual property rights in some countries; and o currency fluctuations. The majority of our product sales outside the United States are denominated 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 depends 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 and services, which could harm our business. We rely on a combination of patents, copyright and trademark laws, trade secrets, confidentiality provisions and other contractual provisions 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 recently settled a lawsuit to protect our intellectual property rights. Further litigation may be necessary to enforce our intellectual property rights, which could result in substantial costs and diversion of management attention and resources. 34 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 entrants into our market increases, the possibility of an intellectual property claim against us grows. For example, we may be inadvertently infringing 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 issues in the future. To address these patent infringement 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 of product infringement against us, and our failure to license the infringed or similar technology, would harm our business. In addition, any infringement claims, with or without merit, would be time-consuming and expensive to litigate or settle and would 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, or at all, through the sale of securities. As of December 31, 2001, we had approximately 20,095,160 shares of common stock outstanding. Virtually all of our shares, other than shares held by affiliates, are freely tradable. In addition, shares held by affiliates are tradable, subject to the volume and other restrictions of Rule 144. OUR STOCK PRICE HAS BEEN, AND MAY CONTINUE TO BE, VOLATILE. Our common stock price has been and may continue to be highly volatile, and we expect that the market price of our common stock will continue to be subject to significant fluctuations, as a result of variations in our quarterly operating results and the overall volatility of the Nasdaq Stock Market. These fluctuations have been, and may continue to be, exaggerated because an active trading market has not developed for our stock. Thus, investors may have difficulty buying or selling shares of our common stock at a desirable price, or at all. In addition, the market price of our common stock may rise or fall in the future as a result of many factors, such as: o variations in our quarterly results; o announcements of technological innovations by us or our competitors; o introductions of new products by us or our competitors; o acquisitions or strategic alliances by us or our competitors; o hiring or departure of key personnel; o the gain or loss of a significant customer or order; o changes in estimates of our financial performance or changes in recommendations by securities analysts; o market conditions and expectations regarding capital spending in the software industry and in our customers' industries; and o adoption of new accounting standards affecting the software industry. The market prices of the common stock of many companies in the software and Internet industries have experienced extreme price and volume fluctuations, which have 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. 35 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 December 31, 2001, executive officers and directors, and entities affiliated with them, owned approximately 21% 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: o establishing a classified board in which only a portion of the total board members will be elected at each annual meeting; o authorizing the board to issue preferred stock; o prohibiting cumulative voting in the election of directors; o limiting the persons who may call special meetings of stockholders; o prohibiting stockholder action by written consent; and o 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. While we have no current agreements or negotiations underway with respect to any major acquisitions of third-party technology, 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: o issue equity securities that would dilute existing stockholders' percentage ownership; o incur substantial debt; o assume contingent liabilities; or o take substantial charges in connection with the impairment of goodwill and amortization of other intangible assets. Acquisitions also entail numerous risks, including: o difficulties in assimilating acquired operations, products and personnel with our pre-existing business; o unanticipated costs; o diversion of management's attention from other business concerns; 36 o adverse effects on existing business relationships with suppliers and customers; o risks of entering markets in which we have limited or no prior experience; and o 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 GENERAL OPERATIONS, 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 have 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 funding 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. ITEM 7A. 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. If market interest rates had changed by ten percent in 2001, our operating results would have changed by approximately $33,000. As of December 31, 2001, most of our cash equivalents were invested in money market accounts and, thus, the principal values are not susceptible to changes in short-term interest rates. FOREIGN CURRENCY FLUCTUATIONS. We have certain operating transactions in foreign currencies, and maintain balances that are due or payable in foreign currencies at December 31, 2001. We estimate that a hypothetical ten percent change in foreign currency rates in 2001 would have impacted our financial results of operations by approximately $12,000. On a net asset basis, a hypothetical ten percent change in foreign currency rates at December 31, 2001 would impact our stockholders' equity by approximately $32,000. We do not hedge any of our foreign currency exposure. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See Item 14(a) for an index to the consolidated financial statements and supplementary data that are attached hereto. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. 37 PART III The Company's Proxy Statement for its 2002 Annual Meeting of Stockholders, when filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, will be incorporated by reference in this Form 10-K pursuant to General Instruction G(3) of Form 10-K and will provide the information required under Part III (Items 10-13), except for the information with respect to the Company's executive officers, which is included in "Item 1. Business-- Executive Officers." PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this report: (1) FINANCIAL STATEMENTS AND REPORT OF DELOITTE & TOUCHE LLP (pages F-1 through F-17): Audited Consolidated Financial Statements: Independent Auditors' Report Consolidated Balance Sheets at December 31, 2001 and 2000 Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Loss for the years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements (2) FINANCIAL STATEMENT SCHEDULE (pages S-1 through S-3) Audited Consolidated Financial Statement Schedule: Independent Auditors' Report Schedule II -- Consolidated Schedule of Valuation and Qualifying Accounts for the years ended December 31, 2001, 2000 and 1999 Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the consolidated financial statements or notes thereto. (3) EXHIBITS (NUMBERED IN ACCORDANCE WITH ITEM 601 OF REGULATION S-K) 38 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------ ----------- 3.2* Amended and Restated Certificate of Incorporation of Persistence. 3.4** Amended and Restated Bylaws of Persistence, as amended on March 2, 2001. 4.1* Specimen Stock Certificate. 4.2*** Common stock warrant, warrant No. W-CS1, dated June 28, 2001, issued to RCG Capital Markets Group, Inc. 10.1* Form of Common Stock Purchase Agreement between Persistence and each of Christopher T. Keene and Derek P. Henninger. 10.2* Fifth Amended and Restated Investor Rights Agreement dated February 19, 1999 among Persistence and certain investors. 10.4* Form of Change of Control Agreement between Persistence and Christine Russell. 10.5* 1994 Stock Purchase Plan (as amended) and Form of Common Stock Purchase Agreement. 10.6*** 1997 Stock Plan (as amended) and Forms of Stock Option Agreement and Common Stock Purchase Agreement. 10.7* 1999 Employee Stock Purchase Plan and Form of Subscription Agreement. 10.8*** 1999 Directors' Stock Option Plan and Form of Option Agreement. 10.9* Lease dated June 12, 1991 between Persistence and Great American Bank (as amended). 10.10*+ Settlement and License Agreement dated March 23, 1998 between Persistence and Sun Microsystems, Inc. 10.11* Form of Indemnification Agreement between Persistence and officers and directors. 10.12*** Registration Rights Agreement dated as of June 28, 2001 between Persistence and RCG Capital Markets Group, Inc. 10.13 Amended and Restated Loan Agreement between Persistence and Comerica Bank. 10.14 Lease Amendment dated February 5, 2002 between Persistence and Cornerstone Properties I, LLC. 10.15 Form of Change of Control Agreement between Persistence and each of Keith Zaky and Ed Murrer. 21.1* List of subsidiaries. 23.1 Independent Auditors' Consent. 24.1 Power of Attorney (see page 40).
- ---------- * Incorporated herein by reference to the exhibit filed with the Company's Registration Statement on Form S-1 (Commission File No. 333-76867). ** Incorporated herein by reference to the exhibit filed with the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001. *** Incorporated herein by reference to the exhibit filed with the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001. + Certain information in this Exhibit has been omitted and filed separately with the Commission. Confidential treatment has been granted with respect to the omitted portions. 39 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K for the fiscal year ended December 31, 2001 to be signed on its behalf by the undersigned, thereunto duly authorized. PERSISTENCE SOFTWARE, INC. By: /s/ CHRISTOPHER T. KEENE -------------------------------------------- Christopher T. Keene CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER (Principal Executive Officer) By: /s/ CHRISTINE RUSSELL -------------------------------------------- Christine Russell CHIEF FINANCIAL OFFICER (Principal Financial and Accounting Officer) Date: March 25, 2002 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Christine Russell his attorney-in-fact, with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ CHRISTOPHER T. KEENE Chairman of the Board and Chief Executive March 25, 2002 - ----------------------------------------- Officer (Principal Executive Officer) Christopher T. Keene /s/ CHRISTINE RUSSELL Chief Financial Officer (Principal Financial March 25, 2002 - ----------------------------------------- and Accounting Officer) Christine Russell /s/ ALAN KING Director March 25, 2002 - ----------------------------------------- Alan King /s/ SANJAY VASWANI Director March 25, 2002 - ----------------------------------------- Sanjay Vaswani /s/ JOSEPH P. ROEBUCK Director March 25, 2002 - ----------------------------------------- Joseph P. Roebuck
40 PERSISTENCE SOFTWARE, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Audited Consolidated Financial Statements: Independent Auditors' Report........................................... F-2 Consolidated Balance Sheets at December 31, 2001 and 2000.............. F-3 Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999.................................................. F-4 Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Loss for the years ended December 31, 2001, 2000 and 1999............................................................. F-5 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999.................................................. F-6 Notes to Consolidated Financial Statements............................. F-7 F-1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Persistence Software, Inc.: We have audited the accompanying consolidated balance sheets of Persistence Software, Inc. and its subsidiaries (the "Company") as of December 31, 2001 and 2000, and the related consolidated statements of operations, changes in stockholders' equity and comprehensive loss, and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP San Jose, California January 22, 2002 (February 28, 2002 as to Note 5 and March 20, 2002 as to Note 12) F-2 PERSISTENCE SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PAR VALUE AMOUNTS)
ASSETS DECEMBER 31, ------------------------- 2001 2000 ----------- ----------- Current assets: Cash and cash equivalents................................................................. $ 7,411 $ 14,103 Short-term investments.................................................................... -- 5,387 Accounts receivable, net of allowances of $152 and $1,228, respectively................... 4,106 7,121 Prepaid expenses and other current assets................................................. 656 831 ----------- ----------- Total current assets................................................................. 12,173 27,442 Property and equipment, net................................................................. 796 1,777 Purchased intangibles, net of amortization of $1,088 and $2,984, respectively............... 722 4,310 Other assets................................................................................ 64 112 ----------- ----------- Total assets......................................................................... $ 13,755 $ 33,641 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................................................... $ 1,070 $ 1,657 Accrued compensation and related benefits................................................. 892 2,787 Other accrued liabilities................................................................. 457 1,731 Deferred revenues......................................................................... 2,124 2,682 Current portion of long-term obligations.................................................. 847 1,296 ----------- ----------- Total current liabilities............................................................ 5,390 10,153 Long-term obligations....................................................................... 421 932 ----------- ----------- Total liabilities.................................................................... 5,811 11,085 ----------- ----------- Commitments (Note 5) Stockholders' equity: Preferred stock, $0.001 par value; authorized -- 5,000,000 shares; designated and outstanding--none......................................................... -- -- Common stock, $0.001 par value; authorized -- 75,000,000 shares; outstanding -- 2001, 20,036,588 shares; 2000, 19,878,712 shares;......................... 64,036 63,994 Deferred stock compensation............................................................... (119) (592) Notes receivable from stockholders........................................................ (54) (94) Accumulated deficit....................................................................... (55,930) (40,798) Accumulated other comprehensive income.................................................... 11 46 ----------- ----------- Total stockholders' equity........................................................... 7,944 22,556 ----------- ----------- Total liabilities and stockholders' equity........................................... $ 13,755 $ 33,641 =========== =========== See notes to consolidated financial statements. F-3
PERSISTENCE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, -------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Revenues: License..................................................................... $ 10,561 $ 17,684 $ 10,890 Service..................................................................... 8,810 7,593 3,553 ----------- ----------- ----------- Total revenues......................................................... 19,371 25,277 14,443 ----------- ----------- ----------- Cost of revenues: License..................................................................... 14 304 170 Service..................................................................... 3,973 3,592 2,633 ----------- ----------- ----------- Total cost of revenues................................................. 3,987 3,896 2,803 ----------- ----------- ----------- Gross profit.................................................................. 15,384 21,381 11,640 Operating expenses: Sales and marketing......................................................... 14,371 22,755 14,052 Research and development.................................................... 5,578 8,127 6,357 General and administrative.................................................. 5,519 5,431 2,820 Amortization and write-down of purchased intangibles........................ 3,634 2,925 576 Restructuring costs......................................................... 1,673 -- -- ----------- ----------- ----------- Total operating expenses............................................... 30,775 39,238 23,805 ----------- ----------- ----------- Loss from operations.......................................................... (15,391) (17,857) (12,165) Interest and other income (expense): Interest income............................................................. 394 1,401 975 Interest expense............................................................ (68) (60) (116) Other, net.................................................................. (67) (210) -- ----------- ----------- ----------- Total interest and other income (expense).............................. 259 1,131 859 ----------- ----------- ----------- Net loss...................................................................... $ (15,132) $ (16,726) $ (11,306) =========== =========== =========== Basic and diluted net loss per share.......................................... $ (0.76) $ (0.87) $ (0.86) =========== =========== =========== Shares used in calculating basic and diluted net loss per share............... 19,919 19,330 13,091 =========== =========== =========== See notes to consolidated financial statements. F-4
PERSISTENCE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
NOTES ACCUMULATED PREFERRED STOCK COMMON STOCK DEFERRED RECEIVABLE OTHER ------------------------ ---------------------- STOCK FROM ACCUMULATED COMPREHENSIVE SHARES AMOUNT SHARES AMOUNT COMPENSATION STOCKHOLDERS DEFICIT (LOSS)/INCOME ----------- ---------- ----------- ---------- ---------- --------- ----------- --------- Balances, January 1, 1999.... 6,922,184 $ 15,717 7,634,414 $ 2,854 (2,222) $ (161) (12,766) Net loss..................... (11,306) Change in unrealized (loss) on investments................ $ (10) Comprehensive loss........... Sale of Series D preferred stock...................... 775,701 4,142 Conversion of preferred stock to common stock............ (7,697,885) (19,859) 7,697,885 19,859 Issuance of common stock, net of repurchases............. 3,937,405 34,799 Reversal of stock arrangements due to cancellations....... (45) 45 Amortization of deferred stock compensation......... 971 ----------- ---------- ----------- ---------- ---------- --------- ----------- --------- Balances, December 31, 1999.. -- -- 19,269,704 57,467 (1,206) (161) (24,072) (10) Net loss..................... (16,726) Change in unrealized gain on investments................ 10 Cumulative translation 46 adjustment................. Comprehensive loss........... Issuance of common stock, net of repurchases............. 609,008 6,725 Collection of notes receivable from stockholders.......... 67 Reversal of stock arrangements due to cancellations......... (198) 198 Amortization of deferred stock compensation......... 416 ----------- ---------- ----------- ---------- ---------- --------- ----------- --------- Balances, December 31, 2000.. -- $ -- 19,878,712 $ 63,994 $ (592) $ (94) $ (40,798) $ 46 Net loss..................... (15,132) Cumulative translation adjustment................... (35) Comprehensive loss........... Issuance of common stock, net of repurchases............. 157,876 270 Collection of notes receivable from stockholders.......... 40 Issuance of stock warrants... 53 (53) Reversal of stock arrangements due to cancellations....... (281) 281 Amortization of deferred stock compensation......... 245 ----------- ---------- ----------- ---------- ---------- --------- ----------- --------- Balances, December 31, 2001.. -- $ -- 20,036,588 $ 64,036 $ (119) $ (54) $ (55,930) $ 11 ========== ========== =========== ========== ========== ========= ========== ========= (CONTINUED BELOW) See notes to consolidated financial statements. F-5
PERSISTENCE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AMOUNTS) TOTAL COMPREHENSIVE TOTAL LOSS ---------- --------- Balances, January 1, 1999.... $ 3,422 Net loss..................... (11,306) $(11,306) Change in unrealized (loss) on investments................ (10) (10) --------- Comprehensive loss........... $(11,316) ========= Sale of Series D preferred stock...................... 4,142 Conversion of preferred stock to common stock............ -- Issuance of common stock, net of repurchases............. 34,799 Reversal of stock arrangements due to cancellations....... -- Amortization of deferred stock compensation......... 971 ---------- Balances, December 31, 1999.. 32,018 Net loss..................... (16,726) $(16,726) Change in unrealized gain on investments................ 10 10 Cumulative translation 46 46 adjustment................. --------- Comprehensive loss........... $(16,670) ========= Issuance of common stock, net of repurchases............. 6,725 Collection of notes receivable from stockholders.......... 67 Reversal of stock arrangements due to cancellations......... -- Amortization of deferred stock compensation......... 416 ---------- Balances, December 31, 2000.. $ 22,556 Net loss..................... (15,132) $(15,132) Cumulative translation adjustment................. (35) (35) --------- Comprehensive loss........... $(15,167) Issuance of common stock, net ========= of repurchases............. 270 Collection of notes receivable from stockholders.......... 40 Issuance of stock warrants... -- Reversal of stock arrangements due to cancellations....... -- Amortization of deferred stock compensation......... 245 ---------- Balances, December 31, 2001.. $ 7,944 ========== See notes to consolidated financial statements. F-5 PERSISTENCE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, -------------------------------------- 2001 2000 1999 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss................................................................ $ (15,132) $ (16,726) $ (11,306) Adjustments to reconcile net loss to net cash used in operating activities: Allowance for doubtful accounts...................................... 951 896 285 Depreciation and amortization........................................ 2,275 3,842 1,135 Write-down of purchased intangibles.................................. 1,988 -- -- Loss on sale of fixed assets......................................... 164 -- -- Amortization of deferred stock compensation.......................... 245 416 971 Changes in operating assets and liabilities: Accounts receivable................................................ 2,064 (2,332) (4,211) Prepaid expenses and other current assets.......................... 175 (265) (1,000) Accounts payable................................................... (587) 287 774 Accrued compensation and related benefits.......................... (1,895) 983 1,292 Other accrued liabilities.......................................... (1,274) 537 1,040 Deferred revenues.................................................. (558) 667 217 Deferred rent...................................................... -- -- (64) ----------- ----------- ----------- Net cash used in operating activities........................... (11,584) (11,695) (10,867) ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Short-term investments.................................................. 5,387 1,965 (7,362) Purchase of property and equipment...................................... (101) (1,422) (919) Proceeds from sale of property and equipment............................ 93 -- -- Acquisition of purchased intangibles.................................... -- (619) (1,663) Deposits and other...................................................... 48 (32) (41) ----------- ----------- ----------- Net cash provided by/(used) in investing activities............. 5,427 (108) (9,985) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Sale of convertible preferred stock, net................................ -- -- 4,142 Sale of common stock, net of repurchases................................ 270 3,465 34,440 Repurchase of common stock.............................................. -- (1) (1) Collection of notes receivable from stockholders........................ 40 67 -- Repayment of capital lease obligations.................................. (43) (77) (167) Repayment of obligations incurred to acquire purchased intangibles...... (470) (160) -- Borrowing under loan agreement.......................................... 122 533 -- Repayment under loan agreements......................................... (419) (267) (200) ----------- ----------- ----------- Net cash provided by/(used) in financing activities............. (500) 3,560 38,214 ----------- ----------- ----------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS.............. (35) 46 -- ----------- ----------- ----------- CASH AND CASH EQUIVALENTS: Net increase (decrease)................................................. (6,692) (8,197) 17,362 Beginning of year....................................................... 14,103 22,300 4,938 ----------- ----------- ----------- End of year............................................................. $ 7,411 $ 14,103 $ 22,300 =========== =========== =========== NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisition of property and equipment under capital leases.............. $ -- $ 73 $ -- =========== =========== =========== Long-term obligations incurred to acquire purchased intangibles......... $ (150) $ 1,435 $ -- =========== =========== =========== Release of compensatory stock arrangements.............................. $ 281 $ -- $ -- =========== =========== =========== Compensatory stock arrangements......................................... $ (53) $ -- $ -- =========== =========== =========== Common stock issued for purchased intangibles........................... $ -- $ 3,063 $ 360 =========== =========== =========== Conversion of convertible preferred stock into common stock............. $ -- $ -- $ 19,859 =========== =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION -- CASH PAID DURING THE YEAR FOR: Interest ............................................................... $ 68 $ 60 $ 114 =========== =========== =========== Income taxes............................................................ $ 66 $ 132 $ 3 =========== =========== =========== See notes to consolidated financial statements. F-6
