-----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, U+15jffXQKZy5vPZkw+5oSt2nVwIjIsNXQFCPIQ4wnG/EwbQ2ZtLFvNUziw1W4bO LowzUw7Ktix80SaFGupgxQ== 0001019687-03-001620.txt : 20030812 0001019687-03-001620.hdr.sgml : 20030812 20030812143810 ACCESSION NUMBER: 0001019687-03-001620 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030812 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 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-25857 FILM NUMBER: 03837164 BUSINESS ADDRESS: STREET 1: 1720 SOUTH AMPHLETT BLVD., 3RD FLOOR CITY: SAN MATEO STATE: CA ZIP: 94402 BUSINESS PHONE: 6503417733 MAIL ADDRESS: STREET 1: 1720 S. AMPHLETT BLVD, 3RD FLOOR CITY: SAN MATEO STATE: CA ZIP: 94402 10-K/A 1 persistence_10ka2-123102.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _______________ FORM 10-K/A Amendment No. 2 _______________ (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, 2002 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 (I.R.S. EMPLOYER IDENTIFICATION NO.) OF INCORPORATION OR ORGANIZATION) 1720 SOUTH AMPHLETT BLVD., THIRD FLOOR SAN MATEO, CALIFORNIA 94402 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) 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. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in the Exchange Act Rule 12b-2). Yes [ ] No [X] The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $4.0 million as of February 28, 2003 based upon the closing sale price on the Nasdaq National Market reported for such date of $2.50 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 2,404,473 shares of the registrant's Common Stock issued and outstanding as of February 28, 2003. DOCUMENTS INCORPORATED BY REFERENCE Part III incorporates information by reference from the definitive proxy statement for the 2003 Annual Meeting of Stockholders to be held on June 5, 2003. ================================================================================ EXPLANATORY NOTE This Amendment No. 2 on Form 10-K/A to our annual report on Form 10-K for the year ended December 31, 2002 is being filed solely for the purposes of responding to comments received by us from the Staff of the Securities and Exchange Commission. This Amendment speaks as of the original filing date of our annual report on Form 10-K and has not been updated to reflect events occurring subsequent to the original filing date except for the restatement of all share and per share amounts for a 1-for-10 reverse stock split previously approved by our stockholders and effected on June 12, 2003. For the convenience of the reader, we have restated our annual report on Form 10-K in its entirety. 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." "PowerTier," "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. Our website is www.persistence.com. We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports available free of charge as soon as reasonably practicable as we file these reports with the Securities and Exchange Commission. PART I ITEM 1. BUSINESS. COMPANY OVERVIEW Persistence provides a suite of Data Services products that sit between existing databases - such as Oracle and DB2 - and application servers - such as BEA, WebLogic, IBM, WebSphere, and Microsoft .NET. Developers can configure these products, creating a "Data Services" layer that positions business information for more efficient access for users, dramatically reduces network traffic and data latency, and results in better application performance at a much lower infrastructure cost. Persistence integrated Data Services include: object-relational mapping, transactional caching, guaranteed synchronization, "uninterruptible" application fail over and rule-based client notification. Persistence's Data Services are also cross-platform, providing a "data bridge" between J2EE, .Net, Java and C++ applications. Persistence caching solutions help systems "remember" answers from each processing step. When the system receives a request for which it has an answer, it can respond immediately, without traveling to back-end databases to generate an answer. Synchronization technology ensures that these cached answers are always accurate, even as the source data changes. Customer profile management, logistics, exchanges, trading desks, and supply chain management systems are just a few examples of query-intensive online systems that can realize significant increases in capacity and performance through online caching. Customers are able to more effectively manage enterprise data through re-architecting their IT infrastructure using Persistence Data Services products. Persistence Data Services solutions result in real-time, highly scalable, distributed applications without incurring the high costs of additional hardware and replicated databases. Decision makers and customers located at any location can now have an immediate "business visibility" into their data, that is, an up-to-date view into the data that they need, when and where they need it. Enterprises are creating competitive advantage by achieving the goal of the zero-latency enterprise through Data Services, the immediate distribution and management of business information. Delivering real-time data enhances employee productivity, improves operations, and enables improved relationships with customers. Data Services also ensures business continuity by providing immediate fail-over options preventing data center outages from interrupting business processing. Our EDGEXTEND data services software for Sun Microsystems' full Java 2 Platform, Enterprise Edition (J2EE, formerly known as Enterprise Java Beans or EJB) application servers, C++ and .NET application servers offers a data architecture that integrates with IBM's WebSphere, BEA's WebLogic, and Microsoft ..NET, plus C++ application servers to support highly distributed and transaction-oriented applications both within data centers and in remote locations. Our DIRECTALERT product is a proactive, personalized client caching and notification reporting product for zero latency applications which extends the reach of enterprise systems to small form-factor devices such as mobile phones, wireless PDAs, and digital set-top boxes. 2 Major customers in 2002 consisted of Air France, Applied Biosystems, Cablevision, Citadel, Eurocontrol, Fiducia AG, Intershop, i2, Lucent, Motorola, NetJets, Nokia, Reuters Financial Software and Salomon Smith Barney. INDUSTRY BACKGROUND Today's Information Technology 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 a cost-effective 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 BUSINESS CONTINUITY: 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. o LIMITED SCALABILITY: As applications are deployed to more and more remote users in a system in order to improve the productivity of those users, the customer needs a system that will 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 services infrastructure is required. The next generation of enterprise applications will require a fundamentally new data management infrastructure, which will allow application servers to scale in order to meet 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 PRODUCTS Our EdgeXtend family of products provides a data services software infrastructure that is specifically designed to enable high volume, high performance, distributed applications. Our products, EDGEXTEND for IBM WebSphere, EDGEXTEND for BEA WebLogic, EDGEXTEND for C++ and EDGEXTEND for Microsoft .NET, 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: 3 REAL-TIME RESPONSE FOR THOUSANDS OF CONCURRENT USERS. Our EDGEXTEND products were designed specifically to accommodate high volume transaction processing and the data integrity requirements of distributed applications. EDGEXTEND utilizes caching technology. Caching is a process in which select data is copied out of back-end systems and into the server cache, which allows the data to be shared and manipulated by multiple users. Replication between EDGEXTEND server caches using the POWERSYNC feature allows a cluster of application servers to provide highly scalable performance as the number of users increases. This architecture helps reduce the workload 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 and rapidly changing data. We believe that our EDGEXTEND 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 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. EDGEXTEND accelerates 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. PROTECTS AND LEVERAGES EXISTING INFORMATION TECHNOLOGY INVESTMENTS. EDGEXTEND enables developers to build new enterprise applications while simultaneously integrating existing back-end systems. EDGEXTEND'S flexible architecture integrates with disparate database servers, web servers and multiple clients, while supporting multiple programming languages and computing platforms. EDGEXTEND provides 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. OPTIMIZED DISTRIBUTED DATA SERVICES ARCHITECTURE. All our products are built on the core Persistence technologies of Object/Relational Mapping, Dynamic Caching and Cache Synchronization. This technology, called Distributed Dynamic Caching (DDC), allows for a distributed data services architecture that 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 multiple data centers. PERSISTENCE STRATEGY Our goal is to fundamentally restructure how companies extend and leverage their vital business information by enabling a distributed data services infrastructure. 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 services 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. 4 WORK WITH SYSTEM INTEGRATORS TO DELIVER COMPLETE SOLUTIONS. In addition to extending our technology leadership, we will work with major System Integrators (SI's) such as BearingPoint (formerly KPMG Consulting) and IBM Global Services to provide our customers the most complete data services solutions for their distributed applications. These system integrators will be an extension of, and a complement to, our existing professional services organization. By working with these SI's on joint customer engagements we can leverage their services expertise and customer channel and they can leverage our products and technology to provide unique, differentiated data services solutions. 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 services 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 and Germany. In addition to our direct sales operations, we also distribute our products throughout Europe and Asia through distributors and systems integrators. We intend to extend these international third-party distributor and systems integrator relationships. PRODUCTS EDGEXTEND Our EDGEXTEND for WebSphere, EDGEXTEND for WebLogic, and EDGEXTEND for .NET 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 application servers, as well as applications built on Microsoft ..NET. EDGEXTEND provides a new distributed data services architecture, which complements J2EE compliant, and other, 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. EDGEXTEND FOR C++ (formerly POWERTIER for C++) Our EDGEXTEND 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. Our EDGEXTEND for C++ platform runs on the Windows and Unix operating systems. We have licensed the J2EE platform and are a contributor to the Java standard. 5 The following table describes the major features and benefits for EDGEXTEND for IBM WebSphere, BEA WebLogic, and Microsoft .NET and EDGEXTEND FOR C++: FEATURES BENEFITS -------- -------- Shared transactional object cache Enables real-time scalability by reducing database traffic Object-relational mapping that Speeds application development by managing provides abstraction to database database details for developer representation Optimized usage of native database Improves application capacity by libraries efficiently 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 cache DIRECT ALERT DIRECTALERT is an end-to-end solution for adding proactive notification services to business applications, allowing information to be delivered to decision makers and customers when and how they need it. DIRECTALERT is a J2EE application server add-in designed to provide sophisticated data and event monitoring as well as filtering. DIRECTALERT is designed to proactively notify clients ranging from desktop applications and ordinary web browsers to mobile phones and television set-top boxes. The following table describes the major features and benefits for the DIRECTALERT product: FEATURES BENEFITS -------- -------- Intelligent Server Engine Provides sophisticated and non-intrusive data monitoring, selection and filtering Flexible and powerful clients with Enables Java devices (mobile phones to "zero footprints" desktop PCs) to receive proactive notification resulting in business decisions being made on updated data Rapid development and Adds functionality to existing applications implementation without modifications as it is built with 100% Java and XML. Server side required only query definitions. No modification is required to existing application logic. POWERTIER Persistence continues to sell current and earlier versions of POWERTIER for J2EE application server to current customers. POWERTIER for J2EE incorporates our patented technologies into a J2EE-based transactional server. The J2EE standard, as defined by the Java Software division of Sun Microsystems, has gained rapid acceptance as a programming language for complex enterprise applications because it provides a consistent way to program and integrate services for companies building distributed business-to-business applications with the Java programming license. POWERTIER for J2EE delivers scalability, high availability, and rapid adaptability for high volume, high performance, and distributed enterprise applications. We believe that research and product development will be a key to our success as a leader in providing data services software. Our research and development expenditures totaled $4.1 million for 2002, $5.6 million for 2001 and $8.1 million for 2000. 6 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 2002, 2001 or 2000 (defined as approximately 1% or more of our total revenues in any year.) E-COMMERCE/INTERNET FINANCIAL SERVICES/EXCHANGES Cisco Systems Chase/JP Morgan i2 CNP Assurances Intershop Citadel Investment Group Credit Suisse First Boston Fiducia AG Kinetech Services Reuters Financial Software Salomon Smith Barney Wells Fargo COMMUNICATIONS Zurich Arippina Gruppe 4T Solutions AT&T CSC Holdings (Cablevision) Lucent Technologies Motorola TRANSPORTATION & LOGISTICS Nokia Air France Spirent Communications Eurocontrol Sprint Federal Express NetJets Sabre Group Holdings (American Airlines) MANUFACTURING & DISTRIBUTION Hewlett Packard Nippon Steel Delco OTHER Applied Biosystems Bundesanstalt fur Arbeit Convergys Information Infron Technologies Refco Group In 2002, sales of products and services to Cablevision accounted for 26% of our total revenues and sales to Salomon Smith Barney accounted for 13% of our total revenues. 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. SALES AND MARKETING We sell our products through both a direct sales force and third party distributors. As of December 31, 2002, we had 30 people in our sales and marketing organization, of which 21 were in the United States, and 9 were in European offices. We intend to increase the size of our direct sales force as well as focusing on indirect distribution channels. While our overall 2003 sales and marketing expense compared to 2002 is expected to decrease, reductions in non-personnel related programs are expected to offset expenses for new hirings. 7 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, a proof of concept, to establish a technical fit. We have engaged in, and may continue to engage in, a variety of targeted marketing activities, including public relations, seminars, trade shows, lead generation programs 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 such as BearingPoint 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 agents and OEMs. As of December 31, 2002, we were represented by one international distributor, who sells our products in Asia. 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. In the EDGEXTEND market, alternative technology is available from a variety of sources. Companies such as Versant, Gemstone and Excelon are middleware vendors that offer alternative data management solutions that directly target EdgeXtend's market. In addition, many prospective customers may build their own custom solutions. In the DIRECTALERT market, alternative approaches are provided by a variety of sources, including the potential for internal development. Companies such as SpiritSoft, TIBCO, and IBM provide message-oriented middleware software that may evolve into competitive products. Vendors such as webMethods and Business Objects provide alternative architectures for business intelligence information. DIRECTALERT is based on licensed technology, which the Company is licensed to distribute on a non-exclusive basis. 8 We continue to sell current and earlier versions of POWERTIER for J2EE application server to current customers. Our competitors for POWERTIER include both publicly and privately-held enterprises, including BEA Systems (WebLogic), IBM (WebSphere), Oracle (OAS), Secant Technologies and Sun Microsystems (Sun ONE Application Server). Many customers may not be willing to purchase our POWERTIER 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. 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, 2003, 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, 2002, we had 68 full-time employees, including 30 in sales and marketing, 26 in research and development and technical services, and 12 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. 9 EXECUTIVE OFFICERS The following table sets forth specific information regarding our executive officers as of February 28, 2003: NAME AGE POSITION ---- --- -------- Christopher T. Keene..........42 Chief Executive Officer Christine Russell.............53 Chief Financial Officer and Secretary Derek Henninger...............40 Vice President of Worldwide Field Operations Ed Murrer.....................53 Vice President of Marketing Vivek Singhal.................34 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 and an M.B.A. degree from Santa Clara University and serves on the Board of Directors of Peak Ltd. International. 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 in January 2003 he became Vice President of Worldwide Field Operations which includes all field sales and technical resources. 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. ED MURRER joined Persistence in July 2001 as Vice President of 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. He holds a B.S. degree in Mechanical Engineering, with highest honors, and a M.S. degree in Mechanical Engineering from Purdue University. 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. 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 and Germany. 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. 10 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. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. PRICE RANGE OF COMMON STOCK. Our common stock was traded on the Nasdaq National Market under the symbol PRSW from the effective date of our initial public offering on June 24, 1999 until September 12, 2002 at which time we moved our stock listing to the Nasdaq SmallCap Market. 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 (before September 12, 2002) or the Nasdaq SmallCap Market (both on and after September 12, 2002) for the periods indicated. HIGH LOW -------- -------- For The Year Ended December 31, 2001: First Quarter......................................... $ 45.00 $ 10.00 Second Quarter........................................ $ 12.50 $ 4.80 Third Quarter......................................... $ 9.90 $ 1.50 Fourth Quarter........................................ $ 13.50 $ 1.90 For The Year Ended December 31, 2002: First Quarter......................................... $ 18.50 $ 8.70 Second Quarter........................................ $ 10.00 $ 5.30 Third Quarter......................................... $ 8.20 $ 4.20 Fourth Quarter........................................ $ 7.20 $ 3.00 We had 159 stockholders of record as of February 28, 2003, 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. RECENT SALES OF UNREGISTERED SECURITIES. On November 26, 2002 we issued 375,869 shares of our common stock at a price of $5.3210 per share, and warrants to purchase up to 120,513 shares of our common stock at an exercise price of $7.50 per share to certain purchasers affiliated with Needham Capital Partners. The warrants expire on the earlier of November 26, 2007 or the closing of a merger, acquisition or sale of substantially all of the assets of Persistence. In issuing these securities we relied upon Section 4(2) of the Securities Act on the basis that the transaction did not involve a public offering. 12 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 annual report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 2002, 2001 and 2000 and the consolidated balance sheet data at December 31, 2002 and 2001, are derived from audited consolidated financial statements included elsewhere in this annual report on Form 10-K. The consolidated statement of operations data for the years ended December 31, 1999 and 1998, and the consolidated balance sheet data as of December 31, 2000, 1999 and 1998 are derived from audited financial statements not included in this annual report on Form 10-K.
YEARS ENDED DECEMBER 31, --------------------------------------------------------- 2002 2001 2000 1999 1998 --------- --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Revenues: License ......................................... $ 9,061 $ 10,561 $ 17,684 $ 10,890 $ 7,478 Service ......................................... 5,525 8,810 7,593 3,553 2,682 --------- --------- --------- --------- --------- Total revenues .......................... 14,586 19,371 25,277 14,443 10,160 Loss from operations .............................. (5,451) (15,391) (17,857) (12,165) (4,090) --------- --------- --------- --------- --------- Net loss .......................................... $ (5,440) $(15,132) $(16,726) $(11,306) $ (4,089) ========= ========= ========= ========= ========= Basic and diluted net loss per share(1) ........... $ (2.65) $ (7.60) $ (8.65) $ (8.64) $ (5.94) ========= ========= ========= ========= ========= Shares used in basic and diluted net loss per share calculation ............................... 2,053 1,992 1,933 1,309 688 ========= ========= ========= ========= ========= AS OF DECEMBER 31, --------------------------------------------------------- 2002 2001 2000 1999 1998 --------- --------- --------- --------- --------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash, cash equivalents and short-term investments.. $ 8,903 $ 7,411 $ 19,490 $ 29,652 $ 4,938 Working capital.................................... 4,942 6,783 17,289 29,582 3,384 Total assets....................................... 11,100 13,755 33,641 39,092 7,064 Long-term obligations.............................. 784 421 932 354 714 Total stockholders' equity......................... 4,711 7,944 22,556 32,018 3,422 __________
(1) Basic net loss per common share 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, 2002 and 2001 and for each of the years ended December 31, 2002, 2001 and 2000, 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," "expects," "future," "intends," "targeting," and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed or forecasted. Factors that might cause such a difference include, but are not limited to, those discussed in the section entitled "Additional Factors That May Affect Future Results" and those appearing elsewhere in this 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. 13 OVERVIEW Persistence provides a suite of Data Services products that sit between existing databases - such as Oracle and DB2 - and application servers - such as BEA, WebLogic, IBM, WebSphere, and Microsoft .NET. Developers can configure these products, creating a "Data Services" layer that positions business information for more efficient access for users, dramatically reduces network traffic and data latency, and results in better application performance at a much lower infrastructure cost. Persistence integrated Data Services include: object-relational mapping, transactional caching, guaranteed synchronization, "uninterruptible" application fail over and rule-based client notification. Persistence's Data Services are also cross-platform, providing a "data bridge" between J2EE, .Net, Java and C++ applications. Persistence caching solutions help systems "remember" answers from each processing step. When the system receives a request for which it has an answer, it can respond immediately, without traveling to back-end databases to generate an answer. Synchronization technology ensures that these cached answers are always accurate, even as the source data changes. Customer profile management, logistics, exchanges, trading desks, and supply chain management systems are just a few examples of query-intensive online systems that can realize significant increases in capacity and performance through online caching. Customers are able to more effectively manage enterprise data through re-architecting their IT infrastructure using Persistence Data Services products. Persistence Data Services solutions result in real-time, highly scalable, distributed applications without incurring the high costs of additional hardware and replicated databases. Decision makers and customers located at any location can now have an immediate "business visibility" into their data, that is, an up-to-date view into the data that they need, when and where they need it. Enterprises are creating competitive advantage by achieving the goal of the zero-latency enterprise through Data Services, the immediate distribution and management of business information. Delivering real-time data enhances employee productivity, improves operations, and enables improved relationships with customers. Data Services also ensures business continuity by providing immediate fail-over options preventing data center outages from interrupting business processing. Our EDGEXTEND data services software for Sun Microsystems' full Java 2 Platform, Enterprise Edition (J2EE, formerly known as Enterprise Java Beans or EJB) application servers, C++ and .NET application servers offers a data architecture that integrates with IBM's WebSphere, BEA's WebLogic, and Microsoft ..NET, plus C++ application servers to support highly distributed and transaction-oriented applications both within data centers and in remote locations. Our DIRECTALERT product is a proactive, personalized client caching and notification reporting product for zero latency applications which extends the reach of enterprise systems to small form-factor devices such as mobile phones, wireless PDAs, and digital set-top boxes. Major customers in 2002 consisted of Air France, Applied Biosystems, Cablevision, Citadel, Eurocontrol, Fiducia AG, Intershop, i2, Lucent, Motorola, NetJets, Nokia, Reuters Financial Software and Salomon Smith Barney. Our revenues, which consist of software license revenues and service revenues, totaled $14.6 million in 2002, $19.4 million in 2001, and $25.3 million in 2000. 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 EDGEXTEND and DIRECTALERT in 2002, we have a limited operating history in the data services markets. We currently expect that sales of our older POWERTIER products will continue to contribute to our revenues, but that sales of our newer EDGEXTEND and DIRECTALERT products will contribute a growing percentage of our revenues over the next several quarters. We market our software and services primarily through our direct sales organizations in the United States, the United Kingdom and Germany. Revenues from licenses and services to customers outside the United States were $4.8 million in 2002, $7.4 million in 2001, and $7.2 million in 2000 which represented approximately 33% of total revenues for 2002, 38% of total revenues for 2001, and 28% of total revenues for 2000. Sales of products to customers in Asia declined by 86% in 2002, from $1.9 million in 2001 to $272,000 in 2002. This decline resulted from a combination of slowing sales in the Asia region and our decision to close our Hong Kong office and shift our international sales 14 focus to Europe because of our perception that Europe has more potential for sales growth than does Asia. Sales of products to customers in Europe declined by 17% in 2002, from $5.5 million in 2001 to $4.6 million in 2002. This decline was slightly less than the decrease in sales of our products to customers in the United States, which fell by 19% in 2002, from $12 million in 2001 to $9.8 million in 2002. 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 sales to a limited number of customers. Sales of products to our top five customers accounted for 55% of total revenues in 2002, 45% of total revenues in 2001, and 40% of total revenues in 2000. In the future, it is likely that a relatively few large customers could continue to account for a relatively large proportion of our revenues and these customers are likely to differ year to year. To date, we have sold our products primarily through our direct sales force, and we will need to continue to hire sales people, including 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 independent software vendors, systems integrators, OEM partners and other resellers. We recognize revenues in accordance with the American Institute of Certified Public Accountants Statement of Position 97-2, "Software Revenue Recognition," as amended by Statements of Position 98-4 and 98-9. 