PERSISTENCE SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES BUSINESS -- Persistence Software solves data access problems for distributed and real-time systems. Persistence solutions help deliver better business visibility for applications which require current information about customers, products and suppliers. Persistence provides a suite of data management products that sit between existing databases - such as Oracle and DB/2 - and application servers - such as WebLogic and WebSphere. Developers can configure these products to structure and position business information with optimal efficiency, improving application server performance and simplifying application distribution while reducing database costs. PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. CASH EQUIVALENTS -- The Company considers all highly liquid debt instruments purchased with remaining maturities of less than three months to be cash equivalents. SHORT-TERM INVESTMENTS -- Short-term investments consist primarily of highly liquid debt and equity instruments purchased with remaining maturity dates of greater than 90 days but less than 12 months. Management determines the classification of debt and equity securities at the time of purchase and reevaluates the classification at each balance sheet date. Debt securities are classified as available-for-sale when the Company generally has the ability and intent to hold such securities to maturity, but, in certain circumstances, may potentially dispose of such securities prior to their maturity. Securities available-for-sale are reported at fair value with unrealized gains and losses reported as a separate component of stockholders' equity. All available-for-sale securities are classified as current assets. At December 31, 2001, the Company had no short-term investments. At December 31, 2000, short-term investments consisted of corporate debt securities (commercial paper) and U.S. government debt securities with maturities of less than one year. Short-term investments and money market funds include the following available-for-sale securities at December 31, 2001 (in thousands):
UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING MARKET COST GAINS LOSSES VALUE ---------- --------- --------- ---------- (IN THOUSANDS) Money market funds...................................... $ 4,485 -- -- $ 4,485 ---------- --------- --------- ---------- Total available-for-sale securities........... $ 4,485 $ -- $ -- $ 4,485 ========== ========= ========= ========== Included in cash equivalents............................ $ 4,485 Included in short-term investments...................... -- ---------- Total available-for-sale securities........... $ 4,485 ==========
Short-term investments and money market funds include the following available-for-sale securities at December 31, 2000 (in thousands):
UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING MARKET COST GAINS LOSSES VALUE ---------- --------- --------- ---------- (IN THOUSANDS) Money market funds...................................... $ 1,863 $ 1,863 Commercial paper........................................ 7,888 7,888 U.S. government agencies................................ 6,615 6,615 ---------- --------- --------- ---------- Total available-for-sale securities........... $ 16,366 $ -- $ -- $ 16,366 ========== ========= ========= ========== Included in cash equivalents............................ $ 10,979 Included in short-term investments...................... 5,387 ---------- Total available-for sale-securities........... $ 16,366 ==========
F-7 PROPERTY AND EQUIPMENT are stated at cost. Depreciation and amortization are computed using the straight-line method over estimated useful lives of three years. Leasehold improvements are amortized over the shorter of the lease term or their useful life. PURCHASED INTANGIBLES are stated at cost. Amortization is computed using the straight-line method over the estimated useful lives of two to three years. IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF -- The Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets or intangibles may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. In June 2001, the Company determined that certain intangible assets were impaired and, thus, recorded a write-down of $2.0 million. Refer to Note 2. SOFTWARE DEVELOPMENT COSTS -- Costs for the development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED. Because the Company believes its current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no costs have been capitalized to date. NOTES RECEIVABLE FROM STOCKHOLDERS -- The notes receivable from stockholders were issued at market rates in exchange for common stock, bear interest at 5.93% per annum, and are due in December 2003. (Refer to Note 12.) The notes are full-recourse. REVENUE RECOGNITION -- Revenue consists primarily of fees for licenses of the Company's software products, maintenance and customer support. LICENSE REVENUE -- Revenue from software licenses is recognized 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. Such 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. SERVICE REVENUE -- Revenue from customer training, support and consulting services is recognized as the services are performed. Support revenue is recognized 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. INCOME TAXES -- Income taxes are provided using an asset and liability approach which requires recognition of deferred tax liabilities and assets, net of valuation allowances, for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities and net operating loss and tax credit carryforwards. FOREIGN CURRENCY TRANSACTIONS -- The functional currencies of the Company's foreign subsidiaries are the British Pound Sterling, German Mark and the Hong Kong Dollar. Accordingly, all monetary assets and liabilities are translated at F-8 the current exchange rate at the end of the year, nonmonetary assets and liabilities are translated at historical rates and net sales and expenses are translated at average exchange rates in effect during the period. Translation gains and losses, which are included in the balance sheets and in other comprehensive income (loss) in the accompanying consolidated statements of changes in stockholders' equity, have not been significant. STOCK COMPENSATION -- The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Accordingly, no accounting recognition is given to employee stock options granted with an exercise price equal to fair market value of the underlying stock on the grant date. Upon exercise, the net proceeds and any related tax benefit are credited to stockholders' equity. NET LOSS PER COMMON 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. This result is due to the exclusion of all potentially dilutive securities, which are anti-dilutive because of the Company's net losses. CONCENTRATION OF CREDIT RISK -- Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments, and trade receivables. The risk associated with cash and cash equivalents and short-term investments is mitigated by using only high-quality financial institutions and investing in high-grade debt securities. The Company primarily sells its products to companies in the United States and Europe. The Company does not require collateral or other security to support accounts receivable. To reduce credit risk, management performs ongoing credit evaluations of its customers' financial condition. The Company maintains allowances for potential credit losses. FINANCIAL INSTRUMENTS -- The Company's financial instruments include cash and cash equivalents, short-term investments, notes receivable from stockholders and long-term debt. At December 31, 2001 and 2000, the fair value of these financial instruments approximated their financial statement carrying amounts, because the financial instruments are either short-term or reflect interest rates consistent with market rates. SIGNIFICANT ESTIMATES -- The preparation of financial statements in conformity with accounting principles as generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. CERTAIN RISKS AND UNCERTAINTIES -- The Company operates in the software industry, and accordingly, can be affected by a variety of factors. For example, management of the Company believes that changes in any of the following areas could have a significant negative effect on the Company in terms of its future financial position, results of operations and cash flows: ability to obtain additional financing; regulatory changes; fundamental changes in the technology underlying software products; market acceptance of the Company's products under development; development of sales channels; loss of significant customers; adverse changes in international market conditions; litigation or other claims against the Company; the hiring, training and retention of key employees; successful and timely completion of product development efforts; and new product introductions by competitors. The Company has incurred net losses each year since 1996 including losses of $15.1 million in 2001, $16.7 million in 2000, and $11.3 million in 1999. As of December 31, 2001, the Company had an accumulated deficit of $55.9 million. The Company believes its cash and cash equivalents of $7.4 million are sufficient to meet its anticipated cash needs for working capital and capital expenditures through at least December 31, 2002. If cash generated from operations is insufficient to satisfy the Company's liquidity requirements, we may seek to raise additional financing or reduce the scope of its planned product development and marketing efforts. COMPREHENSIVE (LOSS)/INCOME -- In 2001, the Company's comprehensive loss included a cumulative translation adjustment of $35,000 and in 2000 the comprehensive income included an unrealized gain on investments of $10,000 and a cumulative translation adjustment of $46,000. F-9 SEGMENTS OF AN ENTERPRISE -- The Company currently operates in one reportable segment and the chief operating decision maker is the Company's Chief Executive Officer. RECENTLY ISSUED ACCOUNTING STANDARDS -- In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("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. The Company has adopted SFAS 133 effective January 1, 2001. The adoption of SFAS 133 had no affect on the financial position, results of operations or cash flow of the Company. In June 2001, the FASB issued No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. The Company will adopt SFAS No. 142 for the fiscal year beginning January 1, 2002. The impact of adopting this standard is not expected to be material to our financial statements as the Company does not currently carry any goodwill or intangible assets with indefinite lives. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 requires that one accounting model be used for long-lived assets to be disposed of by sale whether previously held and used or newly acquired, and broadened the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 will be effective for fiscal years beginning after December 15, 2001 and the Company adopted the provisions of SFAS No. 144 as of January 1, 2002 but does not expect SFAS No. 144 to have a material effect on the Company's financial position or results of operations. 2. ASSET WRITE-DOWNS AND EMPLOYEE TERMINATION COSTS During 2001, the Company recorded an impairment charge of $2.0 million relating to the Company's evaluation of certain purchased intangible assets. These intangible assets were written down to reflect the carrying value of these assets to their net realizable values, which reflect the expected economic benefits to be derived from the use of these assets. During 2001, the Company adopted a plan to make organizational changes and reduce its work force. The Company recorded and paid $1.7 million in charges for employee severance and related operating expenses. This plan involved terminating 68 domestic employees. There are no accrued and unpaid severance costs at December 31, 2001. 3. PROPERTY AND EQUIPMENT Property and equipment consist of: DECEMBER 31, ---------------------- 2001 2000 ---------- ---------- (IN THOUSANDS) Equipment............................................ $ 3,189 $ 3,467 Software............................................. 1,093 1,079 Leasehold improvements............................... 177 218 ---------- ---------- 4,459 4,764 Accumulated depreciation and amortization............ (3,663) (2,987) ---------- ---------- $ 796 $ 1,777 ========== ========== F-10 4. LONG-TERM OBLIGATIONS Long-term obligations consist of: DECEMBER 31, ---------------------- 2001 2000 ---------- ---------- (IN THOUSANDS) Equipment term loan................................... $ 67 $ 333 Equipment term loan................................... 502 533 Capital lease obligations (see Note 5)................ 44 87 Other long-term obligations........................... 655 1,275 ---------- ---------- 1,268 2,228 Less current portion.................................. (847) (1,296) ---------- ---------- $ 421 $ 932 ========== ========== In November 2001, the Company renewed its credit facilities with a bank. Under the renewed facilities, the Company continues to have available a $5 million revolving line of credit facility available through January 31, 2002. (Refer to Note 12 for amendment.) As of December 31, 2001, the Company had no borrowings outstanding under its renewed $5 million line of credit facility. Under this facility, any outstanding borrowings will bear interest at prime rate of 4.75 % at December 31, 2001, plus 0.5%. As of December 31, 2001, the Company had $67,000 outstanding under its $800,000 equipment term loan, which bears interest at 7.75%. The Company is required to make equal principal payments of $22,222 per month plus interest on the unpaid balance, payable in monthly installments through March 2002. As of December 31, 2001, the Company had $502,000 outstanding under its $655,000 equipment term loan with the bank. The Company is required to make principal payments of $21,843 per month, plus interest, at the bank's base rate of 4.75% at December 31, 2001 plus 0.5% per annum, payable in monthly installments through November 2003. The bank's renewed credit facilities require the Company, among other things, to maintain a minimum tangible net worth of $7 million and a minimum quick ratio (current assets, not including inventory, less current liabilities) of 2 to 1. As of December 31, 2001, the Company was in compliance with its debt covenants. Borrowings under the facilities are collateralized by substantially all of the Company's assets. Other long-term obligations represent uncollateralized non-interest-bearing amounts payable for the acquisition of various purchased intangibles that are generally due within two years. As of December 31, 2001, annual maturities under the equipment financing facility, the existing equipment term loan, and the other long-term obligations are as follows: FISCAL YEAR ENDING DECEMBER 31, (IN THOUSANDS) - ------------------------------- -------------- 2002................................................ $ 847 2003................................................ 421 --------- Total....................................... $ 1,268 ========= 5. LEASE COMMITMENTS Equipment with a net book value of $37,000 and $73,000 at December 31, 2001 and 2000, respectively, (net of accumulated amortization of $47,000 and $13,000) has been leased under capital leases. The Company leases its principal facility under a noncancelable operating lease expiring on December 31, 2004. Rent expense was approximately $773,000, $965,000 and $953,000 in 2001, 2000 and 1999, respectively. F-11 Future minimum payments under the Company's leases at December 31, 2001 are: CAPITAL OPERATING LEASES LEASES (A) ------ ---------- (IN THOUSANDS) 2002.............................................. 27 1,022 2003.............................................. 22 926 2004.............................................. -- 798 2005.............................................. -- 61 ------- --------- Total................................... 49 $ 2,807 ========= Amount representing interest...................... (5) ------- Present value..................................... 44 Current portion................................... (21) ------- Long-term portion................................. $ 23 ======= - ---------- (a) The operating lease payment schedule above represents future minimum payments for each of the years presented based on information available as of February 28, 2002 as a result of the renegotiations of certain operating leases by the Company (Refer to Note 12 for amendment). 6. STOCKHOLDERS' EQUITY COMMON STOCK In February 1999, the Company entered into an agreement with a customer and Series D preferred stockholder, whereby such customer was to perform development work to achieve certain performance improvements related to the Company's PowerTier product. In connection with this agreement, the Company allowed such customer to purchase 90,300 shares of common stock at $1.65 per share in February 1999, which was less than the deemed fair value for accounting purposes. The Company has recorded a research and development expense of $303,000 in 1999 for the difference between the deemed fair value and the purchase price of $1.65 per share. 1994 STOCK PURCHASE PLAN Under the 1994 Stock Purchase Plan (the "Plan"), the Company could sell common stock to employees of the Company at the fair market value as determined by the Board of Directors. Sales are to be made pursuant to restricted stock purchase agreements containing provisions established by the Board of Directors. No shares were issued under the Plan in 2001, 2000 and 1999. The Company has the right to repurchase these shares at the original issuance price upon termination of employment; this right expires ratably over four years. During 2001 the Company repurchased no shares. During 2000 and 1999, the Company repurchased 5,782 and 10,084 shares, respectively, at prices ranging from $0.06 to $0.23 per share. At December 31, 2001, no shares were subject to repurchase and no shares were available for future grant. 1997 STOCK PLAN As of December 31, 2001, the Company has reserved 6,594,652 shares of common stock for issuance, at the discretion of the Board of Directors, to officers, directors, employees and consultants pursuant to its 1997 Stock Plan. This reserved amount was increased automatically on January 1, 2002 under the provisions of the Plan by 985,000 shares to 7,579,652 shares reserved. The Plan also provides for an automatic annual increase on the first day of 2003, 2004 and 2005 equal to the lesser of 985,000 shares, 4.94% of the outstanding common stock on the last day of the immediately preceding fiscal year, or such lesser number as determined by the Board of Directors. At December 31, 2000, 796,487 shares have been issued at $0.23 per share pursuant to restricted stock purchase agreements in which the Company has a right to repurchase these shares at the original issuance price upon termination of employment; this right expires ratably over four years. At December 31, 2001, no shares were subject to repurchase. During 2001, the Company repurchased 124,584 shares, at a price of $0.23. No shares were repurchased in 2000 and 1999. F-12 At December 31, 2001 4,931,062 shares are reserved for exercise of issued and outstanding options, and 1,827,592 shares are available for future grant. The shares available for future grant automatically increased by 985,000 shares on January 1, 2002 to 2,812,592 shares. Options granted under the 1997 Stock Plan generally vest over four years and expire ten years from the date of grant. Additional information with respect to options under the 1997 Stock Plan is as follows:
WEIGHTED AVERAGE NUMBER OF OPTION PRICE OPTIONS PER SHARE ------------ --------- Outstanding, January 1, 1999 (112,258 exercisable at a weighted average exercise price of $0.24)............. 1,214,197 $ 0.47 Granted (weighted average fair value of $4.14).................................. 2,895,287 $ 11.39 Exercised....................................................................... (310,499) $ 0.60 Canceled........................................................................ (555,510) $ 3.69 ------------ --------- Outstanding, December 31, 1999 (279,720 exercisable at a weighted average exercise price of $3.33)............. 3,243,475 $ 9.65 Granted (weighted average fair value of $10.95)................................. 2,631,450 $ 13.48 Exercised....................................................................... (365,734) $ 7.02 Canceled........................................................................ (1,656,439) $ 10.80 ------------ --------- Outstanding, December 31, 2000 (992,433 exercisable at a weighted average exercise price of $9.60)............. 3,852,752 $ 12.02 Granted (weighted average fair value of $1.36).................................. 4,636,844 $ 1.47 Exercised....................................................................... (192,096) $ 0.56 Canceled........................................................................ (5,049,030) $ 9.42 ------------ --------- Outstanding, December 31, 2001 (953,710 exercisable at a weighted average exercise price of $3.17)............. 3,248,470 $ 1.67 ============ =========
Additional information regarding options outstanding as of December 31, 2001 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------- --------------------- WEIGHTED AVERAGE WEIGHTED REMAINING WEIGHTED AVERAGE RANGE OF NUMBER CONTRACTUAL AVERAGE NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE (YEARS) EXERCISE PRICE EXERCISABLE PRICE ------------------ ------------ ---------------- -------------- ----------- --------- $ 0.01 to $ 0.50 616,635 9.23 $ 0.41 80,766 $ 0.32 $ 0.51 to $ 5.00 2,419,335 9.76 $ 1.17 678,654 $ 1.24 $ 5.01 to $10.00 155,000 8.00 $ 9.40 142,208 $ 9.54 $10.01 to $15.00 29,000 4.49 $13.85 27,562 $ 13.88 $15.01 to $20.00 23,500 5.61 $16.24 21,500 $ 16.32 $20.01 to $20.94 5,000 7.56 $20.94 3,020 $ 20.94 ---------- ----- ------- -------- -------- 3,248,470 9.49 $ 1.67 953,710 $ 3.17 ========= ========