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 Bulleting ("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 guidance for disclosure related to revenue recognition policies. Since inception, we have incurred substantial research and development costs and have invested heavily in our sales, marketing and professional services organizations to build an infrastructure to support our long-term growth strategy. The total number of our full-time employees decreased from 81 as of December 31, 2001 to 68 as of December 31, 2002, representing a decrease of 16% as a result of periodic assessments during the year of efficient staffing requirements. We have incurred net losses in each quarter since 1996 and, as of December 31, 2002, had an accumulated deficit of $61.4 million. We are currently targeting that sales and marketing expenses, research and development expenses, and general and administrative expenses for 2003 will be below 2002 spending levels. 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. While we are targeting to begin achieving profitability on a quarterly basis in the second half of 2003, we may not achieve it. Our success depends significantly upon broad market acceptance of our recently introduced EDGEXTEND and, to a lesser degree, the DIRECTALERT products. 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 data services and data integration. 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. 15 - - 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. We recognize license revenues upon shipment of the software if collection of the resulting receivable is probable, an agreement has been executed, 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. Royalty revenues are recognized when the software or services has been delivered, collection is reasonably assured and the fees are determinable. We recognize revenues from customer training, support and professional 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 at which such elements are sold separately, or, when not sold separately, the price established by management having the relevant authority to make such decision. While more infrequent, arrangements that require significant modification or customization of software are recognized under the completion of contract method. - - 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. We analyze such factors as historical bad debt experience, customer payment patterns and current economic trends. This analysis requires significant judgment. If the financial condition of the company's customers were to deteriorate further, additional allowances would generally be required resulting in future losses that are not included in our allowances for doubtful accounts at December 31, 2002. - - 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 2002, we took an impairment charge of $160,000. In 2001, we took an impairment charge of $2.0 million. - - STOCK COMPENSATION. We account 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. Our operating results would be affected if other alternatives were used. Information about the impact on our operating results of using the alternative of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, is included in Note 1 of the "Notes to Consolidated Financial Statements," included elsewhere in this report. - - INCOME TAXES. Our income tax policy records the estimated future tax effects of temporary differences between the tax basis 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. 16 RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2002 AND 2001 REVENUES Our total revenues are comprised of license revenues and service revenues. License revenues comprised 62% of total revenues and service revenues comprised 38% of total revenues for the fiscal year ended December 31, 2002. Our revenues were $14.6 million for 2002 and $19.4 million for 2001 representing a decrease of 25%. International revenues were $4.8 million for 2002 and $7.4 million for 2001 representing a decrease of 35%. The decrease in international revenues from 2001 to 2002 is primarily attributable to a general downturn in local economic conditions in Asia, which in turn contributed to our decision to close our sales office in Asia. For 2002, sales to Cablevision accounted for 26% of total revenues, sales to Salomon Smith Barney accounted for 13% of total revenues, and sales to our top five customers accounted for 55% of total revenues. 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. LICENSE REVENUES. License revenues consist of licenses of our software products, which generally are priced based on the number of users or central processing units deploying our software. License revenues were $9.1 million for 2002 and $10.6 million for 2001 representing a decrease of 14%. License revenues represented 62% of total revenues for 2002 and 55% of total revenues for 2001. The decrease in software license revenues was primarily due to decreased spending on IT infrastructure products by our target customers. Given the continuing dramatically reduced level of information technology spending, license revenues may fluctuate substantially over the next several quarters. In addition, for the same reason, our revenues may be flat to down for 2003 compared to 2002. SERVICE REVENUES. Service revenues consist of professional services consulting, customer support and training. Our service revenues were $5.5 million for 2002 and $8.8 million for 2001, representing a decrease of 37%. The decrease in service revenues was primarily due to a decline in consulting service contracts in 2002. Service revenues represented 38% of total revenues for 2002 and 45% of total revenues for 2001. 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 $286,000 for 2002 and $14,000 for 2001. This increase was due to payment of an aggregate of $274,000 in royalties to Isocra, Ltd. and Sun Microsystems, because we sold more software that required payment of royalties. Cost of license revenues as a percentage of license revenues may vary between periods due to royalty charges from third party software vendors. 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 $2.7 million for 2002 and $4.0 million for 2001, representing a decrease of 31%. This decrease was primarily due to a $1.1 million reduction in our use of external consultants in 2002 as a result of the decline in both our technical support and consulting service contracts. As a percentage of service revenues, cost of service revenues were 50% for 2002 and 45% for 2001. Because a large portion of our cost of service revenues is fixed, the percentage increase was due in part to the decrease in our service revenues. Cost of service revenues as a percentage of service revenues may vary between periods due to our use of consultants. OPERATING EXPENSES SALES AND MARKETING. Sales and marketing expenses consist of salaries, benefits, commissions and bonuses earned by sales and marketing personnel, travel and entertainment, and promotional expenses. Our sales and marketing expenses were $8.7 million for 2002 and $14.4 million for 2001, representing a decrease of 40%. This decrease was primarily due to a reduction in staffing and personnel related costs of $3.0 million, reduced office space which lowered expenses by $256,000 and a $1.8 million reduction in commissions expensed based on lower sales revenues. Sales and marketing expenses represented 59% of total revenues for 2002 and 74% of total revenues for 2001. We are presently targeting that 2003 sales and marketing expense levels will be lower than comparable 2002 expense levels because as of July 2003 we had 23 sales and marketing employees as compared to an average of 35 such employees during 2002. We do not anticipate significantly increasing sales and marketing expenses or headcount in the second half of 2003. 17 RESEARCH AND DEVELOPMENT. Research and development expenses consist 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 $4.1 million for 2002 and $5.6 million for 2001, representing a decrease of 26%. This decrease was primarily related to a reduction in both employees and external contract staff, which amounted to a $1.3 million reduction in expenses. Research and development expenses represented 28% of total revenues for 2002 and 29% of total revenues for 2001. We are presently targeting that 2003 research and development expense levels will be lower than comparable 2002 expense levels because as of July 2003 we had 22 research and development employees as compared to an average of 27 such employees during 2002. We do not anticipate significantly increasing research and development expenses or headcount in the second half of 2003. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist of salaries, benefits and related costs for our finance, administrative and executive management personnel, legal costs, accounting costs, bad debt write-offs and various costs associated with our status as a public company. Our general and administrative expenses were $3.5 million for 2002 and $5.5 million for 2001, representing a decrease of 37%. This decrease was primarily related to the termination of patent litigation and related legal fees and settlements of $980,000 and a $598,000 reduction in bad debt expense. General and administrative expenses represented 24% of total revenues for 2002 and 29% of total revenues for 2001. We are presently targeting that 2003 general and administrative expense levels will be lower than comparable 2002 expense levels because as of July 2003 we had ten general and administrative employees as compared to an average of 13 such employees during 2002. We do not anticipate significantly increasing general and administrative expenses or headcount in the second half of 2003. AMORTIZATION AND WRITE-DOWN OF PURCHASED INTANGIBLES. Amortization of purchased intangibles was $768,000 for 2002 and $3.6 million for 2001, representing a decrease of 79%. In December 2002, write-off of purchased intangibles amounted to $160,000. In June 2001, write-offs of intangibles and goodwill amounted to $2.0 million. The write-offs pertained to both software purchased from third parties and goodwill from companies that had been acquired. These assets were deemed to have become impaired due to various factors including the availability of alternative software solutions and the product transition from PowerTier application server to the EdgeXtend data services product. RESTRUCTURING COSTS. Restructuring costs consist of expenses associated in a reduction in employee headcount and the closure of excess field offices. In 2002, no restructuring costs were incurred. We restructured several functions during 2001. This resulted in a one-time charge of $1.7 million. The majority of this charge was related to severance and other employee related benefit costs. INTEREST AND OTHER INCOME (EXPENSE). Interest and other income (expense) consists 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. Net interest and other income was $11,000 for 2002 and $259,000 for 2001, representing a decrease of 96%. This decrease was primarily due to a reduction in our cash balances until November 2002 when we completed a $2 million common stock sale to purchasers affiliated with Needham Capital Partners, and a reduction in market interest rates. 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, 2002 was $31,000, 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 $88,000 in 2002 and $245,000 in 2001. We expect to record amortization expense related to these securities of approximately $31,000 in 2003. 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, 2002, we had $55.9 million of federal and $8.6 million of state net operating loss carryforwards available to offset future taxable income. The federal net operating loss carryforwards expire through 2022, while the state net operating loss carryforwards expire through 2012. 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 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. 18 As of December 31, 2002, the Company also had research and development tax credit carryforwards of $1.7 million and $1.6 million available to offset future federal and state income taxes, respectively. The federal credit carryforward expires in 2022, 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, 2001 AND 2000 REVENUES Our revenues were $19.4 million for 2001 and $25.3 million for 2000 representing a decrease of 23%. License revenues comprised 55% of total revenues and service revenues comprised 45% of total revenues for the fiscal year ended December 31, 2001. 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. 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, which reduced expenses by $231,000. COST OF SERVICE REVENUES. 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. Cost of service revenues as a percentage of service revenues may vary between periods due to our use of third party professional services. OPERATING EXPENSES SALES AND MARKETING. 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, of $2.9 million, a reduction in staff which reduced expenses by $3.1 million and a $605,000 reduction in expensed commissions based on lower sales revenues. Sales and marketing expenses represented 74% of total revenues for 2001 and 90% of total revenues for 2000. RESEARCH AND DEVELOPMENT. 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 which reduced expenses by $2.2 million. Research and development expenses represented 29% of total revenues for 2001 and 32% of total revenues for 2000. GENERAL AND ADMINISTRATIVE. General and administrative expenses were $5.5 million for 2001 and $5.4 million for 2000, representing an increase of 2%. General and administrative expenses represented 29% of total revenues for 2001 and 21% of total revenues for 2000. 19 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. We restructured several operational functions during 2001. This resulted in a one-time charge of $1.7 million. The majority of this charge 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. 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. 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. 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, 2002. 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. 20
QUARTER ENDED -------------------------------------------------------------------------------------- MAR. 31, JUN. 30, SEP. 30, DEC. 31, MAR. 31, JUN. 30, 2000 2000 2000 2000 2001 2001 ----------- ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS, EXCEPT PERCENTAGE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA Revenues: License ............................. $ 2,881 $ 4,402 $ 5,356 $ 5,045 $ 2,131 $ 2,538 Service ............................. 1,329 1,556 1,728 2,980 2,735 2,213 ----------- ----------- ----------- ----------- ----------- ----------- Total revenues .................... 4,210 5,958 7,084 8,025 4,866 4,751 ----------- ----------- ----------- ----------- ----------- ----------- Cost of revenues: License ............................. 50 16 207 31 5 1 Service ............................. 715 902 857 1,118 1,173 1,189 ----------- ----------- ----------- ----------- ----------- ----------- Total cost of revenues ............ 765 918 1,064 1,149 1,178 1,190 ----------- ----------- ----------- ----------- ----------- ----------- Gross profit ......................... 3,445 5,040 6,020 6,876 3,688 3,561 ----------- ----------- ----------- ----------- ----------- ----------- Operating expenses: Sales and marketing ................. 5,998 5,255 5,234 6,268 4,349 3,819 Research and development ............ 2,013 2,213 2,042 1,859 1,748 1,583 General and administrative .......... 867 1,492 1,649 1,423 1,374 1,394 Amortization of purchased intangibles ....................... 496 771 799 859 718 2,458 Restructuring costs ................. -- -- -- -- 785 688 ----------- ----------- ----------- ----------- ----------- ----------- Total operating expenses .......... 9,374 9,731 9,724 10,409 8,974 9,942 ----------- ----------- ----------- ----------- ----------- ----------- Income (loss) from operations ........ (5,929) (4,691) (3,704) (3,533) (5,286) (6,381) Interest income (expense), net ....... 367 290 299 175 177 97 ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) .................... $ (5,562) $ (4,401) $ (3,405) $ (3,358) $ (5,109) $ (6,284) =========== =========== =========== =========== =========== =========== Shares used in calculating basic net income (loss) per share ........................... 1,897 1,915 1,942 1,967 1,979 1,992 =========== =========== =========== =========== =========== =========== Shares used in calculating diluted net income (loss) per share ........................... 1,897 1,915 1,942 1,967 1,979 1,992 =========== =========== =========== =========== =========== =========== Basic net income (loss) per share .... $ (2.93) $ (2.30) $ (1.75) $ (1.71) $ (2.58) $ (3.16) =========== =========== =========== =========== =========== =========== Diluted net income (loss) per share .. $ (2.93) $ (2.30) $ (1.75) $ (1.71) $ (2.58) $ (3.16) =========== =========== =========== =========== =========== =========== AS A PERCENTAGE OF TOTAL REVENUES: Revenues: License ............................. 68.4% 73.9% 75.6% 62.9% 43.8% 53.4% Service ............................. 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% ----------- ----------- ----------- ----------- ----------- ----------- Cost of revenues: License ............................. 1.2 0.3 2.9 0.4 0.1 0.0 Service ............................. 17.0 15.1 12.1 13.9 24.1 25.0 ----------- ----------- ----------- ----------- ----------- ----------- Total cost of revenues ............ 18.2 15.4 15.0 14.3 24.2 25.0 ----------- ----------- ----------- ----------- ----------- ----------- Gross margin ......................... 81.8 84.6 85.0 85.7 75.8 75.0 ----------- ----------- ----------- ----------- ----------- ----------- Operating expenses: Sales and marketing ................. 142.5 88.2 73.9 78.1 89.4 80.4 Research and development ............ 47.8 37.1 28.8 23.2 35.9 33.3 General and administrative .......... 20.6 25.0 23.3 17.7 28.2 29.3 Amortization of purchased intangibles ....................... 11.8 12.9 11.3 10.7 14.8 51.7 Restructuring costs ................. -- -- -- -- 16.1 14.5 ----------- ----------- ----------- ----------- ----------- ----------- Total operating expenses .......... 222.7 163.3 137.3 129.7 184.4 209.3 ----------- ----------- ----------- ----------- ----------- ----------- Income (loss) from operations ........ (140.8) (78.7) (52.3) (44.0) (108.6) (134.3) Interest income (expense) net ........ 8.7 4.9 4.2 2.2 3.6 2.0 ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) .................... (132.4)% (73.9)% (48.1)% (41.8)% (105.0)% (132.3)% =========== =========== =========== =========== =========== =========== Table continued on next page 21a table continued from above page QUARTER ENDED -------------------------------------------------------------------------------------- SEP. 30, DEC. 31, MAR. 31, JUN. 30, SEP. 30, DEC. 31, 2001 2001 2002 2002 2002 2002 ----------- ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS, EXCEPT PERCENTAGE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA Revenues: License ............................. $ 3,114 $ 2,778 $ 833 $ 4,104 $ 2,825 $ 1,299 Service ............................. 2,056 1,806 1,328 1,626 1,319 1,252 ----------- ----------- ----------- ----------- ----------- ----------- Total revenues .................... 5,170 4,584 2,161 5,730 4,144 2,551 ----------- ----------- ----------- ----------- ----------- ----------- Cost of revenues: License ............................. 1 7 27 75 75 109 Service ............................. 975 636 768 759 691 522 ----------- ----------- ----------- ----------- ----------- ----------- Total cost of revenues ............ 976 643 795 834 766 631 ----------- ----------- ----------- ----------- ----------- ----------- Gross profit ......................... 4,194 3,941 1,366 4,896 3,378 1,920 ----------- ----------- ----------- ----------- ----------- ----------- Operating expenses: Sales and marketing ................. 3,739 2,464 2,434 2,586 1,848 1,807 Research and development ............ 1,229 1,018 1,118 1,038 1,040 912 General and administrative .......... 1,464 1,287 927 919 798 815 Amortization of purchased intangibles ....................... 245 213 212 142 126 289 Restructuring costs ................. 200 -- -- -- -- -- ----------- ----------- ----------- ----------- ----------- ----------- Total operating expenses .......... 6,877 4,982 4,691 4,685 3,812 3,823 ----------- ----------- ----------- ----------- ----------- ----------- Income (loss) from operations ........ (2,683) (1,041) (3,325) 211 (434) (1,903) Interest income (expense), net ....... 14 (29) 16 4 (15) 6 ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) .................... $ (2,669) $ (1,070) $ (3,309) $ 215 $ (449) $ (1,897) =========== =========== =========== =========== =========== =========== Shares used in calculating basic net income (loss) per share ........................... 1,997 2,001 2,009 2,015 2,020 2,168 =========== =========== =========== =========== =========== =========== Shares used in calculating diluted net income (loss) per share ........................... 1,997 2,001 2,009 2,049 2,020 2,168 =========== =========== =========== =========== =========== =========== Basic net income (loss) per share .... $ (1.34) $ (0.53) $ (1.65) $ 0.11 $ (0.22) $ (0.88) =========== =========== =========== =========== =========== =========== Diluted net income (loss) per share .. $ (1.34) $ (0.53) $ (1.65) $ 0.10 $ (0.22) $ (0.88) =========== =========== =========== =========== =========== =========== AS A PERCENTAGE OF TOTAL REVENUES: Revenues: License ............................. 60.2% 60.6% 38.5% 71.6% 68.2% 50.9% Service ............................. 39.8 39.4 61.5 28.4 31.8 49.1 ----------- ----------- ----------- ----------- ----------- ----------- Total revenues .................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% ----------- ----------- ----------- ----------- ----------- ----------- Cost of revenues: License ............................. 0.0 0.1 1.2 1.3 1.8 4.3 Service ............................. 18.9 13.9 35.5 13.2 16.7 20.5 ----------- ----------- ----------- ----------- ----------- ----------- Total cost of revenues ............ 18.9 14.0 36.7 14.5 18.5 24.8 ----------- ----------- ----------- ----------- ----------- ----------- Gross margin ......................... 81.1 86.0 63.3 85.5 81.5 75.2 ----------- ----------- ----------- ----------- ----------- ----------- Operating expenses: Sales and marketing ................. 72.3 53.8 112.6 45.1 44.6 70.8 Research and development ............ 23.8 22.2 51.7 18.1 25.1 35.8 General and administrative .......... 28.3 28.1 42.9 16.0 19.3 31.9 Amortization of purchased intangibles ....................... 4.7 4.6 9.8 2.5 3.0 11.3 Restructuring costs ................. 3.9 0.0 0.0 0.0 0.0 0.0 ----------- ----------- ----------- ----------- ----------- ----------- Total operating expenses .......... 133.0 108.7 217.0 81.7 92.0 149.8 ----------- ----------- ----------- ----------- ----------- ----------- Income (loss) from operations ........ (51.9) (22.7) (153.7) 3.8 (10.5) (74.6) Interest income (expense) net ........ 0.2 (0.6) 0.7 0.1 (0.4) 0.2 ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) .................... (51.7)% (23.3)% (153.0)% 3.9% (10.9)% (74.4)% =========== =========== =========== =========== =========== =========== 21b
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 shifts in demand for and market acceptance among our various products, including our newer products, EDGEXTEND and DIRECTALERT, and our older POWERTIER product; o introduction of new products or services by us or our competitors; o annual or quarterly budget cycles of our customers or prospective customers; o the level of product and price competition in the application server and data management 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 possible loss of sales people; 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. 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 the sale of unregistered common stock in the amount of $2.0 million in November 2002, 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 an equipment related loan in the maximum principal amount of $800,000 which has been repaid in full, a second equipment related loan in the amount of $655,000 and a third equipment related loan in the amount of $149,000, and capitalized leases. As of December 31, 2002, we had $8.9 million of cash and cash equivalents and $4.9 million of working capital. Net cash provided by operating activities was $113,000 for 2002. In 2001 and 2000, cash used in operating activities was $11.6 million and $11.7 million respectively. For 2002, cash provided by operating activities was primarily attributable to a decrease in accounts receivable due to a higher level of collections during the year ended December 31, 2002, which increased cash by $2.5 million, a $1.1 million increase in deferred revenues owing to the prepayment of multi-year contracts by two large customers, which also resulted in a long-term balance for deferred revenues and to an increase of $731,000 in other accrued liabilities. We do not expect such trends to continue. This provision of operating cash was offset primarily by net losses of $5.4 million and a decrease in accounts payable of $745,000. For each of 2001 and 2000, cash used for operating activities was attributable primarily to net operating losses of $15.1 million and $16.7 million, respectively. These losses were offset in part by depreciation and amortization expenses of $2.3 million in 2001 and $3.8 million in 2000. 22 Net cash used in investing activities was $325,000 for 2002. Net cash provided by investing activities was $5.4 million for 2001, and net cash used in investing activities was $108,000 for 2000. For 2002, cash used in investing activities was primarily attributable to the purchase of $176,000 in property and equipment and the acquisition of $158,000 in purchased intangibles. For 2001, cash provided by investing activities consisted primarily of the sale of short-term investments yielding $5.4 million. For 2000, cash used in investing activities consisted of purchases of $1.4 million in property and equipment and $619,000 in purchased intangibles, offset by the sale of short-term investments yielding 2.0 million. Net cash provided by financing activities was $1.7 million for 2002. Net cash used in financing activities was $500,000 for 2001. Net cash provided by financing activities was $3.6 million for 2000. Net cash provided by financing activities during 2002 consisted primarily of $2.0 million in proceeds from the sale of unregistered common stock and stock warrants to an investor, offset by $329,000 in repayments under loan agreements. Net cash used in financing activities during 2001 consisted primarily of $462,000 in repayments of capital leases and loan agreements, offset by $270,000 in proceeds from the sale of common stock. Net cash provided by financing activities during 2000 was primarily attributable to the $3.5 million in proceeds from sale of common stock, and from $533,000 in borrowings under an equipment loan facility, offset by $267,000 in repayments under loan agreements. For 2001, net cash was provided from $122,000 in borrowings under an equipment financing facility, offset by $419,000 in repayments under loan agreements. We have credit facilities with Comerica Bank. Under those credit facilities, we had a $5.0 million revolving line of credit facility at December 31, 2002 that was renegotiated in the amount of $2.5 million in March 2003 and is available until April 30, 2004 (refer to Note 11 of the "Notes to Consolidated Financial Statements" included elsewhere in this report). We also have a $655,000 equipment term loan, and a $149,000 equipment term loan. As of December 31, 2002 we had no borrowings outstanding under the revolving line of credit facility. As of December 31, 2002 we had $240,000 outstanding under the $655,000 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. As of December 31, 2002 we had $149,000 outstanding under an equipment facility. Under this facility, borrowings outstanding of $149,000 as of January 3, 2003 converted to an 18 month term loan with principal payments of $8,284 per month beginning on February 1, 2003 plus interest at the bank's base rate plus 1% per annum. The bank's credit facilities required that as of December 31, 2002 we, among other things, maintain a minimum tangible net worth of $5.5 million and a minimum quick ratio (current assets not including inventory less current liabilities) of 2 to 1. As of December 31, 2002, our tangible net worth fell below the minimum tangible net worth ratio then in effect, and the bank waived the event. In March 2003, we renegotiated our revolving credit facility and a new covenant structure is in place. Our credit facilities with Comerica Bank currently require, among other things, that we maintain a tangible net worth of at least $2.25 million. In addition, we must experience net losses below $1.25 million for the quarter ending March 31, 2003, $750,000 for the quarter ending June 30, 2003 and $250,000 for the quarter ending September 30, 2003, and we must show a profit of at least one dollar for each quarter thereafter. We expect to meet these covenants. Borrowings under the facilities are collateralized by substantially all of our assets, including our intellectual property. Currently we have no material commitments for capital expenditures nor do we anticipate a material increase in capital expenditures and lease commitments. We are currently targeting that our current cash and cash equivalents will be sufficient to meet our anticipated cash needs through at least December 31, 2003, provided that we meet our targets with respect to revenues and accounts receivable collections. If we experience difficulties in achieving our revenue targets, our cash and cash equivalents may not be sufficient to meet our anticipated cash needs. Accordingly, our operating plans could be restricted and our business could be harmed. 