STOCK OPTION REPRICING On May 9, 2001, the Company offered to exchange all outstanding options granted under the Company's 1997 Stock Plan that had an exercise price in excess of $1.00 per share and were held by option holders who were employees of the Company on the date of tender and through the grant date, for new options to purchase shares of the Company's common stock. This offer expired on June 7, 2001 and resulted in the cancellation of 2,155,032 unexercised options. Subject to the terms and conditions of the offer, the Company has granted new options under the 1997 Stock Plan to purchase shares of common stock in exchange for such tendered options no earlier than six months and one day after June 7, 2001. The exercise price per share of the new options is $1.23 which is equal to the fair market value of the underlying common stock on the date of grant, December 10, 2001, which was determined to be the last reported sale price of the common stock on the Nasdaq National Market on the grant date. F-13 1999 DIRECTORS' STOCK OPTION PLAN The Company's 1999 Directors' Stock Option Plan (the "Directors' Plan") became effective upon the closing of the Company's initial public offering in June 1999. Under the Directors' Plan, a total of 500,000 shares of common stock have been reserved for the grant of nonstatutory stock options to nonemployee directors of the Company. Options granted under the Director's Plan shall be immediately vested and expire in five years from the date of grant. No options were granted under the Director's Plan during 1999. During 2000, options to purchase 44,000 shares were granted under the Director's Plan at exercise prices ranging from $9.75 to $22.50 and options to purchase 36,000 were outstanding at December 31, 2000. During 2001, 60,000 options were granted under the Director's Plan at exercises prices ranging from $0.45 to $4.47 and 88,000 were outstanding at December 31, 2001. 1999 EMPLOYEE STOCK PURCHASE PLAN The Company's 1999 Employee Stock Purchase Plan (the "ESPP") became effective upon the closing of the Company's initial public offering in June 1999. Under the ESPP, eligible employees may purchase common stock through payroll deductions, which may not exceed 20% of any employee's compensation, nor more than 2,500 shares in any one purchase period. A total of 600,000 shares of common stock has been reserved for issuance under the ESPP. The ESPP allows for an automatic annual increase on the first day of 2000, 2001, 2002, 2003 and 2004 equal to the lesser of 250,000 shares or 1% of outstanding common stock on the last day of the immediately preceding fiscal year. During 2001, 90,364 shares were issued under the ESPP at prices ranging from $0.41 to $3.29 per share resulting in aggregate proceeds of $178,000. During 2000, 104,077 shares were issued under the ESPP at prices ranging from $9.35 to $14.56 per share and aggregate proceeds of $1,037,000. During 1999 no shares were issued under the ESPP. DEFERRED STOCK COMPENSATION In connection with grants of certain stock options and issuance of common stock in 2001, 2000, and 1999, the Company recorded nil (net of terminations of $281,000), $85,000 (net of terminations of $283,000), and $45,000 (net of terminations of $90,000), respectively, for the difference between the estimated fair value and the stock price as determined by the Board of Directors on the date of grant/issuance. This amount is being amortized to expense over the vesting period of the related stock/stock options (generally four years). Amortization of deferred stock compensation for the years ended December 31, 2001, 2000, and 1999 was $245,000, $416,000, and $971,000 respectively. ISSUANCE OF STOCK WARRANTS IN EXCHANGE FOR SERVICES During 2001, the Company issued stock warrants to a nonemployee for consulting services for the purchase of 80,000 shares of common stock at an exercise price of $0.57. Such warrants vest over a period of four years. In accordance with SFAS 123 and its related interpretations, the Company accounted for this award under the fair market value method and as a variable award. Accordingly, the Company recorded compensation expense equal to the fair value of the vested options. The fair value of these awards was calculated using the Black-Scholes pricing model. The compensation expense recorded in 2001 was $53,000 and was recognized in the accompanying statement of operations in accordance with the related service being performed. STOCK-BASED COMPENSATION SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, requires the disclosure of pro forma net loss as if the Company had adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions for options outstanding under the 1997 Stock Plan: expected life, 24 months following vesting; risk free interest rate, 5.0% in 2001, 5.1% in 2000, and 5.4% in 1999; volatility of 183% for 2001, 124% for 2000, 50% for 1999 after the Company's June 1999 initial public offering of common stock and none before that date; and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the awards granted in 1997 and after had been amortized F-14 to expense over the vesting period of the awards, pro forma net loss (net of amortization of deferred compensation expense already recorded for the years ended December 31, 2001, 2000 and 1999, as discussed above) would have been approximately $11.1 million ($0.56 per basic and diluted share) in 2001, $27.0 million ($1.40 per basic and diluted share) in 2000 and $13.0 million ($0.99 per basic and diluted share) in 1999. The pro-forma reduction in net loss for 2001 from the amount reported was due to the cancellation of unvested options that had higher original exercise prices than the repriced options granted later in the year. This issue is further discussed in the "stock repricing" section of this footnote. 7. NET LOSS PER SHARE The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per share (in thousands):
YEAR ENDED DECEMBER 31, -------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Net loss (numerator), basic and diluted........................ $ (15,132) $ (16,726) $ (11,306) Shares (denominator): Weighted average common shares outstanding................... 19,946 19,621 13,605 Weighted average common shares outstanding subject to repurchase............................................. (27) (291) (514) ----------- ----------- ----------- Shares used in computation, basic and diluted................ 19,919 19,330 13,091 =========== =========== =========== Net loss per share, basic and diluted.......................... $ (0.76) $ (0.87) $ (0.86) =========== =========== ===========
For the above mentioned periods, 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:
DECEMBER 31, -------------------------------------------- 2001 2000 1999 -------------- -------------- -------------- Shares of common stock subject to repurchase............... -- 184,167 398,066 Outstanding options........................................ 3,248,470 3,852,752 3,243,475 Warrants................................................... 80,000 -- -- -------------- -------------- -------------- Total............................................ 3,328,470 4,036,919 3,641,541 ============== ============== ============== Weighted average exercise price of options................. $ 3.17 $ 12.02 $ 9.65 ============== ============== ============== Weighted average exercise price of warrants................ $ 0.57 $ -- $ -- ============== ============== ==============
8. INCOME TAXES The Company's deferred income tax assets are comprised of the following at December 31: 2001 2000 ----------- ----------- (IN THOUSANDS) Net deferred tax assets: Net operating loss carryforwards............... $ 17,491 $ 12,352 Accruals deductible in different periods....... 179 1,814 General business credits....................... 2,469 1,478 Depreciation and amortization.................. 3,485 1,047 ----------- ----------- 23,624 16,691 Valuation allowance............................ (23,624) (16,691) ----------- ----------- Total.................................. $ -- $ -- =========== =========== Deferred income taxes reflect the tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as net operating loss and tax credit carryforwards. Due to the uncertainty surrounding the realization of the benefits of its favorable tax attributes in future tax returns, as of December 31, 2001 and 2000, the Company has fully reserved its net deferred tax assets of approximately $23.6 million and $16.7 million, respectively. F-15 The Company's effective rate differs from the expected benefit at the federal statutory tax rate at December 31 as follows: 2001 2000 1999 -------- -------- -------- Federal statutory tax rate.................. (35.0)% (35.0)% (35.0)% State taxes, net of federal benefit......... (6.0) (6.0) (6.0) Stock compensation expense.................. -- 1.0 3.4 Other....................................... 0.1 0.4 0.3 Valuation allowance......................... 40.9 39.6 37.3 -------- -------- -------- Effective tax rate.......................... -- % -- % -- % ======== ======== ======== Substantially all of the Company's loss from operations for all periods presented is generated from domestic operations. At December 31, 2001, the Company has net operating loss (NOL) carryforwards of approximately $48.4 million and $9.5 million for federal and state income tax purposes, respectively. The federal NOL carryforwards expire through 2020, while the state NOL carryforwards expire through 2011. The net operating loss carryforwards available for state tax purposes are substantially less than for federal tax purposes, primarily because only 50% of state net operating losses can be utilized to offset future state taxable income and because state net operating loss carry forwards generated in earlier years have already expired. At December 31, 2001, the Company also has research and development credit carryforwards of approximately $1.5 million and $1.4 million available to offset future federal and state income taxes, respectively. The federal credit carryforward expires in 2021, while the state credit carryforward has no expiration. The extent to which the loss and credit carryforwards can be used to offset future taxable income and tax liabilities, respectively, may be limited, depending on the extent of ownership changes within any three-year period. 9. RELATED PARTY TRANSACTIONS During 2001 and 2000, other than those items disclosed in Note 10, the Company had insignificant transactions with related parties. During 1999, the Company paid $69,000 to a director for consulting services. See also Note 10 for information about significant revenues from common stockholders. 10. SEGMENT INFORMATION, OPERATIONS BY GEOGRAPHIC AREA AND SIGNIFICANT CUSTOMERS The Company is engaged in the development and marketing of transactional application server software products and operates in one reportable segment under SFAS 131, "Disclosures about Segments of an Enterprise and Related Information." GEOGRAPHIC INFORMATION
YEARS ENDED DECEMBER 31, ----------------------------------------------------------------------------- 2001 2000 1999 ------------------------ ------------------------- ------------------------- LONG-LIVED LONG-LIVED LONG-LIVED REVENUES(1) ASSETS REVENUES(1) ASSETS REVENUES(1) ASSETS ----------- ------ ----------- ------ ----------- ------ (IN THOUSANDS) United States............ $ 11,989 $ 740 $ 18,107 $ 1,632 $ 10,369 $1,004 Europe................... 5,505 54 4,755 73 3,338 27 Rest of the world........ 1,877 2 2,415 72 736 20 --------- -------- --------- -------- --------- ------- $ 19,371 $ 796 $ 25,277 $ 1,777 $ 14,443 $1,051 ========= ======== ========= ======== ========= =======
- ---------- (1) Revenues are broken out geographically by the ship-to location of the customer. SIGNIFICANT CUSTOMERS During 2001, one customer accounted for 15% of the Company's total revenues and another customer accounted for 11% of the Company's total revenues. During 2000, one customer accounted for 16% of the Company's total revenues and one F-16 customer (a common stockholder) accounted for 5% of the Company's total revenues. During 1999, one customer (a common stockholder) accounted for 13% of the Company's total revenues. At December 31, 2001, two customers accounted for 11% of accounts receivable. At December 31, 2000, one customer accounted for 19% of accounts receivable, and another customer accounted for 18% of accounts receivable. 11. EMPLOYEE BENEFIT PLAN The Company has a 401(k) tax-deferred savings plan, whereby eligible employees may contribute a percentage of their eligible compensation (presently from 1% to 20% up to the maximum allowed under IRS rules). Company contributions are discretionary; no such Company contributions have been made since inception of this plan. 12. SUBSEQUENT EVENTS The Company renegotiated its lease on principal facility on February 5, 2002. (Refer to Note 5) On March 18, 2002, the Board of Directors extended the due date made to an employee on a stock loan to December 31, 2003. (Refer to Note 1.) On March 20, 2002, the Company renewed its credit facilities with a bank. Under the renewed facilities, the Company continues to have a revolving line of credit facility of up to $5 million available through April 30, 2003. The bank's renewed credit facilities require the Company, among other things, to maintain a minimum tangible net worth of $7 million and a minimum quick ratio of 2 to 1. Borrowings under the facility is collateralized by substantially all of the Company's assets. F-17 PERSISTENCE SOFTWARE, INC. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULE PAGE ---- Audited Consolidated Financial Statement Schedule: Independent Auditors' Report.......................................... S-2 Schedule II-- Consolidated Schedule of Valuation and Qualifying Accounts for the years ended December 31, 2001, 2000 and 1999....... S-3 Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the consolidated financial statements or notes thereto. S-1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Persistence Software, Inc.: We have audited the consolidated financial statements of Persistence Software, Inc. and subsidiaries (the "Company") as of December 31, 2001 and 2000, and for each of the three years in the period ended December 31, 2001, and have issued our report thereon dated January 22, 2002, (February 28, 2002 as to Note 5 and March 20, 2002 as to Note 12). Our audits also included the consolidated financial statement schedule of the Company listed in the Index at Item 14(a)(2). This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. DELOITTE & TOUCHE LLP San Jose, California January 22, 2002 S-2 SCHEDULE II PERSISTENCE SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED $000'S BEGINNING TO COST DEDUCTIONS/ BALANCE AT OF YEAR AND EXPENSES WRITE-OFFS END OF YEAR ------------ ------------ ------------ ------------ Year ended December 31, 1999 Allowance for doubtful accounts .............................. $ 47 $ 467 $ 182 $ 332 ============ =========== ============ ============ Year ended December 31, 2000 Allowance for doubtful accounts............................... $ 332 $ 915 $ 19 $ 1,228 ============ =========== ============ ============ Year ended December 31, 2001 Allowance for doubtful accounts............................... $ 1,228 $ 951 $ 2,027 $ 152 ============ =========== ============ ============
S-3 EX-10.13 3 persistence_10kex10-13.txt EXHIBIT 10.13 COMERICA LOAN AGREEMENT - -------------------------------------------------------------------------------- PERSISTENCE SOFTWARE, INC. AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT - -------------------------------------------------------------------------------- This AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT is entered into as of March 6, 2002, by and between COMERICA BANK - CALIFORNIA ("Bank") and PERSISTENCE SOFTWARE, INC. ("Borrower"). RECITALS -------- A. Bank and Borrower are parties to that certain Revolving Credit Loan and Security Agreement (Accounts and Inventory) dated as of November 4, 1999, as amended, including without limitation by that certain Modification to Loan & Security Agreement dated as of August 18, 2000, that certain Fourth Modification to Loan & Security Agreement dated as of November 7, 2001, and that certain Modification to Revolving Credit Loan & Security Agreement dated as of January 25, 2001 (collectively, the "Credit Agreement"), that certain Master Revolving Note dated as of November 4, 1999, that certain Fixed Rate- Installment Note dated as of November 4, 1999, that certain Master Note dated as of November 1, 2000, that certain Fixed Rate-Installment Note dated as of February 5, 1999, and that certain Intellectual Property Security Agreement dated as of November 4, 1999, each as amended (collectively, the "Original Agreement"). B. Borrower and Bank wish to amend and restate the terms of the Original Agreement. This Agreement sets forth the terms on which Bank will advance credit to Borrower, and Borrower will repay the amounts owing to Bank. AGREEMENT --------- The parties agree as follows: 1. DEFINITIONS AND CONSTRUCTION. ---------------------------- 1.1 DEFINITIONS. As used in this Agreement, the following terms shall have the following definitions: "Accounts" means all presently existing and hereafter arising accounts, contract rights, and all other forms of obligations owing to Borrower arising out of the sale or lease of goods (including, without limitation, the licensing of software and other technology) or the rendering of services by Borrower, whether or not earned by performance, and any and all credit insurance, guaranties, and other security therefor, as well as all merchandise returned to or reclaimed by Borrower and Borrower's Books relating to any of the foregoing. "Advance" or "Advances" means a cash advance or cash advances under the Revolving Facility. "Affiliate" means, with respect to any Person, any Person that owns or controls directly or indirectly such Person, any Person that controls or is controlled by or is under common control with such Person, and each of such Person's senior executive officers, directors, and partners. "Bank Expenses" means all: reasonable costs or expenses (including reasonable attorneys' fees and expenses) incurred in connection with the preparation, negotiation, administration, and enforcement of the Loan Documents; reasonable Collateral audit fees; and Bank's reasonable attorneys' fees and expenses incurred in amending, enforcing or defending the Loan Documents (including fees and expenses of appeal), incurred before, during and after an Insolvency Proceeding, whether or not suit is brought. "Borrower's Books" means all of Borrower's books and records including: ledgers; records concerning Borrower's assets or liabilities, the Collateral, business operations or financial condition; and all computer programs, or tape files, and the equipment, containing such information. "Borrowing Base" means an amount equal to seventy percent (70%) of Eligible Accounts, as determined by Bank with reference to the most recent Borrowing Base Certificate delivered by Borrower. 1 "Business Day" means any day that is not a Saturday, Sunday, or other day on which banks in the State of California are authorized or required to close. "Change in Control" shall mean a transaction in which any "person" or "group" (within the meaning of Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of a sufficient number of shares of all classes of stock then outstanding of Borrower ordinarily entitled to vote in the election of directors, empowering such "person" or "group" to elect a majority of the Board of Directors of Borrower, who did not have such power before such transaction. "Closing Date" means the date of this Agreement. "Code" means the California Uniform Commercial Code. "Collateral" means the property described on EXHIBIT A attached hereto. "Contingent Obligation" means, as applied to any Person, any direct or indirect liability, contingent or otherwise, of that Person with respect to (i) any indebtedness, lease, dividend, letter of credit or other obligation of another, including, without limitation, any such obligation directly or indirectly guaranteed, endorsed, co-made or discounted or sold with recourse by that Person, or in respect of which that Person is otherwise directly or indirectly liable; (ii) any obligations with respect to undrawn letters of credit, corporate credit cards, or merchant services issued or provided for the account of that Person; and (iii) all obligations arising under any interest rate, currency or commodity swap agreement, interest rate cap agreement, interest rate collar agreement, or other agreement or arrangement designed to protect such Person against fluctuation in interest rates, currency exchange rates or commodity prices; provided, however, that the term "Contingent Obligation" shall not include endorsements for collection or deposit in the ordinary course of business. The amount of any Contingent Obligation shall be deemed to be an amount equal to the stated or determined amount of the primary obligation in respect of which such Contingent Obligation is made or, if not stated or determinable, the maximum reasonably anticipated liability in respect thereof as determined by such Person in good faith; provided, however, that such amount shall not in any event exceed the maximum amount of the obligations under the guarantee or other support arrangement. "Copyrights" means any and all copyright rights, copyright applications, copyright registrations and like protections in each work or authorship and derivative work thereof, whether published or unpublished and whether or not the same also constitutes a trade secret, now or hereafter existing, created, acquired or held. "Credit Extension" means each Advance, Term Advance, Letter of Credit or any other extension of credit by Bank for the benefit of Borrower hereunder. "Current Liabilities" means, as of any applicable date, all amounts that should, in accordance with GAAP, be included as current liabilities on the consolidated balance sheet of Borrower and its Subsidiaries, as at such date, plus, to the extent not already included therein, all outstanding Credit Extensions made under this Agreement, including all Indebtedness that is payable upon demand or within one year from the date of determination thereof unless such Indebtedness is renewable or extendible at the option of Borrower or any Subsidiary to a date more than one year from the date of determination. "Daily Balance" means the amount of the Obligations owed at the end of a given day. "Eligible Accounts" means those Accounts that arise in the ordinary course of Borrower's business that comply with all of Borrower's representations and warranties to Bank set forth in Section 5.4; provided, that standards of eligibility may be fixed and revised from time to time by Bank in Bank's reasonable judgment and upon notification thereof to Borrower in accordance with the provisions hereof. Unless otherwise agreed to by Bank, Eligible Accounts shall not include the following: 2 (a) Accounts that the account debtor has failed to pay within ninety (90) days of invoice date; (b) Accounts with respect to an account debtor, twenty-five percent (25%) of whose Accounts the account debtor has failed to pay within ninety (90) days of invoice date; (c) Accounts with respect to which the account debtor is an officer, employee, or agent of Borrower; (d) Accounts with respect to which goods are placed on consignment, guaranteed sale, sale or return, sale on approval, bill and hold, or other terms by reason of which the payment by the account debtor may be conditional; (e) Accounts with respect to which the account debtor is an Affiliate of Borrower; (f) Accounts with respect to which the account debtor does not have its principal place of business in the United States, except for Eligible Foreign Accounts; (g) Accounts with respect to which the account debtor is the United States or any department, agency, or instrumentality of the United States; (h) Accounts with respect to which Borrower is liable to the account debtor for goods sold or services rendered by the account debtor to Borrower (including without limitation account debtors which have made deposits with Borrower), but only to the extent of any amounts owing to the account debtor against amounts owed to Borrower; (i) Accounts with respect to an account debtor, including Subsidiaries and Affiliates, whose total obligations to Borrower exceed twenty percent (20%) of all Accounts, to the extent such obligations exceed the aforementioned percentage, except as approved in writing by Bank; (j) Accounts with respect to which the account debtor disputes liability or makes any claim with respect thereto as to which Bank believes, in its sole discretion, that there may be a basis for dispute (but only to the extent of the amount subject to such dispute or claim), or is subject to any Insolvency Proceeding, or becomes insolvent, or goes out of business; and (k) Accounts the collection of which Bank reasonably determines to be doubtful. "Eligible Foreign Accounts" means Accounts with respect to which the account debtor does not have its principal place of business in the United States and that (i) are supported by one or more letters of credit in an amount and of a tenor, and issued by a financial institution, acceptable to Bank, or (ii) are supported by credit insurance acceptable to Bank, or (iii) are Accounts on which the account debtor is Nokia, the German Labor Unit (BA) or another account debtor acceptable to Bank. "Equipment" means all present and future machinery, equipment, tenant improvements, furniture, fixtures, vehicles, tools, parts and attachments in which Borrower has any interest. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, and the regulations thereunder. "Event of Default" has the meaning assigned in Article 8. "GAAP" means generally accepted accounting principles as in effect from time to time. "Indebtedness" means (a) all indebtedness for borrowed money or the deferred purchase price of property or services, including without limitation reimbursement and other obligations with respect to surety bonds and letters of credit, (b) all obligations evidenced by notes, bonds, debentures or similar instruments, (c) all capital lease obligations and (d) all Contingent Obligations. 