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, our business could be jeopardized. 23 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 was not material to our financial statements. 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. The Company adopted the provisions of SFAS No. 144 as of January 1, 2002. Adoption of SFAS No. 144 did not have a material effect on the Company's financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of our commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. This statement is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 is expected to impact the timing of recognition and the amount of future restructuring activities. In December 2002, the FASB issued SFAS No. 148 ACCOUNTING FOR STOCK-BASED COMPENSATION, TRANSITION AND DISCLOSURE, AN AMENDMENT OF FASB STATEMENT NO. 123. SFAS No. 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects of reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. Finally, this statement amends APB Opinion No. 28, INTERIM FINANCIAL REPORTING, to require disclosure about those effects in interim financial information. The amendments to SFAS No. 123, which provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation is effective for financial statements for fiscal years ending after December 15, 2002. The amendment to SFAS No. 123 relating to disclosures and the amendment to Opinion 28 is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. Management does not intend to adopt the fair value accounting provisions of SFAS No. 123 and currently believes that the adoption of SFAS No. 148 will not have a material impact on our financial statements. In November 2002, the FASB issued FASB Interpretation No. 45, GUARANTOR'S ACCOUNTING FOR DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS, AN INTERPRETATION OF FASB STATEMENTS NO. 5, 57 AND 107 AND RESCISSION OF FASB INTERPRETATION NO. 34, DISCLOSURE OF INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS (FIN 45). FIN 45 clarifies the requirements for a guarantor's accounting for and disclosure of certain guarantees issued and outstanding. It also requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This interpretation also incorporates without reconsideration the guidance in FASB Interpretation No. 34, which is being superseded. The adoption of FIN 45 will not have a material effect on our consolidated financial statements and will be applied prospectively. 24 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. 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 DATA SERVICES MARKETS. Because we only commenced selling EDGEXTEND and DIRECTALERT in 2002, we have a limited operating history in the data services markets. 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 need to achieve market acceptance for our new product introductions, including, DIRECTALERT and EDGEXTEND; o our dependence for revenue from our POWERTIER product, which was first introduced in 1997 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, independent software vendors and systems integrators; o our unproven ability to anticipate and respond to technological and competitive developments in the rapidly changing market for dynamic data management; o our unproven ability to compete in a highly competitive market; o the decline in spending levels in the software infrastructure market; o our dependence on the Java programming language, commonly known as 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 NOT 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 $5.4 million in 2002, $15.1 million in 2001 and $16.7 million in 2000. As of December 31, 2002, we had an accumulated deficit of $61.4 million. While we are currently targeting decreases in sales and marketing, research and development, and general and administrative expenses for 2003, as compared to the levels of those expenses in 2002, we will still need to achieve our revenue targets in order to preserve cash. 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 markets for our products. WE HAVE FINANCED OUR BUSINESS THROUGH THE SALE OF STOCK AND NOT THROUGH CASH GENERATED BY OUR OPERATIONS. Since inception, we have generally had negative cash flow from operations. To date, we have financed our business primarily through sales of common stock and convertible preferred stock and not through cash generated by our operations. We expect to have negative cash flow from operations for the year ending December 31, 2003. 25 WE MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE. We are currently targeting that our current cash and cash equivalents will be sufficient to meet our anticipated cash needs through at least December 31, 2003 provided that we meet our targets with respect to revenues and accounts receivable collections. If we experience difficulties in achieving our revenue targets, our cash and cash equivalents may not be sufficient to meet our anticipated cash needs. Accordingly, our operating plans could be restricted and our business could be harmed. 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, our business could be jeopardized. 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 shifts in demand for and market acceptance among our various products, including our newer products, EDGEXTEND and DIRECTALERT, and our older POWERTIER product; o introduction of new products or services by us or our competitors; o annual or quarterly budget cycles of our customers or prospective customers; o the level of product and price competition in the application server and data management 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 possible loss of sales people; 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. Also, we tend to experience slower sales patterns in Europe in the third quarter. 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. 26 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 prospective 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 product sales to a limited number of customers. In addition, the identity of our top five customers has changed from year to year. In the year ended December 31, 2002, sales to our top five customers accounted for 55% of total revenues. Sales to Cablevision accounted for 26% of total revenues and sales to Salomon Smith Barney accounted for 13% of total revenues. 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. If we lose a significant customer, or fail to increase product sales to an existing customer as planned, we may not be able to replace the lost revenues with sales to other customers. In addition, because our marketing strategy is to concentrate on selling products to industry leaders, any loss of a customer could harm our reputation within the industry and make it harder for us to sell our products to other companies in that industry. The loss of, or a reduction in sales to, one or more significant customers would likely result in a decrease in our revenues. WE ARE CURRENTLY TARGETING THAT A MATERIAL 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. Sales of our EDGEXTEND products currently represent a material 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 release or 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 we are focusing our marketing and sales efforts on our newer EDGEXTEND data management product, any failure in market adoption of this product could affect our business. BECAUSE OUR PRODUCTS PROVIDE ADDITIONAL FEATURES TO SUCCESSFUL APPLICATION SERVER PRODUCTS FROM IBM AND BEA, THEY MAY ADD THESE FEATURES TO A FUTURE VERSION OF THEIR PRODUCT, REDUCING THE NEED FOR OUR PRODUCTS. Because IBM and BEA control the development schedule and feature set of their products, we need to maintain a good working relationship with IBM and BEA if we decide to develop future versions of EDGEXTEND for those new versions of WebSphere and WebLogic. Failure to develop future versions compatible with the 27 latest versions from IBM and BEA could greatly reduce market acceptance for our products. IBM or BEA could add features to their products, which would reduce or eliminate the need for our products, which could harm our business. They could develop their products in a more proprietary way to favor their own products, or as those offered by a third party, which could make it much harder for us to compete in the J2EE software market. WE DEPEND ON THE JAVA PROGRAMMING LANGUAGE, THE ENTERPRISE JAVABEANS STANDARD AND THE JAVA 2 ENTERPRISE EDITION (J2EE) STANDARD AND DISTRIBUTED OBJECT COMPUTING, AND IF THESE TECHNOLOGIES FAIL TO GAIN ACCEPTANCE, OUR BUSINESS COULD SUFFER. We are focusing our marketing efforts on our EDGEXTEND products, which are based on three 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. Distributed object computing combines the use of software modules, or objects, communicating across a computer network to software applications, such as our EDGEXTEND products. Our products depend upon and conform to the EJB standard. Sun Microsystems released the EJB standard in 1998, and thus far EJB has had limited market acceptance. EJB is a part of the J2EE standard; J2EE is the Java programming standard for use in an application server. Since most of our products depend upon the specialized J2EE and EJB standards, 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 and EJB does not become a widespread programming standard for application servers, our revenues and business could suffer. IF WE DO NOT DELIVER PRODUCTS THAT MEET RAPIDLY CHANGING TECHNOLOGY STANDARDS AND CUSTOMER DEMANDS, WE WILL LOSE MARKET SHARE TO OUR COMPETITORS. The market for our products and services is characterized by rapid technological change, dynamic customer demands and frequent new product introductions and enhancements. Customer requirements for products can change rapidly as a result of innovation in software applications and hardware configurations and the emergence or adoption of new industry standards, including Internet technology standards. We may need to increase our research and development investment over our current targeted spending levels 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 may need to introduce new versions of EDGEXTEND designed to support these new specifications to remain competitive. If IBM or BEA introduce new versions of WebSphere and WebLogic, we may need to introduce new versions of EDGEXTEND designed to support these new versions. 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 for WebSphere product was released in March 2002, our EDGEXTEND for WebLogic product was released in August 2002 and our EDGEXTEND for ..NET product was released in October 2002. Any delays in releasing future enhancements to these products or new products on a generally available basis may materially effect our future revenues. BECAUSE OUR DIRECT SALES TEAM IS CURRENTLY OUR MOST CRITICAL SALES CHANNEL, ANY FAILURE TO MAINTAIN AND TRAIN 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. In the past, newly hired employees have required 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 and we may not be able to hire enough qualified individuals in the future. As a result of our employee turnover, 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. 28 BECAUSE OUR FUTURE REVENUE GOALS ARE BASED ON OUR DEVELOPMENT OF A STRONG SALES CHANNEL THROUGH INDEPENDENT SOFTWARE VENDORS, SYSTEMS INTEGRATORS, 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 revenue growth will depend in large part on our success in establishing and leveraging relationships with independent software vendors, system integrators, 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, data management products 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, independent software vendors, system integrators 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, independent software vendors, system integrator 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 J2EE APPLICATION SERVER STANDARD, WE FACE THE RISK THAT THEY MAY DEVELOP THIS STANDARD TO FAVOR THEIR OWN PRODUCTS. Because Sun Microsystems controls the J2EE standard, we need to maintain a good working relationship with Sun Microsystems as we decide to develop future versions of EDGEXTEND, 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 own products, or a third party, which could make it much harder for us to compete in the J2EE software market. MICROSOFT HAS ESTABLISHED A COMPETING APPLICATION SERVER STANDARD, WHICH COULD DIMINISH THE MARKET POTENTIAL FOR OUR PRODUCTS IF IT GAINS WIDESPREAD ACCEPTANCE. Our primary success has come in the J2EE market. Microsoft has established a competing standard for distributed computing, .NET. Our .NET products are new and unproven in the marketplace. If this standard gains widespread market acceptance over the J2EE or CORBA standards, our business could 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. 29 WE FACE SIGNIFICANT COMPETITION FROM COMPANIES WITH GREATER RESOURCES THAN WE HAVE AND MAY FACE ADDITIONAL COMPETITION IN THE FUTURE. The markets for our products are 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 markets are: o performance, including scalability, integrity and availability; o ability to provide a competitive return on investment to the customer; 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 perception of viability; and o price. In the EDGEXTEND market, alternative technology is available from a variety of sources. Companies such as Versant, Gemstone and Excelon are middleware vendors that offer alternative data management solutions that directly target EdgeXtend's market. In addition, many prospective customers may build their own custom solutions. In the DIRECTALERT market, alternative approaches are provided by a variety of sources, including the potential for internal development. Company vendors such as SpiritSoft, TIBCO, and IBM provide message-oriented middleware software which may evolve into competitive products. Vendors such as webMethods and Business Objects provide alternative architectures for business intelligence information. DIRECTALERT is based on licensed technology, which the Company is licensed to distribute on a non-exclusive basis. We continue to sell current and earlier versions of POWERTIER for J2EE application server to current customers. Our competitors for POWERTIER include both publicly and privately-held enterprises, including BEA Systems (WebLogic), IBM (WebSphere), Oracle (OAS), Secant Technologies and Sun Microsystems (Sun ONE Application Server). Many customers may not be willing to purchase our POWERTIER 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. IF THE MARKETS FOR INFRASTRUCTURE SOFTWARE FOR NETWORKS AND WEB-BASED PRODUCTS AND SERVICES DO 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 markets for infrastructure software for networks and web-based products and services. If these markets do 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. 30 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, in particularly because we must achieve our revenue and product development goals using both fewer people and less money. Our ability to manage our resources effectively will require us to continue to improve our sales process and to train, motivate and manage our employees. If we are unable to manage our business effectively within our current budget, 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. 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. Our future success will depend, in part, on our successful development of international markets for our products. Approximately 44% of our total revenues came from sales of products and services outside of the United States for the three months ended December 31, 2002, and approximately 33% of our total revenues came from sales of products and services outside of the United States for the year ended December 31, 2002. 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; 31 o future dependence on the sales efforts of our 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, acts of war, terrorism 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. Litigation may be necessary to enforce our intellectual property rights, which could result in substantial costs and diversion of management attention and resources. WE MAY BE SUED FOR PATENT INFRINGEMENT. The software industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement and the violation of other intellectual property rights. As the number of 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. 32 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, 2002, we had approximately 2,398,995 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. On November 2002, we sold 375,869 shares of common stock at a purchase price of $5.3210 per share, for an aggregate sale price of $2,000,000, and warrants to purchase up to 120,513 shares common stock at an exercise price of $7.50 per share to certain purchasers affiliated with Needham Capital Partners. In connection with this financing, we agreed to file a registration statement with the SEC covering the resale of these shares (including the shares issuable on exercise of the warrants) on the earlier of (i) 30 days after the date of this Annual Report on Form 10-K or (ii) April 30, 2003. We also agreed to file an additional registration statement on the request of the purchasers under certain circumstances. When the SEC declares this S-3 registration statement effective, the Needham affiliated purchasers will be able to freely trade these shares in the public market, subject to certain restrictions as a result of their status as an affiliate, which could result in a decrease in the price of our stock. OUR STOCK PRICE HAS BEEN, AND MAY CONTINUE TO BE, VOLATILE, AND WE HAVE RECEIVED A NOTICE FROM NASDAQ REGARDING THE POSSIBLE DELISTING OF OUR STOCK FROM THE NASDAQ SMALLCAP MARKET. 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 SmallCap 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 selling shares of our common stock at a desirable price, or at all. Furthermore, we have received a notice from the Nasdaq SmallCap Market that if our stock does not meet the minimum $1.00 per share minimum requirement for a 10-day period by June 2, 2003, our stock may be delisted from the Nasdaq SmallCap Market. If we cannot achieve compliance we expect to receive a formal delisting notice from the Nasdaq SmallCap Market. We currently intend to seek a Nasdaq hearing for appeal if and when we receive such notice of delisting. The maintenance of our Nasdaq SmallCap Market listing is very important to us. We intend to take appropriate actions, as necessary, including possibly seeking shareholder approval for a reverse stock split in order to maintain our Nasdaq SmallCap Market listing. If our efforts in this regard are unsuccessful, our stock would trade on the OTC "bulletin board". Delisting from the Nasdaq SmallCap Market could negatively impact our reputation and consequently our business. 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 technology 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. 33 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. 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; 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 34 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. 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 2002, our operating results would not have changed materially. As of December 31, 2002, 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, 2002. We estimate that a hypothetical ten percent change in foreign currency rates in 2002 would not have impacted our financial results of operations materially. 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. 35 PART III ITEMS 10, 11 AND 12. The Company's Proxy Statement for its Annual Meeting of Stockholders for the year ended December 31, 2002, when filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, is incorporated by reference in this Form 10-K pursuant to General Instruction G(3) of Form 10-K and provides the information required under Items 10-12 of Part III, except for the information with respect to the Company's executive officers, which is included in "Item 1. Business -- Executive Officers" and for the information with respect to the Company's compensation committee interlocks and insider participation in compensation decisions, which is included in Item 12: Security Ownership of Certain Beneficial Owners and Related Stockholder Matters. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND RELATED STOCKHOLDER MATTERS COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION None of the members of the Compensation Committee of the Board is an officer or employee of the Company, nor has any member formerly served as an officer of the Company. No executive officer of the Company serves as a member of a board of directors or compensation committee of any entity that has one or more executive officers serving on the Company's Board or Compensation Committee. Thomas P. Shanahan, who was appointed to the Compensation Committee of the Board in January 2003, is affiliated with Needham Capital Partners. On November 26, 2002, the Company issued 375,869 shares of its common stock at a price of $5.3210 per share, and warrants to purchase up to 120,513 shares of its common stock at an exercise price of $7.50 per share to certain purchasers affiliated with Needham Capital Partners. In connection with the issuance of these securities, the Company also appointed Mr. Shanahan to the Board as a Class III director. In addition, pursuant to the terms of a voting agreement among the Company, such purchasers and Christopher T. Keene, the Company's Chairman of the Board and Chief Executive Officer, Mr. Keene has agreed to vote for the election of the purchasers' designee to the Board for so long as the purchasers beneficially own at least 11% of the outstanding capital stock of the Company. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS TRANSACTIONS WITH MANAGEMENT On November 26, 2002, the Company issued 375,869 shares of its common stock at a price of $5.3210 per share, and warrants to purchase up to 120,513 shares of its common stock at an exercise price of $7.50 per share to certain purchasers affiliated with Needham Capital Partners. In connection with the issuance of these securities, the Company also appointed Thomas P. Shanahan, who is affiliated with Needham Capital Partners, to the Company's Board of Directors (the "Board") as a Class III director. In January 2003, Mr. Shanahan was appointed to the Compensation Committee of the Board. In addition, pursuant to the terms of a voting agreement among the Company, such purchasers and Christopher T. Keene, the Company's Chairman of the Board and Chief Executive Officer, Mr. Keene has agreed to vote for the election of the purchasers' designee to the Board for so long as the purchasers beneficially own at least 11% of the outstanding capital stock of the Company. The Company has a change of control agreement with Ed Murrer, which provides that a specified portion of the restricted stock or stock options granted to such officer under the 1997 Stock Plan will immediately vest if such officer is terminated without cause or resigns for good reason within 12 months after a change of control of the Company. The agreement terminates at the earliest of: (1) four years after the date of the agreement, (2) termination of employment with the Company other than within 12 months after a change of control or (3) a written agreement between the individual officer and the Company to terminate the agreement. The Company has entered into indemnification agreements with its officers and directors containing provisions that may require it to indemnify its officers and directors against liabilities that may arise by reason of their status or service as officers or directors, other than liabilities arising from willful misconduct of a culpable nature, and to advance their expenses incurred as a result of any proceeding against them. 36 ITEM 14. CONTROLS AND PROCEDURES. Within 90 days prior to the filing of this report, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined at Exchange Act Rules 13a-14(c) and 15d-14(c). Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures are effective. Our disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching our desired disclosure control objectives and are effective in doing so. No significant changes were made to our internal controls or other factors that could significantly affect these controls subsequent to the date of our evaluation. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this annual report: (1) FINANCIAL STATEMENTS AND INDEPENDENT AUDITOR'S REPORT (pages F-1 through F-18): Audited Consolidated Financial Statements: Independent Auditors' Report Consolidated Balance Sheets at December 31, 2002 and 2001 Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Loss for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 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, 2002, 2001 and 2000 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) (b) Reports on Form 8-K. One report on Form 8-K was filed on November 27, 2002 during the quarter ended December 31, 2002 reporting matters under Item 5. Other Events, and Item 7, Financial Statements Pro Forma Financial Information and Exhibits. 37 CERTIFICATIONS I, Christopher T. Keene, Chief Executive Officer of the registrant, certify that: 1. I have reviewed this annual report on Form 10-K/A of Persistence Software, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: August 12, 2003 /s/ CHRISTOPHER T. KEENE ---------------------------- Christopher T. Keene Chief Executive Officer 38 CERTIFICATIONS I, Christine Russell, Chief Financial Officer of the registrant, certify that: 1. I have reviewed this annual report on Form 10-K/A of Persistence Software, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: August 12, 2003 /s/ CHRISTINE RUSSELL ------------------------- Christine Russell Chief Financial Officer 39 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 February 12, 2003. 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. 10.5* 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 dated March 6, 2002. 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. 10.17**** Second Amendment to the Restated Loan and Security Agreement between Persistence and Comerica Bank dated July 3, 2002. 10.18**** Third Amendment to the Restated Loan and Security Agreement between Persistence and Comerica Bank dated July 17, 2002. 10.19** Common Stock Purchase Agreement dated as of November 26, 2002 by and between Persistence Software, Inc. and Needham Capital Partners III, L.P., Needham Capital Partners IIIA, L.P. and Needham Capital Partners III (Bermuda), L.P. 10.20** Registration Rights Agreement dated as of November 26, 2002 by and between Persistence Software, Inc. and Needham Capital Partners III, L.P., Needham Capital Partners IIIA, L.P. and Needham Capital Partners III (Bermuda), L.P. 10.21** Voting Agreement dated as of November 26, 2002 by and between Persistence Software, Inc., Christopher T. Keene and Needham Capital Partners III, L.P., Needham Capital Partners IIIA, L.P. and Needham Capital Partners III (Bermuda), L.P. 10.22** Form of Common Stock Warrant dated as of November 26, 2002 issued to Needham Capital Partners III, L.P., Needham Capital Partners IIIA, L.P. and Needham Capital Partners III (Bermuda), L.P. 10.23++ Fourth Amendment to the Restated Loan and Security Agreement between Persistence and Comerica Bank dated November 15, 2002. 10.24++ Amended and Restated Loan Agreement between Persistence and Comerica Bank dated March 20, 2003. 21.1* List of subsidiaries. 23.1 Independent Auditors' Consent. 24.1++ Power of Attorney (see page 42). 99.1 Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. __________ 40 * Incorporated herein by reference to our Registration Statement on Form S-1 (Commission File No. 333-76867). ** Incorporated herein by reference to our Current Report on Form 8-K filed on November 27, 2002. *** Incorporated herein by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2001. **** Incorporated herein by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2002. ***** Incorporated herein by reference to our Annual Report on Form 10K for the year ended December 31, 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. ++ Previously filed. 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Amendment No. 2 to Annual Report on Form 10-K/A for the fiscal year ended December 31, 2002 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: August 12, 2003 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 August 12, 2003 - -------------------------------- Officer (Principal Executive Officer) Christopher T. Keene /s/ CHRISTINE RUSSELL Chief Financial Officer (Principal August 12, 2003 - -------------------------------- Financial and Accounting Officer) Christine Russell * Director August 12, 2003 - -------------------------------- Owen Brown * Director August 12, 2003 - -------------------------------- Alan King * Director August 12, 2003 - -------------------------------- Christopher Paisley * Director August 12, 2003 - -------------------------------- Thomas Shanahan * Director August 12, 2003 - -------------------------------- Sanjay Vaswani