3 "Insolvency Proceeding" means any proceeding commenced by or against any person or entity under any provision of the United States Bankruptcy Code, as amended, or under any other bankruptcy or insolvency law, including assignments for the benefit of creditors, formal or informal moratoria, compositions, extension generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief. "Intellectual Property Collateral" means all of Borrower's right, title, and interest in and to the following: (a) Copyrights, Trademarks and Patents; (b) Any and all trade secrets, and any and all intellectual property rights in computer software and computer software products now or hereafter existing, created, acquired or held; (c) Any and all design rights which may be available to Borrower now or hereafter existing, created, acquired or held; (d) Any and all claims for damages by way of past, present and future infringement of any of the rights included above, with the right, but not the obligation, to sue for and collect such damages for said use or infringement of the intellectual property rights identified above; (e) All licenses or other rights to use any of the Copyrights, Patents or Trademarks, and all license fees and royalties arising from such use to the extent permitted by such license or rights; (f) All amendments, renewals and extensions of any of the Copyrights, Trademarks or Patents; and (g) All proceeds and products of the foregoing, including without limitation all payments under insurance or any indemnity or warranty payable in respect of any of the foregoing. "Inventory" means all present and future inventory in which Borrower has any interest, including merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products intended for sale or lease or to be furnished under a contract of service, of every kind and description now or at any time hereafter owned by or in the custody or possession, actual or constructive, of Borrower, including such inventory as is temporarily out of its custody or possession or in transit and including any returns upon any accounts or other proceeds, including insurance proceeds, resulting from the sale or disposition of any of the foregoing and any documents of title representing any of the above, and Borrower's Books relating to any of the foregoing. "Investment" means any beneficial ownership of (including stock, partnership interest or other securities) any Person, or any loan, advance or capital contribution to any Person. "IRC" means the Internal Revenue Code of 1986, as amended, and the regulations thereunder. "Lien" means any mortgage, lien, deed of trust, charge, pledge, security interest or other encumbrance. "Loan Documents" means, collectively, this Agreement, any note or notes executed by Borrower, and any other agreement entered into between Borrower and Bank in connection with this Agreement, all as amended or extended from time to time. 4 "Material Adverse Effect" means a material adverse effect on (i) the business operations, condition (financial or otherwise) or prospects of Borrower and its Subsidiaries taken as a whole or (ii) the ability of Borrower to repay the Obligations or otherwise perform its obligations under the Loan Documents or (iii) the value or priority of Bank's security interests in the Collateral. "Negotiable Collateral" means all of Borrower's present and future letters of credit of which it is a beneficiary, notes, drafts, instruments, securities, documents of title, and chattel paper, and Borrower's Books relating to any of the foregoing. "Obligations" means all debt, principal, interest, Bank Expenses and other amounts owed to Bank by Borrower pursuant to this Agreement or any other agreement, whether absolute or contingent, due or to become due, now existing or hereafter arising, including any interest that accrues after the commencement of an Insolvency Proceeding and including any debt, liability, or obligation owing from Borrower to others that Bank may have obtained by assignment or otherwise. "Patents" means all patents, patent applications and like protections including without limitation improvements, divisions, continuations, renewals, reissues, extensions and continuations-in-part of the same. "Periodic Payments" means all installments or similar recurring payments that Borrower may now or hereafter become obligated to pay to Bank pursuant to the terms and provisions of any instrument, or agreement now or hereafter in existence between Borrower and Bank. "Permitted Indebtedness" means: (a) Indebtedness of Borrower in favor of Bank arising under this Agreement or any other Loan Document; (b) Indebtedness existing on the Closing Date and disclosed in the Schedule; (c) Subject to the cap set forth in Section 7.13, Indebtedness secured by a lien described in clause (c) of the defined term "Permitted Liens," provided such Indebtedness does not exceed the lesser of the cost or fair market value of the equipment financed with such Indebtedness; (d) Indebtedness to trade creditors incurred in the ordinary course of Borrower's business; and (e) Subordinated Debt. "Permitted Investment" means: (a) Investments existing on the Closing Date disclosed in the Schedule; and (b) (i) marketable direct obligations issued or unconditionally guaranteed by the United States of America or any agency or any State thereof maturing within one (1) year from the date of acquisition thereof, (ii) commercial paper maturing no more than one (1) year from the date of creation thereof and currently having rating of at least A-2 or P-2 from either Standard & Poor's Corporation or Moody's Investors Service, (iii) certificates of deposit maturing no more than one (1) year from the date of investment therein issued by Bank and (iv) Bank's money market accounts. "Permitted Liens" means the following: (a) Any Liens existing on the Closing Date and disclosed in the Schedule or arising under this Agreement or the other Loan Documents; 5 (b) Liens for taxes, fees, assessments or other governmental charges or levies, either not delinquent or being contested in good faith by appropriate proceedings, provided the same have no priority over any of Bank's security interests; (c) Liens (i) upon or in any equipment acquired or held by Borrower or any of its Subsidiaries to secure the purchase price of such equipment or indebtedness incurred solely for the purpose of financing the acquisition of such equipment, or (ii) existing on such equipment at the time of its acquisition, provided that the Lien is confined solely to the property so acquired and improvements thereon, and the proceeds of such equipment; (d) Liens incurred in connection with the extension, renewal or refinancing of the indebtedness secured by Liens of the type described in clauses (a) through (c) above, provided that any extension, renewal or replacement Lien shall be limited to the property encumbered by the existing Lien and the principal amount of the indebtedness being extended, renewed or refinanced does not increase. "Person" means any individual, sole proprietorship, partnership, limited liability company, joint venture, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or governmental agency. "Prime Rate" means the variable rate of interest, per annum, most recently announced by Bank, as its "prime rate," whether or not such announced rate is the lowest rate available from Bank. "Quick Assets" means, at any date as of which the amount thereof shall be determined, the unrestricted cash and cash-equivalents, accounts receivable and investments with maturities not to exceed 90 days, of Borrower determined in accordance with GAAP. "Responsible Officer" means each of the Chief Executive Officer, the Chief Operating Officer, the Chief Financial Officer and the Controller of Borrower. "Revolving Facility" means the facility under which Borrower may request Bank to issue Advances, as specified in Section 2.1(a) hereof. "Revolving Line" means a credit extension of up to Five Million Dollars ($5,000,000). "Revolving Maturity Date" means April 30, 2003. "Schedule" means the schedule of exceptions attached hereto and approved by Bank, if any. "Subordinated Debt" means any debt incurred by Borrower that is subordinated to the debt owing by Borrower to Bank on terms acceptable to Bank (and identified as being such by Borrower and Bank). "Subsidiary" means any corporation, company or partnership in which (i) any general partnership interest or (ii) more than 50% of the stock or other units of ownership which by the terms thereof has the ordinary voting power to elect the Board of Directors, managers or trustees of the entity, at the time as of which any determination is being made, is owned by Borrower, either directly or through an Affiliate. "Tangible Net Worth" means at any date as of which the amount thereof shall be determined, the sum of the capital stock and additional paid-in capital plus retained earnings (or minus accumulated deficit) of Borrower and its Subsidiaries minus intangible assets, plus Subordinated Debt, on a consolidated basis determined in accordance with GAAP. "Term Advance" has the meaning set forth in Section 2.1(b). "Term Date" means November 1, 2003. 6 "Trademarks" means any trademark and servicemark rights, whether registered or not, applications to register and registrations of the same and like protections, and the entire goodwill of the business of Borrower connected with and symbolized by such trademarks. 1.2 ACCOUNTING TERMS. All accounting terms not specifically defined herein shall be construed in accordance with GAAP and all calculations made hereunder shall be made in accordance with GAAP. When used herein, the terms "financial statements" shall include the notes and schedules thereto. 2. LOAN AND TERMS OF PAYMENT. ------------------------- 2.1 CREDIT EXTENSIONS. Borrower promises to pay to the order of Bank, in lawful money of the United States of America, the aggregate unpaid principal amount of all Credit Extensions made by Bank to Borrower hereunder. Borrower shall also pay interest on the unpaid principal amount of such Credit Extensions at rates in accordance with the terms hereof. (a) REVOLVING ADVANCES. (i) Subject to and upon the terms and conditions of this Agreement, Borrower may request Advances in an aggregate outstanding amount not to exceed the Revolving Line MINUS the aggregate undrawn face amount of all outstanding Letters of Credit, provided that, at any time during which the aggregate amount of the outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit is in excess of $200,000, the aggregate amount of the outstanding Advances plus the aggregate face amount of all outstanding Letters of Credit shall not exceed the Borrowing Base. Subject to the terms and conditions of this Agreement, amounts borrowed pursuant to this Section 2.1(a) may be repaid and reborrowed at any time prior to the Revolving Maturity Date, at which time all Advances under this Section 2.1(a) shall be immediately due and payable. Borrower may prepay any Advances without penalty or premium. (ii) Whenever Borrower desires an Advance, Borrower will notify Bank by facsimile transmission or telephone no later than 3:00 p.m. Pacific time, on the Business Day that the Advance is to be made. Each such notification shall be promptly confirmed by a Payment/Advance Form in substantially the form of EXHIBIT B hereto. Bank is authorized to make Advances under this Agreement, based upon instructions received from a Responsible Officer or a designee of a Responsible Officer, or without instructions if in Bank's discretion such Advances are necessary to meet Obligations which have become due and remain unpaid. Bank shall be entitled to rely on any telephonic notice given by a person who Bank reasonably believes to be a Responsible Officer or a designee thereof, and Borrower shall indemnify and hold Bank harmless for any damages or loss suffered by Bank as a result of such reliance. Bank will credit the amount of Advances made under this Section 2.1(a) to Borrower's deposit account. (b) TERM ADVANCES. As of the Closing Date, there are outstanding advances (the "Term Advances") in an aggregate principal amount equal to $436,863.07 under the Original Agreement. Borrower shall not request or receive any further Term Advances. Interest shall continue to accrue on the Term Advances at the rate specified in Section 2.3. Borrower shall continue to make monthly payments on the Term Advances in the principal amount of $21,843.15, plus all accrued interest on the first day of each month through the Term Maturity Date, at which time all Term Advances shall be immediately due and payable. Term Advances, once repaid, may not be reborrowed. Borrower may prepay any Term Advances without penalty or premium. (c) LETTERS OF CREDIT. (i) Subject to the terms and conditions of this Agreement, Bank agrees to issue or cause to be issued letters of credit for the account of Borrower (each, a "Letter of Credit" and collectively, the "Letters of Credit") in an aggregate outstanding face amount not to exceed the Revolving Line MINUS the aggregate amount of the outstanding Advances at any time, provided (i) that the aggregate face amount of all outstanding Letters of Credit shall not exceed $200,000 and (ii) that at any time the aggregate amount of the outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit is in excess of $200,000, the aggregate amount of the 7 outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit shall not exceed the Borrowing Base. All Letters of Credit shall be, in form and substance, acceptable to Bank in its sole discretion and shall be subject to the terms and conditions of Bank's form of standard application and letter of credit agreement (the "Application"), which Borrower hereby agrees to execute, including Bank's standard fee equal to 1.0% per annum of the face amount of each Letter of Credit. On any drawn but unreimbursed Letter of Credit, the unreimbursed amount shall be deemed an Advance under Section 2.1(a). Prior to the Revolving Maturity Date, Borrower shall secure in cash all obligations under any outstanding Letters of Credit on terms acceptable to Bank. (ii) The obligation of Borrower to reimburse Bank for drawings made under Letters of Credit shall be absolute, unconditional and irrevocable, and shall be performed strictly in accordance with the terms of this Agreement, the Application, and such Letters of Credit, under all circumstances whatsoever. Borrower shall indemnify, defend, protect, and hold Bank harmless from any loss, cost, expense or liability, including, without limitation, reasonable attorneys' fees, arising out of or in connection with any Letters of Credit, except for expenses caused by Bank's gross negligence or willful misconduct. 2.2 OVERADVANCES. If the aggregate amount of the outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit is greater than $200,000 and exceeds the lesser of the Revolving Line or the Borrowing Base at any time, Borrower shall immediately pay to Bank, in cash, the amount of such excess. 2.3 INTEREST RATES, PAYMENTS, AND CALCULATIONS. ------------------------------------------ (a) INTEREST RATES. (i) ADVANCES. Except as set forth in Section 2.3(b), the Advances shall bear interest, on the outstanding Daily Balance thereof, at a rate equal to one half percent (0.50%) above the Prime Rate. (ii) TERM ADVANCES. Except as set forth in Section 2.3(b), the Term Advances shall bear interest, on the outstanding Daily Balance thereof, at a rate equal to one half percent (0.50%) above the Prime Rate. (b) LATE FEE; DEFAULT RATE. If any payment is not made within ten (10) days after the date such payment is due, Borrower shall pay Bank a late fee equal to the lesser of (i) five percent (5%) of the amount of such unpaid amount or (ii) the maximum amount permitted to be charged under applicable law. All Obligations shall bear interest, from and after the occurrence and during the continuance of an Event of Default, at a rate equal to five (5) percentage points above the interest rate applicable immediately prior to the occurrence of the Event of Default. (c) PAYMENTS. Interest hereunder shall be due and payable on the first (1st) calendar day of each month during the term hereof. Bank shall, at its option, charge such interest, all Bank Expenses, and all Periodic Payments against any of Borrower's deposit accounts or against the Revolving Line, in which case those amounts shall thereafter accrue interest at the rate then applicable hereunder. Any interest not paid when due shall be compounded by becoming a part of the Obligations, and such interest shall thereafter accrue interest at the rate then applicable hereunder. All payments shall be free and clear of any taxes, withholdings, duties, impositions or other charges, to the end that Bank will receive the entire amount of any Obligations payable hereunder, regardless of source of payment. (d) COMPUTATION. In the event the Prime Rate is changed from time to time hereafter, the applicable rate of interest hereunder shall be increased or decreased, effective as of the day the Prime Rate is changed, by an amount equal to such change in the Prime Rate. All interest chargeable under the Loan Documents shall be computed on the basis of a three hundred sixty (360) day year for the actual number of days elapsed. 8 2.4 CREDITING PAYMENTS. Prior to the occurrence of an Event of Default, Bank shall credit a wire transfer of funds, check or other item of payment to such deposit account or Obligation as Borrower specifies. After the occurrence of an Event of Default, the receipt by Bank of any wire transfer of funds, check, or other item of payment shall be immediately applied to conditionally reduce Obligations, but shall not be considered a payment on account unless such payment is of immediately available federal funds or unless and until such check or other item of payment is honored when presented for payment. Notwithstanding anything to the contrary contained herein, any wire transfer or payment received by Bank after 12:00 noon Pacific time shall be deemed to have been received by Bank as of the opening of business on the immediately following Business Day. Whenever any payment to Bank under the Loan Documents would otherwise be due (except by reason of acceleration) on a date that is not a Business Day, such payment shall instead be due on the next Business Day, and additional fees or interest, as the case may be, shall accrue and be payable for the period of such extension. 2.5 FEES. Borrower shall pay to Bank the following: (a) FACILITY FEE. On the Closing Date and on each anniversary of the Closing Date, a Facility Fee equal to Twenty Five Thousand Dollars ($25,000), which shall be nonrefundable and which Bank shall charge against any of Borrower's deposit accounts; and (b) BANK EXPENSES. On the Closing Date, all Bank Expenses incurred through the Closing Date, including reasonable attorneys' fees and expenses and, after the Closing Date, all Bank Expenses, including reasonable attorneys' fees and expenses, as and when they become due. 2.6 ADDITIONAL COSTS. In case any law, regulation, treaty or official directive or the interpretation or application thereof by any court or any governmental authority charged with the administration thereof or the compliance with any guideline or request of any central bank or other governmental authority (whether or not having the force of law): (a) subjects Bank to any tax with respect to payments of principal or interest or any other amounts payable hereunder by Borrower or otherwise with respect to the transactions contemplated hereby (except for taxes on the overall net income of Bank imposed by the United States of America or any political subdivision thereof); (b) imposes, modifies or deems applicable any deposit insurance, reserve, special deposit or similar requirement against assets held by, or deposits in or for the account of, or loans by, Bank; or (c) imposes upon Bank any other condition with respect to its performance under this Agreement, and the result of any of the foregoing is to increase the cost to Bank, reduce the income receivable by Bank or impose any expense upon Bank with respect to the Obligations, Bank shall notify Borrower thereof. Borrower agrees to pay to Bank the amount of such increase in cost, reduction in income or additional expense as and when such cost, reduction or expense is incurred or determined, upon presentation by Bank of a statement of the amount and setting forth Bank's calculation thereof, all in reasonable detail, which statement shall be deemed true and correct absent manifest error. 2.7 TERM. This Agreement shall become effective on the Closing Date and, subject to Section 12.7, shall continue in full force and effect for so long as any Obligations remain outstanding or Bank has any obligation to make Credit Extensions under this Agreement. Notwithstanding the foregoing, Bank shall have the right to terminate its obligation to make Credit Extensions under this Agreement immediately and without notice upon the occurrence and during the continuance of an Event of Default. Notwithstanding termination, Bank's Lien on the Collateral shall remain in effect for so long as any Obligations are outstanding. 9 3. CONDITIONS OF LOANS. ------------------- 3.1 CONDITIONS PRECEDENT TO INITIAL CREDIT EXTENSION. The obligation of Bank to make the initial Credit Extension is subject to the condition precedent that Bank shall have received, in form and substance satisfactory to Bank, the following: (a) this Agreement; (b) a certificate of the Secretary of Borrower with respect to incumbency and resolutions authorizing the execution and delivery of this Agreement; (c) agreement to provide insurance; (d) payment of the fees and Bank Expenses then due specified in Section 2.4 hereof; and (e) such other documents, and completion of such other matters, as Bank may reasonably deem necessary or appropriate. 3.2 CONDITIONS PRECEDENT TO ALL CREDIT EXTENSIONS. The obligation of Bank to make each Credit Extension, including the initial Credit Extension, is further subject to the following conditions: (a) timely receipt by Bank of the Payment/Advance Form as provided in Section 2.1; (b) receipt by Bank of (i) a Borrowing Base Certificate signed by a Responsible Officer in substantially the form of EXHIBIT C hereto, together with aged listings of accounts receivable and accounts payable, (ii) a company prepared consolidated balance sheet, income, and cash flow statement covering Borrower's operations for the month ended immediately prior to the date on which the applicable Credit Extension is requested, prepared in accordance with GAAP on a consolidated and consolidating basis, consistently applied, in a form acceptable to Bank and certified by a Responsible Officer, and (iii) a current Compliance Certificate signed by a Responsible Officer in substantially the form of EXHIBIT D hereto; and (c) the representations and warranties contained in Section 5 shall be true and correct in all material respects on and as of the date of such Payment/Advance Form and on the effective date of each Credit Extension as though made at and as of each such date, and no Event of Default shall have occurred and be continuing, or would exist after giving effect to such Credit Extension (provided, however, that those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date). The making of each Credit Extension shall be deemed to be a representation and warranty by Borrower on the date of such Credit Extension as to the accuracy of the facts referred to in this Section 3.2. 4. CREATION OF SECURITY INTEREST. ----------------------------- 4.1 GRANT OF SECURITY INTEREST. Borrower grants and pledges to Bank a continuing security interest in all presently existing and hereafter acquired or arising Collateral in order to secure prompt repayment of any and all Obligations and in order to secure prompt performance by Borrower of each of its covenants and duties under the Loan Documents. Except as set forth in the Schedule, such security interest constitutes a valid, first priority security interest in the presently existing Collateral, and will constitute a valid, first priority security interest in Collateral acquired after the date hereof. 4.2 DELIVERY OF ADDITIONAL DOCUMENTATION REQUIRED. Borrower shall from time to time execute and deliver to Bank, at the request of Bank, all Negotiable Collateral, all financing statements and other documents that Bank may reasonably request, in form satisfactory to Bank, to perfect and continue the perfection of Bank's security interests in the Collateral and in order to fully consummate all of the transactions contemplated under the Loan Documents. 10 4.3 RIGHT TO INSPECT. Bank (through any of its officers, employees, or agents) shall have the right, upon reasonable prior notice, from time to time during Borrower's usual business hours but no more than twice a year (unless an Event of Default has occurred and is continuing), to inspect Borrower's Books and to make copies thereof and to check, test, and appraise the Collateral in order to verify Borrower's financial condition or the amount, condition of, or any other matter relating to, the Collateral. 5. REPRESENTATIONS AND WARRANTIES. ------------------------------ Borrower represents and warrants as follows: 5.1 DUE ORGANIZATION AND QUALIFICATION. Borrower and each Subsidiary is a corporation duly existing under the laws of its state of incorporation and qualified and licensed to do business in any state in which the conduct of its business or its ownership of property requires that it be so qualified. 5.2 DUE AUTHORIZATION; NO CONFLICT. The execution, delivery, and performance of the Loan Documents are within Borrower's powers, have been duly authorized, and are not in conflict with nor constitute a breach of any provision contained in Borrower's Certificate of Incorporation or Bylaws, nor will they constitute an event of default under any material agreement to which Borrower is a party or by which Borrower is bound. Borrower is not in default under any material agreement to which it is a party or by which it is bound. 5.3 NO PRIOR ENCUMBRANCES. Borrower has good and marketable title to its property, free and clear of Liens, except for Permitted Liens. 5.4 BONA FIDE ELIGIBLE ACCOUNTS. The Eligible Accounts are bona fide existing obligations. The property and services giving rise to such Eligible Accounts has been delivered or rendered to the account debtor or to the account debtor's agent for immediate and unconditional acceptance by the account debtor. Borrower has not received notice of actual or imminent Insolvency Proceeding of any account debtor that is included in any Borrowing Base Certificate as an Eligible Account. 