* /s/ Christine Russell ----------------------------------- Christine Russell, Attorney-in-fact 42 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, 2002 and 2001................. F-3 Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000....................................... F-4 Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Loss for the years ended December 31, 2002, 2001 and 2000.......................................................... F-5 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000....................................... 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, 2002 and 2001, 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, 2002. 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, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP San Jose, California January 24, 2003 (March 20, 2003 as to the first paragraph of Note 11 and June 12, 2003 as to the second paragraph of Note 11) F-2 PERSISTENCE SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PAR VALUE AMOUNTS)
ASSETS DECEMBER 31, --------------------- 2002 2001 --------- --------- Current assets: Cash and cash equivalents ........................................................... $ 8,903 $ 7,411 Accounts receivable, net of allowances of $220 and $152, respectively ............... 1,252 4,106 Prepaid expenses and other current assets ........................................... 392 656 --------- --------- Total current assets ........................................................... 10,547 12,173 Property and equipment, net ........................................................... 375 796 Purchased intangibles, net of amortization of $785 and $1,088, respectively ........... 123 722 Other assets .......................................................................... 55 64 --------- --------- Total assets ................................................................... $ 11,100 $ 13,755 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable .................................................................... $ 325 $ 1,070 Accrued compensation and related benefits ........................................... 722 892 Other accrued liabilities ........................................................... 1,188 457 Deferred revenues, net of long-term portion ......................................... 2,529 2,124 Current portion of long-term obligations ............................................ 841 847 --------- --------- Total current liabilities ...................................................... 5,605 5,390 Long-term liabilities Long-term portion of deferred revenues .............................................. 691 -- Long-term obligations ............................................................... 93 421 --------- --------- Total long-term liabilities .................................................... 784 421 --------- --------- Total liabilities .............................................................. 6,389 5,811 --------- --------- 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 -- 2002, 2,398,995 shares; 2001, 2,003,658 shares ........................................... 66,103 64,036 Deferred stock compensation ......................................................... (31) (119) Notes receivable from stockholders .................................................. -- (54) Accumulated deficit ................................................................. (61,370) (55,930) Accumulated other comprehensive income .............................................. 9 11 --------- --------- Total stockholders' equity ..................................................... 4,711 7,944 --------- --------- Total liabilities and stockholders' equity ..................................... $ 11,100 $ 13,755 ========= ========= 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, --------------------------------- 2002 2001 2000 --------- --------- --------- Revenues: License ......................................................... $ 9,061 $ 10,561 $ 17,684 Service ......................................................... 5,525 8,810 7,593 --------- --------- --------- Total revenues ............................................. 14,586 19,371 25,277 --------- --------- --------- Cost of revenues: License ......................................................... 286 14 304 Service ......................................................... 2,740 3,973 3,592 --------- --------- --------- Total cost of revenues ..................................... 3,026 3,987 3,896 --------- --------- --------- Gross profit ...................................................... 11,560 15,384 21,381 Operating expenses: Sales and marketing ............................................. 8,676 14,371 22,755 Research and development ........................................ 4,108 5,578 8,127 General and administrative ...................................... 3,459 5,519 5,431 Amortization and write-down of purchased intangibles ............ 768 3,634 2,925 Restructuring costs ............................................. -- 1,673 -- --------- --------- --------- Total operating expenses ................................... 17,011 30,775 39,238 --------- --------- --------- Loss from operations .............................................. (5,451) (15,391) (17,857) Interest and other income (expense): Interest income ................................................. 94 394 1,401 Interest expense ................................................ (44) (68) (60) Other, net ...................................................... (39) (67) (210) --------- --------- --------- Total interest and other income (expense) .................. 11 259 1,131 --------- --------- --------- Net loss .......................................................... $ (5,440) $(15,132) $(16,726) ========= ========= ========= Basic and diluted net loss per share .............................. $ (2.65) $ (7.60) $ (8.65) ========= ========= ========= Shares used in calculating basic and diluted net loss per share ... 2,053 1,992 1,933 ========= ========= ========= 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)
PREFERRED STOCK COMMON STOCK DEFERRED ----------------------------- ----------------------------- STOCK SHARES AMOUNT SHARES AMOUNT COMPENSATION ------------- ------------- ------------- ------------- ------------- Balances, January 1, 2000 ......... -- $ -- 1,926,970 $ 57,467 $ (1,206) Net loss .......................... Change in unrealized gain on investments ..................... Cumulative translation adjustment ...................... Comprehensive loss ................ Issuance of common stock, net of repurchases .............. 60,900 6,725 Collection of notes receivable from stockholders ............... Reversal of stock arrangements due to cancellations ............ (198) 198 Amortization of deferred stock compensation .............. 416 ------------- ------------- ------------- ------------- ------------- Balances, December 31, 2000 ....... -- -- 1,987,870 63,994 (592) Net loss .......................... Cumulative translation adjustment ...................... Comprehensive loss ................ Issuance of common stock, net of repurchases ..................... 15,787 270 Collection of notes receivable from stockholders ............... 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 ....... -- -- 2,003,657 64,036 (119) Net loss .......................... Cumulative translation adjustment ...................... Comprehensive loss ................ Issuance of common stock and common stock warrants, net of repurchases .................. 395,337 2,025 Collection of notes receivable from stockholders ............... Issuance of stock options, non-employees ................... 42 Amortization of deferred stock compensation .............. 88 ------------- ------------- ------------- ------------- ------------- Balances, December 31, 2002 ....... -- $ -- 2,398,994 $ 66,103 $ (31) ============= ============= ============= ============= ============= table continued on next page F-5a NOTES ACCUMULATED RECEIVABLE OTHER TOTAL FROM ACCUMULATED COMPREHENSIVE COMPREHENSIVE STOCKHOLDERS DEFICIT (LOSS)INCOME TOTAL LOSS ------------- ------------- ------------- ------------- ------------- Balances, January 1, 2000 ......... $ (161) $ (24,072) $ (10) $ 32,018 Net loss .......................... (16,726) (16,726) $ (16,726) Change in unrealized gain on investments ..................... 10 10 10 Cumulative translation adjustment ...................... 46 46 46 ------------- Comprehensive loss ................ $ (16,670) ============= Issuance of common stock, net of repurchases .............. 6,725 Collection of notes receivable from stockholders ............... 67 67 Reversal of stock arrangements due to cancellations ............ Amortization of deferred stock compensation .............. 416 ------------- ------------- ------------- ------------- Balances, December 31, 2000 ....... (94) (40,798) 46 22,556 Net loss .......................... (15,132) (15,132) $ (15,132) Cumulative translation adjustment ...................... (35) (35) (35) ------------- Comprehensive loss ................ $ (15,167) ============= Issuance of common stock, net of repurchases ..................... 270 Collection of notes receivable from stockholders ............... 40 40 Issuance of stock warrants ........ Reversal of stock arrangements due to cancellations ............ Amortization of deferred stock compensation .............. 245 ------------- ------------- ------------- ------------- Balances, December 31, 2001 ....... (54) (55,930) 11 7,944 Net loss .......................... (5,440) (5,440) $ (5,440) Cumulative translation adjustment ...................... (2) (2) (2) ------------- Comprehensive loss ................ $ (5,442) ============= Issuance of common stock and common stock warrants, net of repurchases .................. 2,025 Collection of notes receivable from stockholders ............... 54 54 Issuance of stock options, non-employees ................... 42 Amortization of deferred stock compensation .............. 88 ------------- ------------- ------------- ------------- Balances, December 31, 2002 ....... $ -- $ (61,370) $ 9 $ 4,711 ============= ============= ============= ============= See notes to consolidated financial statements. F-5b
PERSISTENCE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, --------------------------------- 2002 2001 2000 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ............................................................. $ (5,440) $(15,132) $(16,726) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Allowance for doubtful accounts ................................... 353 951 896 Depreciation and amortization ..................................... 1,198 2,275 3,842 Write-down of purchased intangibles ............................... 160 1,988 -- Loss on sale of fixed assets ...................................... 14 164 -- Amortization of deferred stock compensation ....................... 88 245 416 Issuance of warrants and options to non-employees ................. 42 -- -- Reserve for loss on lease liability ............................... 22 -- -- Changes in operating assets and liabilities: Accounts receivable ............................................. 2,501 2,064 (2,332) Prepaid expenses and other current assets ....................... 264 175 (265) Accounts payable ................................................ (745) (587) 287 Accrued compensation and related benefits ....................... (171) (1,895) 983 Other accrued liabilities ....................................... 731 (1,274) 537 Deferred revenues ............................................... 1,096 (558) 667 --------- --------- --------- Net cash provided by (used in) operating activities .......... 113 (11,584) (11,695) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of short-term investments ......................... -- 5,387 1,965 Purchase of property and equipment ................................... (176) (101) (1,422) Proceeds from sale of property and equipment ......................... -- 93 -- Acquisition of purchased intangibles ................................. (158) -- (619) Deposits and other ................................................... 9 48 (32) --------- --------- --------- Net cash provided by (used) in investing activities .......... (325) 5,427 (108) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Sale of common stock, net of repurchases and issuance costs .......... 2,025 270 3,465 Repurchase of common stock ........................................... -- -- (1) Collection of notes receivable from stockholders ..................... 54 40 67 Repayment of capital lease obligations ............................... (33) (43) (77) Repayment of obligations incurred to acquire purchased intangibles ... (160) (470) (160) Borrowing under loan agreement ....................................... 149 122 533 Repayment under loan agreements ...................................... (329) (419) (267) --------- --------- --------- Net cash provided by (used) in financing activities .......... 1,706 (500) 3,560 --------- --------- --------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS ........... (2) (35) 46 --------- --------- --------- CASH AND CASH EQUIVALENTS: Net increase (decrease) .............................................. 1,492 (6,692) (8,197) Beginning of year .................................................... 7,411 14,103 22,300 --------- --------- --------- End of year .......................................................... $ 8,903 $ 7,411 $ 14,103 ========= ========= ========= NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisition of property and equipment under capital leases ........... $ 18 $ -- $ 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 ========= ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION --CASH PAID DURING THE YEAR FOR: Interest ............................................................. $ 44 $ 68 $ 60 ========= ========= ========= Income taxes ......................................................... $ 34 $ 66 $ 132 ========= ========= ========= See notes to consolidated financial statements. F-6