5.5 MERCHANTABLE INVENTORY. All Inventory is in all material respects of good and marketable quality, free from all material defects, except for Inventory for which adequate reserves have been made. 5.6 INTELLECTUAL PROPERTY COLLATERAL. Borrower is the sole owner of the Intellectual Property Collateral, except for non-exclusive licenses granted by Borrower to its customers in the ordinary course of business. Each of the Patents is valid and enforceable, and no part of the Intellectual Property Collateral has been judged invalid or unenforceable, in whole or in part, and no claim has been made that any part of the Intellectual Property Collateral violates the rights of any third party. Except as set forth in the Schedule, Borrower's rights as a licensee of intellectual property do not give rise to more than five percent (5%) of its gross revenue in any given month, including without limitation revenue derived from the sale, licensing, rendering or disposition of any product or service. Except as set forth in the Schedule, Borrower is not a party to, or bound by, any agreement that restricts the grant by Borrower of a security interest in Borrower's rights under such agreement. 5.7 NAME; LOCATION OF CHIEF EXECUTIVE OFFICE. Except as disclosed in the Schedule, Borrower has not done business under any name other than that specified on the signature page hereof. The chief executive office of Borrower is located at the address indicated in Section 10 hereof. All Borrower's Inventory and Equipment is located only at the location set forth in Section 10 hereof. 5.8 LITIGATION. Except as set forth in the Schedule, there are no actions or proceedings pending by or against Borrower or any Subsidiary before any court or administrative agency in which an adverse decision could have a Material Adverse Effect, or a material adverse effect on Borrower's interest or Bank's security interest in the Collateral. 5.9 NO MATERIAL ADVERSE CHANGE IN FINANCIAL STATEMENTS. All consolidated financial statements related to Borrower and any Subsidiary that Bank has received fairly present in all material respects Borrower's consolidated financial condition as of the date thereof and Borrower's consolidated results of operations for the period then ended. There has not been a material adverse change in the consolidated financial condition of Borrower since the date of the most recent of such financial statements submitted to Bank. 11 5.10 SOLVENCY, PAYMENT OF DEBTS. Borrower is solvent and able to pay its debts (including trade debts) as they mature. 5.11 REGULATORY COMPLIANCE. Borrower and each Subsidiary have met the minimum funding requirements of ERISA with respect to any employee benefit plans subject to ERISA, and no event has occurred resulting from Borrower's failure to comply with ERISA that could result in Borrower's incurring any material liability. Borrower is not an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940. Borrower is not engaged principally, or as one of the important activities, in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulations T and U of the Board of Governors of the Federal Reserve System). Borrower has complied with all the provisions of the Federal Fair Labor Standards Act. Borrower has not violated any statutes, laws, ordinances or rules applicable to it, violation of which could have a Material Adverse Effect. 5.12 ENVIRONMENTAL CONDITION. Except as disclosed in the Schedule, none of Borrower's or any Subsidiary's properties or assets has ever been used by Borrower or any Subsidiary or, to the best of Borrower's knowledge, by previous owners or operators, in the disposal of, or to produce, store, handle, treat, release, or transport, any hazardous waste or hazardous substance other than in accordance with applicable law; to the best of Borrower's knowledge, none of Borrower's properties or assets has ever been designated or identified in any manner pursuant to any environmental protection statute as a hazardous waste or hazardous substance disposal site, or a candidate for closure pursuant to any environmental protection statute; no lien arising under any environmental protection statute has attached to any revenues or to any real or personal property owned by Borrower or any Subsidiary; and neither Borrower nor any Subsidiary has received a summons, citation, notice, or directive from the Environmental Protection Agency or any other federal, state or other governmental agency concerning any action or omission by Borrower or any Subsidiary resulting in the releasing, or otherwise disposing of hazardous waste or hazardous substances into the environment. 5.13 TAXES. Borrower and each Subsidiary have filed or caused to be filed all tax returns required to be filed, and have paid, or have made adequate provision for the payment of, all taxes reflected therein. 5.14 SUBSIDIARIES. Borrower does not own any stock, partnership interest or other equity securities of any Person, except for Permitted Investments. 5.15 GOVERNMENT CONSENTS. Borrower and each Subsidiary have obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all governmental authorities that are necessary for the continued operation of Borrower's business as currently conducted, the failure to obtain which could have a Material Adverse Effect. 5.16 INVESTMENT ACCOUNTS. None of Borrower's nor any Subsidiary's property is maintained or invested with a Person other than Bank. 5.17 FULL DISCLOSURE. No representation, warranty or other statement made by Borrower in any certificate or written statement furnished to Bank contains any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements contained in such certificates or statements not misleading. 6. AFFIRMATIVE COVENANTS. --------------------- Borrower covenants and agrees that, until payment in full of all outstanding Obligations, and for so long as Bank may have any commitment to make a Credit Extension hereunder, Borrower shall do all of the following: 12 6.1 GOOD STANDING. Borrower shall maintain its and each of its Subsidiaries' corporate existence and good standing in its jurisdiction of incorporation and maintain qualification in each jurisdiction in which it is required under applicable law. Borrower shall maintain, and shall cause each of its Subsidiaries to maintain, in force all licenses, approvals and agreements, the loss of which could have a Material Adverse Effect. 6.2 GOVERNMENT COMPLIANCE. Borrower shall meet, and shall cause each Subsidiary to meet, the minimum funding requirements of ERISA with respect to any employee benefit plans subject to ERISA. Borrower shall comply, and shall cause each Subsidiary to comply, with all statutes, laws, ordinances and government rules and regulations to which it is subject, noncompliance with which could have a Material Adverse Effect. 6.3 FINANCIAL STATEMENTS, REPORTS, CERTIFICATES. Borrower shall deliver the following to Bank: (a) as soon as available, but in any event within forty five (45) days after the end of each quarter, a company prepared consolidated balance sheet, income, and cash flow statement covering Borrower's operations during such period, prepared in accordance with GAAP on a consolidated and consolidating basis, consistently applied, in a form acceptable to Bank and certified by a Responsible Officer (Borrower shall deliver such financial information on a monthly basis within twenty (20) days after the end of each month for any month in which the aggregate amount of the outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit exceeded $200,000 at any time); (b) as soon as available, but in any event within ninety (90) days after the end of Borrower's fiscal year, audited consolidated and consolidating financial statements of Borrower prepared in accordance with GAAP, consistently applied, together with an unqualified opinion on such financial statements of an independent certified public accounting firm reasonably acceptable to Bank; (c) copies of all statements, reports and notices sent or made available generally by Borrower to its security holders or to any holders of Subordinated Debt and all reports on Forms 10-K and 10-Q filed with the Securities and Exchange Commission (to the extent their delivery is not already required pursuant to subsections (a) and (b) above); (d) promptly upon receipt of notice thereof, a report of any legal actions pending or threatened against Borrower or any Subsidiary that could result in damages or costs to Borrower or any Subsidiary of Fifty Thousand Dollars ($50,000) or more; (e) such budgets, sales projections, operating plans or other financial information as Bank may reasonably request from time to time generally prepared by Borrower in the ordinary course of business; and (f) within forty five (45) days of the last day of each fiscal quarter, a report signed by Borrower, in form reasonably acceptable to Bank, listing any applications or registrations that Borrower has made or filed in respect of any Patents, Copyrights or Trademarks and the status of any outstanding applications or registrations, as well as any material change in Borrower's intellectual property, including but not limited to any subsequent ownership right of Borrower in or to any Trademark, Patent or Copyright not specified in EXHIBITS A, B, and C of the Intellectual Property Security Agreement delivered to Bank by Borrower in connection with this Agreement. Within fifteen (15) days after the last day of each month in which the aggregate amount of the outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit exceeds $200,000 at any time, Borrower shall deliver to Bank a Borrowing Base Certificate signed by a Responsible Officer in substantially the form of EXHIBIT C hereto, together with aged listings of accounts receivable and accounts payable. Borrower shall deliver to Bank with the quarterly and (if required) monthly financial statements, a Compliance Certificate signed by a Responsible Officer in substantially the form of EXHIBIT D hereto. Bank shall have a right from time to time hereafter to audit Borrower's Accounts and appraise Collateral at Borrower's expense, provided that such audits will be conducted no more often than every six (6) months unless an Event of Default has occurred and is continuing. 6.4 INVENTORY; RETURNS. Borrower shall keep all Inventory in good and marketable condition, free from all material defects except for Inventory for which adequate reserves have been made. Returns and allowances, if any, as between Borrower and its account debtors shall be on the same basis and in accordance with the usual customary practices of Borrower, as they exist at the time of the execution and delivery of this Agreement. Borrower shall promptly notify Bank of all returns and recoveries and of all disputes and claims, where the return, recovery, dispute or claim involves more than Fifty Thousand Dollars ($50,000). 13 6.5 TAXES. Borrower shall make, and shall cause each Subsidiary to make, due and timely payment or deposit of all material federal, state, and local taxes, assessments, or contributions required of it by law, and will execute and deliver to Bank, on demand, appropriate certificates attesting to the payment or deposit thereof; and Borrower will make, and will cause each Subsidiary to make, timely payment or deposit of all material tax payments and withholding taxes required of it by applicable laws, including, but not limited to, those laws concerning F.I.C.A., F.U.T.A., state disability, and local, state, and federal income taxes, and will, upon request, furnish Bank with proof satisfactory to Bank indicating that Borrower or a Subsidiary has made such payments or deposits; provided that Borrower or a Subsidiary need not make any payment if the amount or validity of such payment is contested in good faith by appropriate proceedings and is reserved against (to the extent required by GAAP) by Borrower. 6.6 INSURANCE. (a) Borrower, at its expense, shall keep the Collateral insured against loss or damage by fire, theft, explosion, sprinklers, and all other hazards and risks, and in such amounts, as ordinarily insured against by other owners in similar businesses conducted in the locations where Borrower's business is conducted on the date hereof. Borrower shall also maintain insurance relating to Borrower's business, ownership and use of the Collateral in amounts and of a type that are customary to businesses similar to Borrower's. (b) All such policies of insurance shall be in such form, with such companies, and in such amounts as reasonably satisfactory to Bank. All such policies of property insurance shall contain a lender's loss payable endorsement, in a form satisfactory to Bank, showing Bank as an additional loss payee thereof, and all liability insurance policies shall show the Bank as an additional insured and shall specify that the insurer must give at least twenty (20) days notice to Bank before canceling its policy for any reason. Upon Bank's request, Borrower shall deliver to Bank certified copies of such policies of insurance and evidence of the payments of all premiums therefor. All proceeds payable under any such policy shall, at the option of Bank, be payable to Bank to be applied on account of the Obligations. 6.7 ACCOUNTS. Borrower shall maintain and shall cause each of its Subsidiaries to maintain its primary depository, operating, and investment accounts with Bank and/or Comerica Securities, Inc. 6.8 QUICK RATIO. On a consolidated basis, Borrower shall maintain a ratio of Quick Assets to Current Liabilities PLUS, to the extent not already included therein, all Indebtedness (including without limitation any Contingent Obligations) owing from Borrower to Bank, LESS deferred revenue, of at least 2.0 to 1.0. This covenant shall be measured as of the last day of each quarter, provided that, at any time that the aggregate amount of the outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit is in excess of $200,000, this covenant shall be measured as of the last day of each month. 6.9 TANGIBLE NET WORTH. On a consolidated basis, Borrower shall maintain a Tangible Net Worth of at least $7,000,000, provided that such required amount shall increase by 50% of Borrower's net income in each quarter after the Closing Date and by 75% of any proceeds received by Borrower after the Closing Date from the sale and issuance of its equity securities. This covenant shall be measured as of the last day of each quarter, provided that, at any time that the aggregate amount of the outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit is in excess of $200,000, this covenant shall be measured as of the last day of each month. 6.10 REGISTRATION OF INTELLECTUAL PROPERTY RIGHTS. (a) Borrower shall register or cause to be registered on an expedited basis (to the extent not already registered) with the United States Patent and Trademark Office or the United States Copyright Office, as applicable: (i) those intellectual property rights listed on EXHIBITS A, B and C to the Intellectual Property Security Agreement delivered to Bank by Borrower in connection with this Agreement, within thirty (30) days of the date of this Agreement, (ii) all registerable intellectual property rights Borrower has developed as of the date of this Agreement but heretofore failed to register, within thirty (30) days of the date of this Agreement, and (iii) those additional intellectual property rights developed or acquired by Borrower from time to time in connection with any product or service, prior to the sale or licensing of such product or the rendering of such service to any third party, and prior to Borrower's use of such product (including without limitation major revisions or additions to the intellectual property rights listed on such EXHIBITS A, B and C). Borrower shall give Bank notice of all such applications or registrations. 14 (b) Borrower shall execute and deliver such additional instruments and documents from time to time as Bank shall reasonably request to perfect Bank's security interest in the Intellectual Property Collateral. (c) Borrower shall (i) protect, defend and maintain the validity and enforceability of the Trademarks, Patents and Copyrights, (ii) use its best efforts to detect infringements of the Trademarks, Patents and Copyrights and promptly advise Bank in writing of material infringements detected and (iii) not allow any material Trademarks, Patents or Copyrights to be abandoned, forfeited or dedicated to the public without the written consent of Bank, which shall not be unreasonably withheld. (d) Bank may audit Borrower's Intellectual Property Collateral to confirm compliance with this Section, provided such audit may not occur more often than twice per year, unless an Event of Default has occurred and is continuing. Bank shall have the right, but not the obligation, to take, at Borrower's sole expense, any actions that Borrower is required under this Section to take but which Borrower fails to take, after fifteen (15) days' notice to Borrower. Borrower shall reimburse and indemnify Bank for all reasonable costs and reasonable expenses incurred in the reasonable exercise of its rights under this Section. 6.11 FURTHER ASSURANCES. At any time and from time to time Borrower shall execute and deliver such further instruments and take such further action as may reasonably be requested by Bank to effect the purposes of this Agreement. 7. NEGATIVE COVENANTS. ------------------ Borrower covenants and agrees that, so long as any credit hereunder shall be available and until payment in full of the outstanding Obligations or for so long as Bank may have any commitment to make any Credit Extensions, Borrower will not do any of the following: 7.1 DISPOSITIONS. Convey, sell, lease, transfer or otherwise dispose of (collectively, a "Transfer"), or permit any of its Subsidiaries to Transfer, all or any part of its business or property, other than: (i) Transfers of Inventory in the ordinary course of business; (ii) Transfers of non-exclusive licenses and similar arrangements for the use of the property of Borrower or its Subsidiaries in the ordinary course of business; or (iii) Transfers of worn-out or obsolete Equipment which was not financed by Bank. 7.2 CHANGE IN BUSINESS; CHANGE IN CONTROL OR EXECUTIVE OFFICE. Engage in any business, or permit any of its Subsidiaries to engage in any business, other than the businesses currently engaged in by Borrower and any business substantially similar or related thereto (or incidental thereto); or cease to conduct business in the manner conducted by Borrower as of the Closing Date; or suffer or permit a Change in Control; or without thirty (30) days prior written notification to Bank, relocate its chief executive office or state of incorporation; or without Bank's prior written consent, change the date on which its fiscal year ends. 7.3 MERGERS OR ACQUISITIONS. Merge or consolidate, or permit any of its Subsidiaries to merge or consolidate, with or into any other business organization, or acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the capital stock or property of another Person. Notwithstanding the foregoing, this Section 7.3 shall not apply to acquisitions in which the sole consideration is Borrower's stock or cash (provided that the aggregate amount of all cash used by Borrower for acquisitions shall not exceed $1,000,000 in the aggregate during the term of this Agreement), Borrower is the surviving entity, and, after giving effect to such transaction, there is no Change in Control, provided that (i) the acquired entity is in a line of business directly related to Borrower's line of business and (ii) at the time of any such transaction an Event of Default has not occurred which is continuing and no Event of Default would exist after giving effect to any such transaction. 15 7.4 INDEBTEDNESS. Create, incur, assume or be or remain liable with respect to any Indebtedness, or permit any Subsidiary so to do, other than Permitted Indebtedness. 7.5 ENCUMBRANCES. Create, incur, assume or suffer to exist any Lien with respect to any of its property, or assign or otherwise convey any right to receive income, including the sale of any Accounts, or permit any of its Subsidiaries so to do, except for Permitted Liens. Agree with any Person other than Bank not to grant a security interest in, or otherwise encumber, any of its property, or permit any Subsidiary to do so. 7.6 DISTRIBUTIONS. Pay any dividends or make any other distribution or payment on account of or in redemption, retirement or purchase of any capital stock (other than distributions payable solely in Borrower's equity securities), or permit any of its Subsidiaries to do so, except that Borrower may repurchase the stock of former employees pursuant to stock repurchase agreements as long as an Event of Default does not exist prior to such repurchase or would not exist after giving effect to such repurchase. 7.7 INVESTMENTS. Directly or indirectly acquire or own, or make any Investment in or to any Person, or permit any of its Subsidiaries so to do, other than Permitted Investments; or maintain or invest any of its property with a Person other than Bank or permit any of its Subsidiaries to do so unless such Person has entered into an account control agreement in form and substance satisfactory to Bank; or suffer or permit any Subsidiary to be a party to, or be bound by, an agreement that restricts such Subsidiary from paying dividends or otherwise distributing property to Borrower. Allow any money or other assets with an aggregate value of more than $1,000,000 to be conveyed or transferred to another entity or other entities (including a Subsidiary) by any means, including without limitation in the form of an Investment, an Account, a loan, a guaranty of the Indebtedness of another, a pledge of assets in supports of the obligations of another, an advance for operational purposes and/or otherwise, during the term of this Agreement. 7.8 TRANSACTIONS WITH AFFILIATES. Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower except for transactions that are in the ordinary course of Borrower's business, upon fair and reasonable terms that are no less favorable to Borrower than would be obtained in an arm's length transaction with a non-affiliated Person. 7.9 SUBORDINATED DEBT. Make any payment in respect of any Subordinated Debt, or permit any of its Subsidiaries to make any such payment, except in compliance with the terms of such Subordinated Debt, or amend any provision contained in any documentation relating to the Subordinated Debt without Bank's prior written consent. 7.10 INVENTORY AND EQUIPMENT. Store the Inventory or the Equipment with a bailee, warehouseman, or other third party unless the third party has been notified of Bank's security interest and Bank (a) has received an acknowledgment from the third party that it is holding or will hold the Inventory or Equipment for Bank's benefit or (b) is in pledge possession of the warehouse receipt, where negotiable, covering such Inventory or Equipment. Store or maintain any Equipment or Inventory at a location other than the location set forth in Section 10 of this Agreement. 7.11 COMPLIANCE. Become an "investment company" or be controlled by an "investment company," within the meaning of the Investment Company Act of 1940, or become principally engaged in, or undertake as one of its important activities, the business of extending credit for the purpose of purchasing or carrying margin stock, or use the proceeds of any Credit Extension for such purpose. Fail to meet the minimum funding requirements of ERISA, permit a Reportable Event or Prohibited Transaction, as defined in ERISA, to occur, fail to comply with the Federal Fair Labor Standards Act or violate any law or regulation, which violation could have a Material Adverse Effect, or a material adverse effect on the Collateral or the priority of Bank's Lien on the Collateral, or permit any of its Subsidiaries to do any of the foregoing. 7.12 NEGATIVE PLEDGE AGREEMENTS. Permit the inclusion in any contract to which it or a Subsidiary becomes a party of any provisions that could restrict or invalidate the creation of a security interest in any of Borrower's or such Subsidiary's property. 16 7.13 CAPITAL EXPENDITURES. On a consolidated basis, Borrower's capital expenditures and payments on equipment leases (including all purchase money transactions) shall not exceed $2,000,000 in any given year. 8. EVENTS OF DEFAULT. ----------------- Any one or more of the following events shall constitute an Event of Default by Borrower under this Agreement: 8.1 PAYMENT DEFAULT. If Borrower fails to pay, when due, any of the Obligations; 8.2 COVENANT DEFAULT. If Borrower fails to perform any obligation under Article 6 or violates any of the covenants contained in Article 7 of this Agreement, or fails or neglects to perform, keep, or observe any other material term, provision, condition, covenant, or agreement contained in this Agreement, in any of the Loan Documents, or in any other present or future agreement between Borrower and Bank and as to any default under such other term, provision, condition, covenant or agreement that can be cured, has failed to cure such default within ten (10) days after Borrower receives notice thereof or any officer of Borrower becomes aware thereof; provided, however, that if the default cannot by its nature be cured within the ten (10) day period or cannot after diligent attempts by Borrower be cured within such ten (10) day period, and such default is likely to be cured within a reasonable time, then Borrower shall have an additional reasonable period (which shall not in any case exceed thirty (30) days) to attempt to cure such default, and within such reasonable time period the failure to have cured such default shall not be deemed an Event of Default (provided that no Credit Extensions will be required to be made during such cure period); 8.3 MATERIAL ADVERSE EFFECT. If there occurs any circumstance or circumstances that could have a Material Adverse Effect; 8.4 ATTACHMENT. If any portion of Borrower's assets is attached, seized, subjected to a writ or distress warrant, or is levied upon, or comes into the possession of any trustee, receiver or person acting in a similar capacity and such attachment, seizure, writ or distress warrant or levy has not been removed, discharged or rescinded within ten (10) days, or if Borrower is enjoined, restrained, or in any way prevented by court order from continuing to conduct all or any material part of its business affairs, or if a judgment or other claim becomes a lien or encumbrance upon any material portion of Borrower's assets, or if a notice of lien, levy, or assessment is filed of record with respect to any of Borrower's assets by the United States Government, or any department, agency, or instrumentality thereof, or by any state, county, municipal, or governmental agency, and the same is not paid within ten (10) days after Borrower receives notice thereof, provided that none of the foregoing shall constitute an Event of Default where such action or event is stayed or an adequate bond has been posted pending a good faith contest by Borrower (provided that no Credit Extensions will be required to be made during such cure period); 8.5 INSOLVENCY. If Borrower becomes insolvent, or if an Insolvency Proceeding is commenced by Borrower, or if an Insolvency Proceeding is commenced against Borrower and is not dismissed or stayed within thirty (30) days (provided that no Credit Extensions will be made prior to the dismissal of such Insolvency Proceeding); 8.6 OTHER AGREEMENTS. If there is a default or other failure to perform in any agreement to which Borrower is a party or by which it is bound resulting in a right by a third party or parties, whether or not exercised, to accelerate the maturity of any Indebtedness in an amount in excess of Fifty Thousand Dollars ($50,000); or which could have a Material Adverse Effect; 8.7 SUBORDINATED DEBT. If Borrower makes any payment on account of Subordinated Debt, except to the extent such payment is allowed under any subordination agreement entered into with Bank; 8.8 JUDGMENTS. If a judgment or judgments for the payment of money in an amount, individually or in the aggregate, of at least Fifty Thousand Dollars ($50,000) shall be rendered against Borrower and shall remain unsatisfied and unstayed for a period of ten (10) days (provided that no Credit Extensions will be made prior to the satisfaction or stay of such judgment); or 17 8.9 MISREPRESENTATIONS. If any material misrepresentation or material misstatement exists now or hereafter in any warranty or representation set forth herein or in any certificate delivered to Bank by any Responsible Officer pursuant to this Agreement or to induce Bank to enter into this Agreement or any other Loan Document. 9. BANK'S RIGHTS AND REMEDIES. -------------------------- 9.1 RIGHTS AND REMEDIES. Upon the occurrence and during the continuance of an Event of Default, Bank may, at its election, without notice of its election and without demand, do any one or more of the following, all of which are authorized by Borrower: (a) Declare all Obligations, whether evidenced by this Agreement, by any of the other Loan Documents, or otherwise, immediately due and payable (provided that upon the occurrence of an Event of Default described in Section 8.5, all Obligations shall become immediately due and payable without any action by Bank); (b) Cease advancing money or extending credit to or for the benefit of Borrower under this Agreement or under any other agreement between Borrower and Bank; (c) Settle or adjust disputes and claims directly with account debtors for amounts, upon terms and in whatever order that Bank reasonably considers advisable; (d) Make such payments and do such acts as Bank considers necessary or reasonable to protect its security interest in the Collateral. Borrower agrees to assemble the Collateral if Bank so requires, and to make the Collateral available to Bank as Bank may designate. Borrower authorizes Bank to enter the premises where the Collateral is located, to take and maintain possession of the Collateral, or any part of it, and to pay, purchase, contest, or compromise any encumbrance, charge, or lien which in Bank's determination appears to be prior or superior to its security interest and to pay all expenses incurred in connection therewith. With respect to any of Borrower's owned premises, Borrower hereby grants Bank a license to enter into possession of such premises and to occupy the same, without charge, in order to exercise any of Bank's rights or remedies provided herein, at law, in equity, or otherwise; (e) Set off and apply to the Obligations any and all (i) balances and deposits of Borrower held by Bank, or (ii) indebtedness at any time owing to or for the credit or the account of Borrower held by Bank; (f) Ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell (in the manner provided for herein) the Collateral. Bank is hereby granted a license or other right, solely pursuant to the provisions of this Section 9.1, to use, without charge, Borrower's labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks, service marks, and advertising matter, or any property of a similar nature, as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral and, in connection with Bank's exercise of its rights under this Section 9.1, Borrower's rights under all licenses and all franchise agreements shall inure to Bank's benefit; (g) Dispose of the Collateral by way of one or more contracts or transactions, for cash or on terms, in such manner and at such places (including Borrower's premises) as Bank determines is commercially reasonable, and apply any proceeds to the Obligations in whatever manner or order Bank deems appropriate; (h) Bank may credit bid and purchase at any public sale; and 18 (i) Any deficiency that exists after disposition of the Collateral as provided above will be paid immediately by Borrower. 9.2 POWER OF ATTORNEY. Effective only upon the occurrence and during the continuance of an Event of Default, Borrower hereby irrevocably appoints Bank (and any of Bank's designated officers, or employees) as Borrower's true and lawful attorney to: (a) send requests for verification of Accounts or notify account debtors of Bank's security interest in the Accounts; (b) endorse Borrower's name on any checks or other forms of payment or security that may come into Bank's possession; (c) sign Borrower's name on any invoice or bill of lading relating to any Account, drafts against account debtors, schedules and assignments of Accounts, verifications of Accounts, and notices to account debtors; (d) dispose of any Collateral; (e) make, settle, and adjust all claims under and decisions with respect to Borrower's policies of insurance; (f) settle and adjust disputes and claims respecting the accounts directly with account debtors, for amounts and upon terms which Bank determines to be reasonable; (g) to file, in its sole discretion, one or more financing or continuation statements and amendments thereto, relative to any of the Collateral without the signature of Borrower where permitted by law; and (h) to transfer the Intellectual Property Collateral into the name of Bank or a third party to the extent permitted under the California Uniform Commercial Code; provided Bank may exercise such power of attorney to sign the name of Borrower on any of the documents described in Section 4.2 regardless of whether an Event of Default has occurred, including without limitation to modify, in its sole discretion, any intellectual property security agreement entered into between Borrower and Bank without first obtaining Borrower's approval of or signature to such modification by amending Exhibits A, B, and C, thereof, as appropriate, to include reference to any right, title or interest in any Copyrights, Patents or Trademarks acquired by Borrower after the execution hereof or to delete any reference to any right, title or interest in any Copyrights, Patents or Trademarks in which Borrower no longer has or claims to have any right, title or interest. The appointment of Bank as Borrower's attorney in fact, and each and every one of Bank's rights and powers, being coupled with an interest, is irrevocable until all of the Obligations have been fully repaid and performed and Bank's obligation to provide Credit Extensions hereunder is terminated. 9.3 ACCOUNTS COLLECTION. At any time during the term of this Agreement, Bank may notify any Person owing funds to Borrower of Bank's security interest in such funds and verify the amount of such Account. Borrower shall collect all amounts owing to Borrower for Bank, receive in trust all payments as Bank's trustee, and immediately deliver such payments to Bank in their original form as received from the account debtor, with proper endorsements for deposit. 9.4 BANK EXPENSES. If Borrower fails to pay any amounts or furnish any required proof of payment due to third persons or entities, as required under the terms of this Agreement, then Bank may do any or all of the following after reasonable notice to Borrower: (a) make payment of the same or any part thereof; (b) set up such reserves under a loan facility in Section 2.1 as Bank deems necessary to protect Bank from the exposure created by such failure; or (c) obtain and maintain insurance policies of the type discussed in Section 6.6 of this Agreement, and take any action with respect to such policies as Bank deems prudent. Any amounts so paid or deposited by Bank shall constitute Bank Expenses, shall be immediately due and payable, and shall bear interest at the then applicable rate hereinabove provided, and shall be secured by the Collateral. Any payments made by Bank shall not constitute an agreement by Bank to make similar payments in the future or a waiver by Bank of any Event of Default under this Agreement. 9.5 BANK'S LIABILITY FOR COLLATERAL. So long as Bank complies with reasonable banking practices, Bank shall not in any way or manner be liable or responsible for: (a) the safekeeping of the Collateral; (b) any loss or damage thereto occurring or arising in any manner or fashion from any cause; (c) any diminution in the value thereof; or (d) any act or default of any carrier, warehouseman, bailee, forwarding agency, or other person whomsoever. All risk of loss, damage or destruction of the Collateral shall be borne by Borrower. 9.6 REMEDIES CUMULATIVE. Bank's rights and remedies under this Agreement, the Loan Documents, and all other agreements shall be cumulative. Bank shall have all other rights and remedies not inconsistent herewith as provided under the Code, by law, or in equity. No exercise by Bank of one right or remedy shall be deemed an election, and no waiver by Bank of any Event of Default on Borrower's part shall be deemed a continuing waiver. No delay by Bank shall constitute a waiver, election, or acquiescence by it. No waiver by Bank shall be effective unless made in a written document signed on behalf of Bank and then shall be effective only in the specific instance and for the specific purpose for which it was given. 19 9.7 DEMAND; PROTEST. Borrower waives demand, protest, notice of protest, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees at any time held by Bank on which Borrower may in any way be liable. 10. NOTICES. ------- Unless otherwise provided in this Agreement, all notices or demands by any party relating to this Agreement or any other agreement entered into in connection herewith shall be in writing and (except for financial statements and other informational documents which may be sent by first-class mail, postage prepaid) shall be personally delivered or sent by a recognized overnight delivery service, certified mail, postage prepaid, return receipt requested, or by telefacsimile to Borrower or to Bank, as the case may be, at its addresses set forth below: If to Borrower: PERSISTENCE SOFTWARE, INC. 1720 South Amphlett Boulevard 3rd Floor San Mateo, CA 94402 Attn: Christine Russell FAX: (____) _______________ If to Bank: Comerica Bank-California 333 W. Santa Clara St. San Jose, CA 95113 Attn: Corporate Banking Center with a copy to: Comerica Bank-California 800 Oak Grove Avenue Menlo Park, CA 94025 Attn: Guy Simpson FAX: (650) 462-6058 The parties hereto may change the address at which they are to receive notices hereunder, by notice in writing in the foregoing manner given to the other. 11. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER. ------------------------------------------ This Agreement shall be governed by, and construed in accordance with, the internal laws of the State of California, without regard to principles of conflicts of law. Each of Borrower and Bank hereby submits to the exclusive jurisdiction of the state and Federal courts located in the County of Santa Clara, State of California. BORROWER AND BANK EACH HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN, INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS. EACH PARTY RECOGNIZES AND AGREES THAT THE FOREGOING WAIVER CONSTITUTES A MATERIAL INDUCEMENT FOR IT TO ENTER INTO THIS AGREEMENT. EACH PARTY REPRESENTS AND WARRANTS THAT IT HAS REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL AND THAT IT KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. 12. GENERAL PROVISIONS. ------------------ 12.1 SUCCESSORS AND ASSIGNS. This Agreement shall bind and inure to the benefit of the respective successors and permitted assigns of each of the parties; provided, however, that neither this Agreement nor any rights hereunder may be assigned by Borrower without Bank's prior written consent, which consent may be granted or withheld in Bank's sole discretion. Bank shall have the right without the consent of or notice to Borrower to sell, transfer, negotiate, or grant participation in all or any part of, or any interest in, Bank's obligations, rights and benefits hereunder. 20 12.2 INDEMNIFICATION. Borrower shall defend, indemnify and hold harmless Bank and its officers, employees, and agents against: (a) all obligations, demands, claims, and liabilities claimed or asserted by any other party in connection with the transactions contemplated by this Agreement; and (b) all losses or Bank Expenses in any way suffered, incurred, or paid by Bank as a result of or in any way arising out of, following, or consequential to transactions between Bank and Borrower whether under this Agreement, or otherwise (including without limitation reasonable attorneys' fees and expenses), except for losses caused by Bank's gross negligence or willful misconduct. 12.3 TIME OF ESSENCE. Time is of the essence for the performance of all obligations set forth in this Agreement. 12.4 SEVERABILITY OF PROVISIONS. Each provision of this Agreement shall be severable from every other provision of this Agreement for the purpose of determining the legal enforceability of any specific provision. 12.5 AMENDMENTS IN WRITING, INTEGRATION. Neither this Agreement nor the Loan Documents cannot be amended or terminated orally. All prior agreements, understandings, representations, warranties, and negotiations between the parties hereto with respect to the subject matter of this Agreement and the Loan Documents, if any, are merged into this Agreement and the Loan Documents. 12.6 COUNTERPARTS. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, shall be deemed to be an original, and all of which, when taken together, shall constitute but one and the same Agreement. 12.7 SURVIVAL. All covenants, representations and warranties made in this Agreement shall continue in full force and effect so long as any Obligations remain outstanding. The obligations of Borrower to indemnify Bank with respect to the expenses, damages, losses, costs and liabilities described in Section 12.2 shall survive until all applicable statute of limitations periods with respect to actions that may be brought against Bank have run. 12.8 EFFECT OF AMENDMENT AND RESTATEMENT. This Agreement is intended to and does completely amend and restate, without novation, the Original Agreement. All security interests granted under the Original Agreement are hereby confirmed and ratified and shall continue to secure all Obligations under this Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written. PERSISTENCE SOFTWARE, INC. By: /s/ CHRISTINE RUSSELL --------------------- Title: CFO COMERICA BANK - CALIFORNIA By: --------------------- Title: --------------------- 21 DEBTOR PERSISTENCE SOFTWARE, INC. SECURED PARTY: COMERICA BANK - CALIFORNIA EXHIBIT A --------- COLLATERAL DESCRIPTION ATTACHMENT TO AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT All personal property of Borrower (herein referred to as "Borrower" or "Debtor") whether presently existing or hereafter created or acquired, and wherever located, including, but not limited to: (a) all accounts (including health-care-insurance receivables), chattel paper (including tangible and electronic chattel paper), deposit accounts, documents (including negotiable documents), equipment (including all accessions and additions thereto), general intangibles (including payment intangibles and software), goods (including fixtures), instruments (including promissory notes), inventory (including all goods held for sale or lease or to be furnished under a contract of service, and including returns and repossessions), investment property (including securities and securities entitlements), letter of credit rights, money, and all of Debtor's books and records with respect to any of the foregoing, and the computers and equipment containing said books and records; (b) all common law and statutory copyrights and copyright registrations, applications for registration, now existing or hereafter arising, in the United States of America or in any foreign jurisdiction, obtained or to be obtained on or in connection with any of the forgoing, or any parts thereof or any underlying or component elements of any of the forgoing, together with the right to copyright and all rights to renew or extend such copyrights and the right (but not the obligation) of Secured Party to sue in its own name and/or in the name of the Debtor for past, present and future infringements of copyright; (c) all trademarks, service marks, trade names and service names and the goodwill associated therewith, together with the right to trademark and all rights to renew or extend such trademarks and the right (but not the obligation) of Secured Party to sue in its own name and/or in the name of the Debtor for past, present and future infringements of trademark; (d) all (i) patents and patent applications filed in the United States Patent and Trademark Office or any similar office of any foreign jurisdiction, and interests under patent license agreements, including, without limitation, the inventions and improvements described and claimed therein, (ii) licenses pertaining to any patent whether Debtor is licensor or licensee, (iii) income, royalties, damages, payments, accounts and accounts receivable now or hereafter due and/or payable under and with respect thereto, including, without limitation, damages and payments for past, present or future infringements thereof, (iv) right (but not the obligation) to sue in the name of Debtor and/or in the name of Secured Party for past, present and future infringements thereof, (v) rights corresponding thereto throughout the world in all jurisdictions in which such patents have been issued or applied for, and (vi) reissues, divisions, continuations, renewals, extensions and continuations-in-part with respect to any of the foregoing; and (e) any and all cash proceeds and/or noncash proceeds of any of the foregoing, including, without limitation, insurance proceeds, and all supporting obligations and the security therefor or for any right to payment. All terms above have the meanings given to them in the California Uniform Commercial Code, as amended or supplemented from time to time, including revised Division 9 of the Uniform Commercial Code-Secured Transactions, added by Stats. 1999, c.991 (S.B. 45), Section 35, operative July 1, 2001. 22 EXHIBIT B --------- LOAN PAYMENT/ADVANCE TELEPHONE REQUEST FORM DEADLINE FOR SAME DAY PROCESSING IS 3:00 P.M., PACIFIC TIME TO: TECHNOLOGY & LIFE SCIENCES DIVISION DATE: _______________ FAX #: 650-846-6840 Attn: Compliance TIME: _______________ - -------------------------------------------------------------------------------- FROM: PERSISTENCE SOFTWARE, INC. -------------------------------------------------------------------------- CLIENT NAME (BORROWER) REQUESTED BY: ------------------------------------------------------------------- AUTHORIZED SIGNER'S NAME AUTHORIZED SIGNATURE: ----------------------------------------------------------- PHONE NUMBER: ------------------------------------------------------------------- FROM ACCOUNT # ______________________ TO ACCOUNT # _______________________ REQUESTED TRANSACTION TYPE REQUEST DOLLAR AMOUNT - -------------------------- --------------------- $_________________________ PRINCIPAL INCREASE (ADVANCE) $_________________________ PRINCIPAL PAYMENT (ONLY) $_________________________ INTEREST PAYMENT (ONLY) $_________________________ PRINCIPAL AND INTEREST (PAYMENT) $_________________________ OTHER INSTRUCTIONS: ------------------------------------------------------------ - -------------------------------------------------------------------------------- All representations and warranties of Borrower stated in the Amended and Restated Loan and Security Agreement are true, correct and complete in all material respects as of the date of the telephone request for an Advance confirmed by this Borrowing Certificate; provided, however, that those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- BANK USE ONLY TELEPHONE REQUEST: - ----------------- The following person is authorized to request the loan payment transfer/loan advance on the advance designated account and is known to me. - ----------------------------------------- ---------------------- Authorized Requester Phone # - ----------------------------------------- ---------------------- Received By (Bank) Phone # --------------------------------------------- Authorized Signature (Bank) - -------------------------------------------------------------------------------- 23
EXHIBIT C --------- BORROWING BASE CERTIFICATE - ------------------------------------------------------------------------------------------------------------------------ Borrower: PERSISTENCE SOFTWARE, INC. Lender: Comerica Bank-California Commitment Amount: $5,000,000 - ------------------------------------------------------------------------------------------------------------------------ ACCOUNTS RECEIVABLE 1. Accounts Receivable Book Value as of ___ $___________ 2. Additions (please explain on reverse) $___________ 3. TOTAL ACCOUNTS RECEIVABLE $___________ ACCOUNTS RECEIVABLE DEDUCTIONS (without duplication) 4. Amounts over 90 days due $___________ 5. Balance of 25% over 90 day accounts $___________ 6. Concentration Limits $___________ 7. Foreign Accounts $___________ 8. Governmental Accounts $___________ 9. Contra Accounts $___________ 10. Demo Accounts $___________ 11. Intercompany/Employee Accounts $___________ 12. Other (please explain on reverse) $___________ 13. TOTAL ACCOUNTS RECEIVABLE DEDUCTIONS $___________ 14. Eligible Accounts (#3 minus #13) $___________ 15. LOAN VALUE OF ACCOUNTS (greater of $200,000 or 70% of #14) $___________ BALANCES 16. Maximum Loan Amount $___________ 17. Total Funds Available [Lesser of #16 or #15] $___________ 18. Present balance owing on Line of Credit $___________ 19. Outstanding under Sublimits (Letters of Credit) $___________ 20. RESERVE POSITION (#17 minus #18 and #19) $___________ THE UNDERSIGNED REPRESENTS AND WARRANTS THAT THE FOREGOING IS TRUE, COMPLETE AND CORRECT, AND THAT THE INFORMATION REFLECTED IN THIS BORROWING BASE CERTIFICATE COMPLIES WITH THE REPRESENTATIONS AND WARRANTIES SET FORTH IN THE LOAN AND SECURITY AGREEMENT BETWEEN THE UNDERSIGNED AND COMERICA BANK-CALIFORNIA. PERSISTENCE SOFTWARE, INC. By:_______________________________________ Authorized Signer
24 EXHIBIT D --------- COMPLIANCE CERTIFICATE TO: COMERICA BANK - CALIFORNIA FROM: PERSISTENCE SOFTWARE, INC. The undersigned authorized officer of PERSISTENCE SOFTWARE, INC. hereby certifies that in accordance with the terms and conditions of the Amended and Restated Loan and Security Agreement between Borrower and Bank (the "Agreement"), (i) Borrower is in complete compliance for the period ending _______________ with all required covenants except as noted below and (ii) all representations and warranties of Borrower stated in the Agreement are true and correct as of the date hereof. Attached herewith are the required documents supporting the above certification. The Officer further certifies that these are prepared in accordance with Generally Accepted Accounting Principles (GAAP) and are consistently applied from one period to the next except as explained in an accompanying letter or footnotes. PLEASE INDICATE COMPLIANCE STATUS BY CIRCLING YES/NO UNDER "COMPLIES" COLUMN.
REPORTING COVENANT REQUIRED COMPLIES - ------------------ -------- -------- Financial statements Quarterly within 45 days (monthly w/i 20 Yes No days if Line exposure > $200,000) Annual (CPA Audited) FYE within 90 days Yes No 10K and 10Q When filed Yes No A/R Audit Semi-Annual Yes No A/R & A/P Agings, Borrowing Base Cert. Monthly within 15 days if Line exposure > Yes No $200,000 IP Report Quarterly within 45 days Yes No Total amount of Borrower's cash and investments Amount: $________ Yes No Total amount of Borrower's cash and investments maintained with Bank Amount: $________ Yes No FINANCIAL COVENANT REQUIRED ACTUAL COMPLIES - ------------------ -------- ------ -------- Maintain on a Quarterly / Monthly* Basis: Minimum Quick Ratio 2.00:1.00 _____:1.00 Yes No Minimum Tangible Net Worth $7,000,000** $________ Yes No * These covenants shall be measured as of the last day of each quarter, provided that, at any time that the aggregate amount of the outstanding Advances plus the aggregate undrawn face amount of all outstanding Letters of Credit is in excess of $200,000, this covenant shall be measured as of the last day of each month. ** such required amount shall increase by 50% of Borrower's net income in each quarter after the Closing Date and by 75% of any proceeds received by Borrower after the Closing Date from the sale and issuance of its equity securities. ------------------------------------------------------- COMMENTS REGARDING EXCEPTIONS: See Attached. BANK USE ONLY Received by: ----------------------------------------- Sincerely, AUTHORIZED SIGNER Date: ------------------------------------------------- Verified: ---------------------------------------------- - ------------------------------------------------ SIGNATURE AUTHORIZED SIGNER Date: -------------------------------------------------- - ------------------------------------------------ TITLE Compliance Status Yes No DATE -------------------------------------------------------
25 SCHEDULE OF EXCEPTIONS ---------------------- PERMITTED INDEBTEDNESS (Section 1.1) - ---------------------- PERMITTED INVESTMENTS (Section 1.1) - --------------------- PERMITTED LIENS (Section 1.1) - --------------- PRIOR NAMES (Section 5.7) - ----------- LITIGATION (Section 5.8) - ---------- 26 CORPORATE RESOLUTIONS TO BORROW - -------------------------------------------------------------------------------- BORROWER: PERSISTENCE SOFTWARE, INC. - -------------------------------------------------------------------------------- I, the undersigned Secretary or Assistant Secretary of PERSISTENCE SOFTWARE, INC. (the "Corporation"), HEREBY CERTIFY that the Corporation is organized and existing under and by virtue of the laws of the State of Delaware. I FURTHER CERTIFY that attached hereto as Attachments 1 and 2 are true and complete copies of the Certificate of Incorporation, as amended, and the Restated Bylaws of the Corporation, each of which is in full force and effect on the date hereof. I FURTHER CERTIFY that at a meeting of the Directors of the Corporation, duly called and held, at which a quorum was present and voting (or by other duly authorized corporate action in lieu of a meeting), the following resolutions were adopted. BE IT RESOLVED, that any one (1) of the following named officers, employees, or agents of this Corporation, whose actual signatures are shown below: NAMES POSITION ACTUAL SIGNATURES ----- -------- ----------------- - ------------------------ ------------------------- --------------------------- - ------------------------ ------------------------- --------------------------- - ------------------------ ------------------------- --------------------------- - ------------------------ ------------------------- --------------------------- acting for and on behalf of this Corporation and as its act and deed be, and they hereby are, authorized and empowered: BORROW MONEY. To borrow from time to time from COMERICA BANK - CALIFORNIA ("Bank"), on such terms as may be agreed upon between the officers, employees, or agents of the Corporation and Bank, such sum or sums of money as in their judgment should be borrowed, without limitation. EXECUTE LOAN DOCUMENTS. To execute and deliver to Bank that certain Amended and Restated Loan and Security Agreement dated as of March 6, 2002 (the "Loan Agreement") and any other agreement entered into between Corporation and Bank in connection with the Loan Agreement, including any amendments, all as amended or extended from time to time (collectively, with the Loan Agreement, the "Loan Documents"), and also to execute and deliver to Bank one or more renewals, extensions, modifications, refinancings, consolidations, or substitutions for the Loan Documents, or any portion thereof. GRANT SECURITY. To grant a security interest to Bank in the Collateral described in the Loan Documents, which security interest shall secure all of the Corporation's Obligations, as described in the Loan Documents. NEGOTIATE ITEMS. To draw, endorse, and discount with Bank all drafts, trade acceptances, promissory notes, or other evidences of indebtedness payable to or belonging to the Corporation or in which the Corporation may have an interest, and either to receive cash for the same or to cause such proceeds to be credited to the account of the Corporation with Bank, or to cause such other disposition of the proceeds derived therefrom as they may deem advisable. LETTERS OF CREDIT. To execute letter of credit applications and other related documents pertaining to Bank's issuance of letters of credit. FURTHER ACTS. In the case of lines of credit, to designate additional or alternate individuals as being authorized to request advances thereunder, and in all cases, to do and perform such other acts and things, to pay any and all fees and costs, and to execute and deliver such other documents and agreements as they may in their discretion deem reasonably necessary or proper in order to carry into effect the provisions of these Resolutions. 1 BE IT FURTHER RESOLVED, that any and all acts authorized pursuant to these resolutions and performed prior to the passage of these resolutions are hereby ratified and approved, that these Resolutions shall remain in full force and effect and Bank may rely on these Resolutions until written notice of their revocation shall have been delivered to and received by Bank. Any such notice shall not affect any of the Corporation's agreements or commitments in effect at the time notice is given. I FURTHER CERTIFY that the officers, employees, and agents named above are duly elected, appointed, or employed by or for the Corporation, as the case may be, and occupy the positions set forth opposite their respective names; that the foregoing Resolutions now stand of record on the books of the Corporation; and that the Resolutions are in full force and effect and have not been modified or revoked in any manner whatsoever. IN WITNESS WHEREOF, I have hereunto set my hand on March 6, 2002 and attest that the signatures set opposite the names listed above are their genuine signatures. CERTIFIED AND ATTESTED BY: X /S/ BRIAN TOBIN - -------------------------------------------------------------------------------- 2 COMERICA BANK - CALIFORNIA MEMBER FDIC ITEMIZATION OF AMOUNT FINANCED DISBURSEMENT INSTRUCTIONS Name(s): PERSISTENCE SOFTWARE, INC. Date: March 6, 2002 $ credited to deposit account No. ___________ when Advances are requested by Borrower Amounts paid to others on your behalf: $ to COMERICA BANK - CALIFORNIA for Loan Fee $ to Bank counsel fees and expenses $ to _______________ $ to _______________ $5,000,000 TOTAL (AMOUNT FINANCED) Upon consummation of this transaction, this document will also serve as the authorization for COMERICA BANK - CALIFORNIA to disburse the loan proceeds as stated above. -------------------------------- --------------------------------- Signature Signature AGREEMENT TO PROVIDE INSURANCE TO: COMERICA BANK - CALIFORNIA Date: March 6, 2002 attn: Collateral Operations, M/C 4604 9920 South La Cienega Blvd, Suite 628 Inglewood, CA 90301-4423 Borrower: PERSISTENCE SOFTWARE, INC. In consideration of a loan in the amount of $5,436,863.07, secured by all tangible personal property including inventory and equipment. I/We agree to obtain adequate insurance coverage to remain in force during the term of the loan. I/We also agree to advise the below named agent to add COMERICA BANK - CALIFORNIA as lender's loss payable on the new or existing insurance policy, and to furnish Bank at above address with a copy of said policy/endorsements and any subsequent renewal policies. I/We understand that the policy must contain: 1. Fire and extended coverage in an amount sufficient to cover: (a) The amount of the loan, OR (b) All existing encumbrances, whichever is greater, But not in excess of the replacement value of the improvements on the real property. 2. Lender's "Loss Payable" Endorsement Form 438 BFU in favor of COMERICA BANK - CALIFORNIA, or any other form acceptable to Bank. INSURANCE INFORMATION Insurance Co./Agent Telephone No.: Agent's Address: Signature of Obligor: ------------------------------- Signature of Obligor: ------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - --------------------------------------------- FOR BANK USE ONLY INSURANCE VERIFICATION: Date: Person Spoken to: ---------------------------- Policy Number: ------------------------------- Effective From: To: ------------- ------------- Verified by: --------------------------------- - --------------------------------------------- - -------------------------------------------------------------------------------- COMERICA BANK - CALIFORNIA CALIFORNIA'S BUSINESS BANKS AUTOMATIC DEBIT AUTHORIZATION MEMBER FDIC - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- To: COMERICA BANK - CALIFORNIA Re: LOAN # ___________________________________ You are hereby authorized and instructed to charge account No. _________________________ in the name of PERSISTENCE SOFTWARE, INC. - -------------------------------------------------------------------------------- for principal and interest payments due on above referenced loan as set forth below and credit the loan referenced above. [X] Debit each interest payment as it becomes due according to the terms of the note and any renewals or amendments thereof. [X] Debit each principal payment as it becomes due according to the terms of the note and any renewals or amendments thereof. This Authorization is to remain in full force and effect until revoked in writing. - -------------------------------------------------------------------------------- - ----------------------------------------------------- -------------------------- Borrower Signature Date - ----------------------------------------------------- -------------------------- March 6, 2002 - ----------------------------------------------------- -------------------------- - ----------------------------------------------------- -------------------------- DEBTOR: PERSISTENCE SOFTWARE, INC. SECURED PARTY: COMERICA BANK - CALIFORNIA EXHIBIT A --------- COLLATERAL DESCRIPTION ATTACHMENT TO UCC-1 FINANCING STATEMENT All personal property of Borrower (herein referred to as "Borrower" or "Debtor") whether presently existing or hereafter created or acquired, and wherever located, including, but not limited to: (a) all accounts (including health-care-insurance receivables), chattel paper (including tangible and electronic chattel paper), deposit accounts, documents (including negotiable documents), equipment (including all accessions and additions thereto), general intangibles (including payment intangibles and software), goods (including fixtures), instruments (including promissory notes), inventory (including all goods held for sale or lease or to be furnished under a contract of service, and including returns and repossessions), investment property (including securities and securities entitlements), letter of credit rights, money, and all of Debtor's books and records with respect to any of the foregoing, and the computers and equipment containing said books and records; (b) all common law and statutory copyrights and copyright registrations, applications for registration, now existing or hereafter arising, in the United States of America or in any foreign jurisdiction, obtained or to be obtained on or in connection with any of the forgoing, or any parts thereof or any underlying or component elements of any of the forgoing, together with the right to copyright and all rights to renew or extend such copyrights and the right (but not the obligation) of Secured Party to sue in its own name and/or in the name of the Debtor for past, present and future infringements of copyright; (c) all trademarks, service marks, trade names and service names and the goodwill associated therewith, together with the right to trademark and all rights to renew or extend such trademarks and the right (but not the obligation) of Secured Party to sue in its own name and/or in the name of the Debtor for past, present and future infringements of trademark; (d) all (i) patents and patent applications filed in the United States Patent and Trademark Office or any similar office of any foreign jurisdiction, and interests under patent license agreements, including, without limitation, the inventions and improvements described and claimed therein, (ii) licenses pertaining to any patent whether Debtor is licensor or licensee, (iii) income, royalties, damages, payments, accounts and accounts receivable now or hereafter due and/or payable under and with respect thereto, including, without limitation, damages and payments for past, present or future infringements thereof, (iv) right (but not the obligation) to sue in the name of Debtor and/or in the name of Secured Party for past, present and future infringements thereof, (v) rights corresponding thereto throughout the world in all jurisdictions in which such patents have been issued or applied for, and (vi) reissues, divisions, continuations, renewals, extensions and continuations-in-part with respect to any of the foregoing; and (e) any and all cash proceeds and/or noncash proceeds of any of the foregoing, including, without limitation, insurance proceeds, and all supporting obligations and the security therefor or for any right to payment. All terms above have the meanings given to them in the California Uniform Commercial Code, as amended or supplemented from time to time, including revised Division 9 of the Uniform Commercial Code-Secured Transactions, added by Stats. 1999, c.991 (S.B. 45), Section 35, operative July 1, 2001. EX-10.14 4 persistence_10kex10-14.txt EXHIBIT 10.14 AMENDMENT #15 AMENDMENT #15 RENEWAL/DOWNSIZE OF SUITE 230 AMENDMENT, made this 5th day of February 2002, between CORNERSTONE PROPERTIES I, LLC, having an office at 1720 So. Amphlett Blvd., Suite 110, San Mateo, California, 94402, "Lessor", and PERSISTENCE SOFTWARE, having an office at 1720 So. Amphlett Blvd., Suite 300 San Mateo, California, 94402, "Lessee." WHEREAS, PERSISTENCE SOFTWARE, and BAYSHORE CORPORATE CENTER, entered into a Master Lease dated June 21, 1991 covering Suite 250 in the Building 1700 South Amphlett Blvd., San Mateo, California, 94402, at the rental and upon the terms and conditions there more particularly set forth; and WHEREAS, Lessor and Lessee are desirous of amending said Lease in the manner set forth below. SQUARE FOOTAGE: Lessee occupies 17,181 square feet in Suite 300 and 11,527 square feet in suite 230. Effective February 1, 2002 lessee will relinquish 11,527 in suite 230. Floor plan attached. The total leased square footage is 17,181. LEASE TERM: The term for the above mentioned space shall be from February 1, 2002 to December 31, 2004. RENT SCHEDULE: February 1, 2002 - December 31, 2002 $2.25/square foot $38,657.00/month January 1, 2003 - December 31, 2003 $2.50/square foot $42,953.00/month January 1, 2004 - December 31, 2004 $2.75/square foot $47,248.00/month SECURITY DEPOSIT: Prior to this Lease Amendment "Lessee" had deposited with "Lessor" a security deposit in the amount of $1,545.00. There will be no increase in security deposit at this time. ================================================================================ TENANT IMPROVEMENT COSTS: Paid by Lessor; none Paid by Lessee; none ADDITIONAL BLDG/SUITE TENANT OCCUPIES: none OPERATING EXPENSES: Lessee will be billed for Operating Costs and Property Taxes at a proportionate rate of 5.16%. The base year for Operating Costs and Property Taxes shall be 2001. GENERAL TERMS: All other terms, covenants, provisions, and agreements of said Lease dated June 21, 1991 and subsequent Amendments shall remain in full force. NON-DISCLOSURE OF TERMS: Tenant acknowledges and agrees that the terms of the Lease, this Amenment, and any other amendments to the Lease are intended to be confidential. Disclosure of such terms could adversely affect the ability of Landlord to negotiate other leases, amendments to leases, and impair Landlords relationship with other tenants. Accordingly, Tenant agrees that it, and its partners, officers, directors, members, employees, agents and attorneys, shall not intentionally and voluntarily disclose the terms and conditions of the Lease, this Amendment, and any other amendments to the Lease to any newspaper or other publication or any other tenant or apparent prospective tenant of the building in which the Premises are located or other portion of the project in which the Premises are located, or any real estate broker or agent, either directly or indirectly, without the prior writeen consent of Landlord; provided, however, that Tenant may disclose such terms to the following parties on the express condition that Tenant has obtained a written non-disclosure agreement for the benefit of Landlord, identical to the agreement of Tenant as contained in this paragraph, from such party: (a) any prospective subtenants or assignees under the Lease, and (b) Tenant's real estate broker or agent. IN WITNESS WHEREOF, this Amendment to Lease has been duly executed by the parties hereto. Dated: 2/7/02 Lessor: CORNERSTONE PROPERTIES I, LLC /s/ Steve Kaufman ----------------------------------- By: Steve Kaufman Dated: Feb 5, 2002 Lessee: PERSISTENCE SOFTWARE /s/ Andrew Olding ----------------------------------- By: Andrew Olding Corp Controller EX-10.15 5 persistence_10kex10-15.txt EXHIBIT 10.15 PERSISTENCE SOFTWARE, INC. 1720 S. Amphlett Blvd. Third Floor San Mateo, CA 94402 PRIVILEGED AND CONFIDENTIAL September 17, 2001 Keith Zaky 1491 Canada Lane Woodside, CA 94062 Dear Keith, Persistence Software, Inc. (the "Company") considers it essential to the best interests of its shareholders, in appropriate circumstances, to foster the continuous employment of key management personnel. In this connection, the Board of Directors of the Company (the "Board") recognizes that, as is the case with many corporations today, the possibility of a change in control may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its shareholders. The Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company's management, including yourself, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a change in control of the Company. In order to induce you to remain in the employ of the Company and in consideration of your agreements set forth in subparagraph 2(e) hereof, the Company agrees that you shall receive the severance benefits set forth in this letter agreement ("Agreement") in the event your employment with the Company terminates within twelve (12) months subsequent to a "Change in Control" of the Company (as defined in subparagraph 2(c) hereof) under the circumstances described below. 1. TERM OF AGREEMENT. This Agreement shall commence on the date hereof and shall continue in effect until the earliest of (a) the fourth anniversary of the date of this Agreement (b) termination of your employment with the Company other than after a Change in Control, or (c) written agreement between you and the Company to terminate the Agreement. 2. DEFINITIONS. As used in this Agreement: 1 (a) "Board" shall mean the Board of Directors of the Company. (b) "Cause" shall mean grounds for termination of your employment by the Company as set forth in Paragraph 4 hereof which, as herein provided, shall not result in any compensation upon termination as provided in Paragraph 3 hereof. (c) "Change in Control" shall mean an acquisition of all or substantially all of the assets of the Company or the acquisition of the Company by merger or pursuant to a registered tender or exchange offer or combination of the Company with another corporation, resulting in less than a majority of the outstanding voting shares of the surviving corporation being held, immediately after such acquisition or combination, by the holders of the voting shares of the Company outstanding immediately prior to such acquisition or combination. (d) "Good Reason" shall mean grounds for termination by you of your employment by the Company based upon prior constructive termination by the Company as provided in Paragraph 5 hereof. (e) "Potential Change in Control of the Company" shall be deemed to have occurred if (i) the Company enters into an agreement or letter of intent, the consummation of which would result in the occurrence of a Change in Control of the Company, (ii) any person (including the company) publicly announces an intention to take or consider taking actions which if consummated would constitute a Change in Control of the Company; (iii) any person, other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company, who is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 9.5% or more of the combined voting power of the Company's then outstanding securities, increases his beneficial ownership of such securities by 5 percentage points or more over the percentage so owned by such person on the date hereof; or (iv) the Board adopts a resolution to the effect that for the purposes of this Agreement, a Potential Change in Control of the Company has occurred. You agree that, subject to the terms and conditions of this Agreement, in the event of a Potential Change in Control of the Company, you will remain in the employ of the Company (or the subsidiary thereof by which you are employed at the date such Potential Change in Control occurs) until the earliest of (x) a date which is six months after the occurrence of such Potential Change in Control of the Company, or (y) the occurrence of a Change in Control of the Company. 3. COMPENSATION UPON TERMINATION OF EMPLOYMENT FOLLOWING A CHANGE IN CONTROL. Subject to Sections 6 and 7 below, if your employment with the Company is terminated within 12 (twelve) months after a Change in Control, (a) The Company agrees that vesting of restricted stock previously sold or options previously issued to you under the Company's 1997 Stock Plan (including any stock or options issued in exchange for such stock as a result of a Change in Control), whether vested or unvested, shall be immediately accelerated upon such termination, to the extent of twenty-four (24) additional months of vesting. 2 (b) Anything contained in subparagraph (a) above to the contrary notwithstanding, the Company shall have no obligation to accelerate vesting under this Agreement in the event of termination prior to a Change in Control or if, after a Change in Control, it terminates your employment for "Cause," or if your employment terminates due to death, retirement or resignation other than for "Good Reason." Furthermore, if it is determined by the Company's Board of Directors, upon receipt of a written opinion of the Company's independent public accountants that acceleration of vesting would preclude accounting for the acquisition of the Company as a pooling of interests, and the Board otherwise desires to approve a proposed acquisition of the Company by an acquiring company which requires as a condition to closing of the acquisition, that the acquisition be accounted for as a pooling of interests, then the Company shall not be obligated to accelerate your vesting under this Paragraph 3. 4. TERMINATION FOR CAUSE. Termination of your employment with the Company shall be regarded as termination for Cause only upon: (a) your willful and continued failure to substantially perform your duties with the Company (other than such failure resulting from your incapacity due to physical or mental illness) after there is delivered to you by the President and CEO a written demand for substantial performance which sets forth in detail the specific respects in which it believes you have not substantially performed your duties; (b) your willfully engaging in gross misconduct which is materially and demonstrably injurious to the Company; (c) your committing a felony or an act of fraud against the Company or its affiliates; or (d) your breaching materially the terms of your employee confidentiality and proprietary information agreement with the Company. No act, or failure to act, by you shall be considered "willful" if done, or omitted to be done, by you in good faith and in your reasonable belief that your act or omission was in the best interest of the Company and/or required by applicable law. 5. TERMINATION FOR GOOD REASON. Your employment with the Company may be regarded as having been constructively terminated by the Company and you may therefore terminate your employment for Good Reason and thereupon become entitled to compensation pursuant to Paragraph 3 above, if, after a Change in Control, one or more of the following events shall occur: (i) the significant reduction of your duties or the assignment to you of duties which are inconsistent with your position as Senior Vice President, Sales with the Company immediately prior to a Change in Control; it being understood that your assignment of the position of Senior Vice President, Sales, reporting to the CEO of the Company or a company into which the Company is merged in a Change of Control or otherwise acquiring assets or voting shares of the Company in connection with a Change of Control, or a parent of such a company, shall not constitute a significant reduction of your duties or assignment of duties inconsistent with your position and shall not constitute grounds for you to terminate your employment of Good Reason; 3 (ii) without your express written consent, the substantial reduction, without good business reasons, of the facilities and perquisites (including office space and location) available to you immediately prior to a Change in Control; (iii) a reduction by the Company in your salary or in any bonus compensation formula applicable to you as in effect immediately prior to a Change in Control, or the failure by the Company to increase such base salary each year following a Change in Control by an amount which equals at least three-fourths (3/4), on a percentage basis, of the average annual percentage increase in base salary for all officers of the Company (and any successor of the Company) during the prior two full calendar years; (iv) a material reduction by the Company in the kind or level of employee benefits to which you were entitled prior to a Change in Control with the result that your overall benefits package is significantly reduced after the Change in Control; or the taking of any action by the Company which would materially and adversely affect your participation in any plan, program or policy generally applicable to executives or employees of the Company or any successor of the Company (including but not limited to paid vacation days), or deprive you in a material and substantial way of any fringe benefits enjoyed by you prior to a Change in Control; (v) the Company's requiring you to be based anywhere other than your present location (except for required travel on the Company's business to an extent substantially consistent with your present business travel obligations) or a location more than 50 miles from your then present location, without your consent; (vi) any purported termination of your employment by the Company which is not effected for Cause, or any purported termination for which the grounds relied upon are not valid; or (vii) the failure of the Company to obtain the assumption of this Agreement by any successor as contemplated in Paragraph 10 hereof. 6. DISPUTES. To dispute a termination for Good Reason by you, the Company must give you written notice of such dispute within 30 working days after your effective date of termination. To dispute a termination by the Company or any failure to make payments claimed to be due hereunder, you must give written notice of such a dispute to the Company within 30 days after the date on which a payment claimed by you to be due hereunder was due to be made, as the case may be. 7. NO MITIGATION. No payment or benefit to which you are entitled pursuant to Paragraph 3 hereof shall be reduced by reason of compensation or other income you receive for services rendered after your termination of employment with the Company. 4 8. COMPANY'S SUCCESSORS. The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform the obligations under this Agreement in the same manner and to the same extent the Company would be required to perform if no such succession had taken place. As used in this Paragraph, "Company" includes any successor to its business or assets as aforesaid which executes and delivers this Agreement or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 9. NOTICE. Notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when personally delivered or five (5) days after deposit with postal authorities transmitted by United States registered or certified mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth on the first or last page of this Agreement, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 10. AMENDMENT OR WAIVER. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing by you and the Company. No waiver of either party at any time of the breach of, or lack of compliance with, any conditions or provisions of this Agreement shall be deemed a waiver of other provisions or conditions hereof. 11. SOLE AGREEMENT. This Agreement represents the entire agreement between you and the Company with respect to the matters set forth herein. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter of this Agreement will be made by either party which are not set forth expressly herein. 12. EMPLOYEE'S SUCCESSORS. This Agreement shall inure to the benefit of and be enforceable by your personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If you should die while any amounts are still payable to you hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of the Agreement to your devisee, legatee or other designee or, if there be no such designees, to your estate. 13. VALIDITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 14. APPLICABLE LAW. This Agreement shall be interpreted and enforced in accordance with the laws of the State of California. 15. COUNTERPARTS. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together will constitute one and the same instrument. 5 If the foregoing conforms with our understanding, please indicate your agreement to the terms hereof by signing where indicted below and returning one copy of this Agreement to the undersigned. IN WITNESS WHEREOF, this Agreement is executed effective as of the date set forth above. Very truly yours, PERSISTENCE SOFTWARE, INC. By: /S/ Christopher Keene --------------------- Name: Christopher Keene Title: President and CEO Accepted and Agreed to as of the Date First Set Forth Above: Keith Zaky /S/ Keith Zaky - -------------------------- (Signature) Address 6 PERSISTENCE SOFTWARE, INC. 1720 S. Amphlett Blvd. Suite 300 San Mateo, CA 94402 PRIVILEGED AND CONFIDENTIAL June 7, 2000 Ed Murrer 935 Canada Road Woodside, CA 94062 Dear Ed, Persistence Software, Inc. (the "Company") considers it essential to the best interests of its shareholders, in appropriate circumstances, to foster the continuous employment of key management personnel. In this connection, the Board of Directors of the Company (the "Board") recognizes that, as is the case with many corporations today, the possibility of a change in control may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its shareholders. The Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company's management, including yourself, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a change in control of the Company. In order to induce you to remain in the employ of the Company and in consideration of your agreements set forth in subparagraph 2(e) hereof, the Company agrees that you shall receive the severance benefits set forth in this letter agreement ("Agreement") in the event your employment with the Company terminates subsequent to a "Change in Control" of the Company (as defined in subparagraph 2(c) hereof) under the circumstances described below. 1. TERM OF AGREEMENT. This Agreement shall commence on the date hereof and shall continue in effect until the earliest of (a) the fourth anniversary of the date of this Agreement (b) termination of your employment with the Company other than after a Change in Control, or (c) written agreement between you and the Company to terminate the Agreement. 2. DEFINITIONS. As used in this Agreement: (a) "Board" shall mean the Board of Directors of the Company. 1 (b) "Cause" shall mean grounds for termination of your employment by the Company as set forth in Paragraph 4 hereof which, as herein provided, shall not result in any compensation upon termination as provided in Paragraph 3 hereof. (c) "Change in Control" shall mean an acquisition of all or substantially all of the assets of the Company or the acquisition of the Company by merger or pursuant to a registered tender or exchange offer or combination of the Company with another corporation, resulting in less than a majority of the outstanding voting shares of the surviving corporation being held, immediately after such acquisition or combination, by the holders of the voting shares of the Company outstanding immediately prior to such acquisition or combination. (d) "Good Reason" shall mean grounds for termination by you of your employment by the Company based upon prior constructive termination by the Company as provided in Paragraph 5 hereof. 3. COMPENSATION UPON TERMINATION OF EMPLOYMENT FOLLOWING A CHANGE IN CONTROL. Subject to Sections 6 and 7 below, if your employment with the Company is terminated within 12 months after a Change in Control, (a) The Company agrees that vesting of options issued to you under the Company's 1997 Stock Plan (including any options issued in exchange for such options as a result of a Change in Control), shall be immediately accelerated upon such termination, to the extent of forty-eight (48) additional months of vesting. (b) Anything contained in subparagraph (a) above to the contrary notwithstanding, the Company shall have no obligation to accelerate vesting under this Agreement in the event of termination prior to a Change in Control or if, after a Change in Control, it terminates your employment for "Cause", or if your employment terminates due to death, retirement or resignation other than for "Good Reason." 4. TERMINATION FOR CAUSE. Termination of your employment with the Company shall be regarded as termination for Cause only upon: (a) your willful and continued failure to substantially perform your duties with the Company (other than such failure resulting from your incapacity due to physical or mental illness) after there is delivered to you by the Board a written demand for substantial performance which sets forth in detail the specific respects in which it believes you have not substantially performed your duties; (b) your willfully engaging in gross misconduct which is materially and demonstrably injurious to the Company; (c) your committing a felony or an act of fraud against the Company or its affiliates; or (d) your breaching materially the terms of your employee confidentiality and proprietary information agreement with the Company. 2 No act, or failure to act, by you shall be considered "willful" if done, or omitted to be done, by you in good faith and in your reasonable belief that your act or omission was in the best interest of the Company and/or required by applicable law. Anything contained in this Paragraph 4 to the contrary notwithstanding, you shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to you a copy of a resolution duly adopted by the affirmative vote of not less than a majority of the entire membership of the Board at a meeting of the Board called and held for that purpose after reasonable notice to and an opportunity for you, together with your counsel, to be heard before the Board. 5. TERMINATION FOR GOOD REASON. Your employment with the Company may be regarded as having been constructively terminated by the Company and you may therefore terminate your employment for Good Reason and thereupon become entitled to compensation pursuant to Paragraph 3 above, if, after a Change in Control, one or more of the following events shall occur (unless such event(s) applies generally to all officers of the Company and any successor the Company, or applies to a person solely in his capacity as a member of the Board): (i) without your express written consent, the assignment to you of any duties or the significant reduction of your duties, either of which is inconsistent with your position with the Company (or the duties and responsibilities of such position) immediately prior to a Change in Control, or your removal from and failure to re-elect you to any such position, it being understood and agreed that your assignment of the position of Senior Vice President, Marketing of a business unit, division or subsidiary or Senior Vice President, Marketing of the Company or a company into which the Company is merged in a Change of Control or otherwise acquiring assets or voting shares of the Company in connection with a Change of Control, or a parent of such a company, shall not constitute a significant reduction of your duties or assignment of duties inconsistent with your position and shall not constitute grounds for you to terminate your employment of Good Reason; (ii) without your express written consent, the substantial reduction, without good business reasons, of the facilities and perquisites (including office space and location) available to you immediately prior to a Change in Control; (iii) a reduction by the Company in your salary or in any bonus compensation formula applicable to you as in effect immediately prior to a Change in Control, or the failure by the Company to increase such base salary each year following a Change in Control by an amount which equals at least three-fourths (3/4), on a percentage basis, of the average annual percentage increase in base salary for all officers of the Company (and any successor of the Company) during the prior two full calendar years; (iv) a material reduction by the Company in the kind or level of employee benefits to which you were entitled prior to a Change in Control with the result that your overall benefits package is significantly reduced after the Change in Control; or the taking of any action by the Company which would materially and adversely affect your participation in any plan, program or policy generally applicable to executives or employees of the Company or any successor of the Company (including but not limited to paid vacation days), or deprive you in a material and substantial way of any fringe benefits enjoyed by you prior to a Change in Control; 3 (v) the Company's requiring you to be based anywhere other than your present location (except for required travel on the Company's business to an extent substantially consistent with your present business travel obligations) or a location more than 50 miles from your then present location, without your consent; (vi) any purported termination of your employment by the Company which is not effected for Cause, or any purported termination for which the grounds relied upon are not valid; or (vii) the failure of the Company to obtain the assumption of this Agreement by any successor as contemplated in Paragraph 10 hereof. 6. DISPUTES. To dispute a termination for Good Reason by you, the Company must give you written notice of such dispute within 30 working days after your effective date of termination. To dispute a termination by the Company or any failure to make payments claimed to be due hereunder, you must give written notice of such a dispute to the Company within 30 days after the date on which a payment claimed by you to be due hereunder was due to be made, as the case may be. If any such dispute is finally determined in your favor, the Company shall pay all reasonable fees and expenses, including attorneys' and consultants' fees, that you incur in good faith in connection therewith. 7. NO MITIGATION. No payment or benefit to which you are entitled pursuant to Paragraph 3 hereof shall be reduced by reason of compensation or other income you receive for services rendered after your termination of employment with the Company. 8. COMPANY'S SUCCESSORS. The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform the obligations under this Agreement in the same manner and to the same extent the Company would be required to perform if no such succession had taken place. As used in this Paragraph, "Company" includes any successor to its business or assets as aforesaid which executes and delivers this Agreement or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 9. NOTICE. Notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when personally delivered or five (5) days after deposit with postal authorities transmitted by United States registered or certified mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth on the first or last page of this Agreement, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 4 10. AMENDMENT OR WAIVER. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing by you and the Company. No waiver of either party at any time of the breach of, or lack of compliance with, any conditions or provisions of this Agreement shall be deemed a waiver of other provisions or conditions hereof. 11. SOLE AGREEMENT. This Agreement represents the entire agreement between you and the Company with respect to the matters set forth herein. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter of this Agreement will be made by either party which are not set forth expressly herein. 12. EMPLOYEE'S SUCCESSORS. This Agreement shall inure to the benefit of and be enforceable by your personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If you should die while any amounts are still payable to you hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of the Agreement to your devisee, legatee or other designee or, if there be no such designees, to your estate. 13. VALIDITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 14. APPLICABLE LAW. This Agreement shall be interpreted and enforced in accordance with the laws of the State of California. 15. COUNTERPARTS. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together will constitute one and the same instrument. If the foregoing conforms with our understanding, please indicate your agreement to the terms hereof by signing where indicted below and returning one copy of this Agreement to the undersigned. IN WITNESS WHEREOF, this Agreement is executed effective as of the date set forth above. Very truly yours, PERSISTENCE SOFTWARE, INC. By: /S/ Christopher Keene --------------------- Name: Christopher Keene Title: President and CEO 5 Accepted and Agreed to as of the Date First Set Forth Above: Ed Murrer /S/ Ed Murrer - ------------------------ (Signature) 935 Canada Road Woodside, CA 94062 6 EX-23.1 6 persistence_10kex23-1.txt EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 333-53176, 333-82543 and 333-68798 of Persistence Software, Inc. on Form S-8 of our reports dated January 22, 2001 (February 28, 2002 as to Note 5 and March 20, 2002 as to the table in Note 12) appearing in this Annual Report on Form 10-K of Persistence Software, Inc. for the year ended December 31, 2001. DELOITTE & TOUCHE LLP San Jose, California April 1, 2002 -----END PRIVACY-ENHANCED MESSAGE-----