PERSISTENCE SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES BUSINESS -- Persistence Software solves data access problems for distributed and real-time systems. The Company's solutions help deliver better business visibility for applications which require current information about customers, products and suppliers. The Company 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. 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. Purchased intangibles at December 31, 2002 were $123,000 net of amortization. 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 fiscal 2002, the Company determined that certain intangible assets were impaired and, thus, recorded a write-down of $160,000. In fiscal 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 were paid in full during fiscal 2002. The notes were full-recourse. REVENUE RECOGNITION -- Revenue consists primarily of fees for licenses of the Company's software products, maintenance and customer support. F-7 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. Royalty revenues are recognized when the software or services has been delivered, collection is reasonably assured and the fees are determinable. 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 until support revenue is recognized it is included in "deferred revenue" on the accompanying consolidated balance sheet. 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, Euro and the Hong Kong Dollar. Accordingly, all monetary assets and liabilities are translated at 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. SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION as amended by SFAS 148 ACCOUNTING FOR STOCK-BASED COMPENSATION TRANSITION AND DISCLOSURE, 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, 30 months following vesting in 2002, 24 months following vesting in 2001 and 2000; risk free interest rate of 4.0% in 2002, 5.0% in 2001, 5.1% in 2000; volatility of 147% for 2002, 183% for 2001, 124% for 2000; 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 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, 2002, 2001 and 2000, as discussed above) would have been approximately as follows: F-8
YEAR ENDED DECEMBER 31, --------------------------------- 2002 2001 2000 --------- --------- --------- Net loss applicable to common shareholders: ................. As reported ................................................. $ (5,440) $(15,132) $(16,726) Stock-based employee compensation expense included in reported loss ............................................. 88 245 416 Total stock-based employee compensation expense determined under fair value based method for all awards .. (1,301) 3,785 (10,677) --------- --------- --------- Pro forma net loss .......................................... $ (6,653) $(11,102) $(26,987) ========= ========= ========= Basic and diluted net loss applicable to common shareholders per share: As reported ................................................. $ (2.65) $ (7.60) $ (8.65) ========= ========= ========= Pro forma ................................................... $ (3.24) $ (5.57) $ (13.960) ========= ========= =========
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 option repricing" section of Note 6. The Company accounts for stock-based awards to consultants using the multiple option method as described by FASB Interpretation No. 28. Stock-based compensation expense is recognized as earned. At each reporting date, the Company re-values the stock-based compensation using the Black-Scholes option-pricing model. As a result, the stock-based compensation expense will fluctuate as the fair market value of the Company's common stock fluctuates. NET LOSS PER COMMON SHARE -- Basic net loss per common share 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, and trade receivables. The risk associated with cash and cash equivalents is mitigated by using only high-quality financial institutions. 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, notes receivable from stockholders and long-term debt. At December 31, 2002 and 2001, 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. This includes our bad debt policy which requires that we maintain a specific allowance for certain doubtful accounts and a general allowance for the majority of the non-specifically reserved accounts. 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. F-9 The Company has incurred net losses each year since 1996 including losses of $5.4 million in 2002, $15.1 million in 2001, and $16.7 million in 2000. As of December 31, 2002, the Company had an accumulated deficit of $61.4 million. The Company believes its cash and cash equivalents of $8.9 million are sufficient to meet its anticipated cash needs for working capital and capital expenditures through at least December 31, 2003. 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 our planned product development and marketing efforts. COMPREHENSIVE (LOSS)/INCOME -- In 2002, the Company's comprehensive loss included a cumulative translation adjustment of $2,000. 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. 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 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 was not material to the Company's financial statements as the Company did not carry any goodwill or intangible assets. A reconciliation of our previously reported net income and net income per share to amounts for the exclusion of goodwill amortization follows. 2000 2001 2002 Net loss, as reported $ (5,440) $ (15,132) $ (16,726) Less: Goodwill amortization 1,003 487 -- ---------------------------------------- Adjusted net loss $ (4,437) $ (14,645) $ (16,726) ======================================== Basic and diluted net loss per share, as reported (adjusted for reverse split) $ (2.65) $ (7.60) $ (8.65) Less: Goodwill amortization 0.49 0.24 -- ---------------------------------------- Adjusted basic and diluted net loss per share $ (2.16) $ (7.35) $ (8.65) ======================================== 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. The Company adopted the provisions of SFAS No. 144 as of January 1, 2002. Adoption of SFAS No. 144 did not have a material effect on the Company's financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of the Company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. This statement is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 is expected to impact the timing of recognition and the amount of future restructuring activities. In December 2002, the FASB issued SFAS No. 148 ACCOUNTING FOR STOCK-BASED COMPENSATION, TRANSITION AND DISCLOSURE, AN AMENDMENT OF FASB STATEMENT NO. 123. SFAS No. 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects of reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. Finally, this statement amends APB Opinion No. 28, INTERIM FINANCIAL REPORTING, to require disclosure about those effects in interim financial information. The amendments to SFAS No. 123, which provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation is effective for financial statements for fiscal years ending after December 15, 2002. The amendment to SFAS No. 123 relating to disclosures and the amendment to Opinion 28 is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. Management does not intend to adopt the fair value accounting provisions of SFAS No. 123 and currently believes that the adoption of SFAS No. 148 will not have a material impact on our financial statements. F-10 In November 2002, the FASB issued FASB Interpretation No. 45, GUARANTOR'S ACCOUNTING FOR DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS, AN INTERPRETATION OF FASB STATEMENTS NO. 5, 57 AND 107 AND RESCISSION OF FASB INTERPRETATION NO. 34, DISCLOSURE OF INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS (FIN 45). FIN 45 clarifies the requirements for a guarantor's accounting for and disclosure of certain guarantees issued and outstanding. It also requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This interpretation also incorporates without reconsideration the guidance in FASB Interpretation No. 34, which is being superseded. The adoption of FIN 45 will not have a material effect on our consolidated financial statements and will be applied prospectively. 2. ASSET WRITE-DOWNS AND EMPLOYEE TERMINATION COSTS During 2002, the Company recorded an impairment charge of $160,000 relating to the Company's evaluation of certain purchased intangible assets. During 2001, the Company recorded an impairment charge of $2.0 million relating to the Company's evaluation of certain purchased intangible assets. The write-offs pertained to both software purchased from third parties and goodwill from companies that had been acquired. These assets were deemed to have become impaired due to various factors including the availability of alternative software solutions and the product transition from PowerTier application server to the EdgeXtend data services product. During 2002, no restructuring costs were incurred. 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, of which 35 were in sales and marketing, 25 were in research and development and 8 were in the general and administration functions. There were no accrued and unpaid severance costs at December 31, 2001. 3. PROPERTY AND EQUIPMENT Property and equipment consist of: DECEMBER 31, ---------------------- 2002 2001 ---------- ---------- (IN THOUSANDS) Equipment............................................... $ 3,306 $ 3,189 Software................................................ 1,119 1,093 Leasehold improvements.................................. 177 177 ---------- ---------- 4,602 4,459 Accumulated depreciation and amortization............... (4,227) (3,663) ---------- ---------- $ 375 $ 796 ========== ========== 4. LONG-TERM OBLIGATIONS Long-term obligations consist of: DECEMBER 31, ---------------------- 2002 2001 ---------- ---------- (IN THOUSANDS) Equipment term loan..................................... $ -- $ 67 Equipment term loan..................................... 240 502 Equipment term loan..................................... 149 -- Capital lease obligations (see Note 5).................. 28 44 Other long-term obligations............................. 517 655 ---------- ---------- 934 1,268 Less current portion.................................... (841) (847) ---------- ---------- $ 93 $ 421 ========== ========== F-11 Borrowings under the following facilities with a bank are collateralized by substantially all of the Company's assets. In November 2001, the Company renewed its credit facilities with the bank for a $5 million revolving line of credit facility available through April 30, 2003. As of December 31, 2002, the Company had no borrowings outstanding under the credit facility. Under this facility, any outstanding borrowings will bear interest at the bank's prime rate (4.25 % at December 31, 2002) plus 0.5%. On March 20, 2003, the Company renewed its credit facilities with the bank. Under the renewed facilities the Company's revolving credit line has been reduced to $2.5 million and is available through April 30, 2004. (Refer to Note 11 for amendment.) As of March 2002, the Company had paid in full $67,000 outstanding under its $800,000 equipment term loan, which bore interest at 7.75%. As of December 31, 2002, the Company had $240,000 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 (4.25% at December 31, 2002) plus 0.5% per annum, payable in monthly installments through November 2003. As of December 31, 2002, the Company had $149,000 outstanding under an equipment term loan for the maximum principal amount of $250,000. Under this facility borrowings outstanding on January 3, 2003 converted to an 18-month term loan with principal payments of $8,284 per month beginning on February 1, 2003 with interest at the bank's base rate plus 1% per annum. The credit facilities require the Company, among other things, to maintain a minimum tangible net worth of $5.5 million and a minimum quick ratio (current assets, not including inventory, less current liabilities) of 2 to 1. As of December 31, 2002, the Company's tangible net worth fell below the minimum tangible net worth then in effect and the bank waived this covenant. On March 20, 2003, the Company renewed its credit facilities with the bank and a new covenant structure is in place. (Refer to Note 11 for amendment.) 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, 2002, annual maturities under the equipment financing facility, the existing equipment term loan, and the other long-term obligations are as follows (includes capital lease obligations): FISCAL YEAR ENDING DECEMBER 31, (IN THOUSANDS) - ------------------------------- -------------- 2003.................................................... $ 841 2004.................................................... 85 2005.................................................... 6 2006.................................................... 2 --------- Total........................................... $ 934 ========= 5. LEASE COMMITMENTS Equipment with a net book value of $28,000 and $37,000 at December 31, 2002 and 2001, respectively, (net of accumulated amortization of $80,000 and $47,000) 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 $463,000, $773,000 and $965,000 in 2002, 2001 and 2000, respectively. F-12 Future minimum payments under the Company's leases at December 31, 2002 are: CAPITAL OPERATING LEASES LEASES ---------- ---------- (IN THOUSANDS) 2003................................................ 20 540 2004................................................ 8 761 2005................................................ 8 67 2006................................................ 3 -- ---------- ---------- Total..................................... 39 $ 1,368 Amount representing interest........................ (11) ========== ---------- Present value....................................... 28 Current portion..................................... (15) ---------- Long-term portion................................... $ 13 ========== The Company has sublet a portion of its office space to sub-tenants. The future minimum lease payments due to the Company under these subleases is $210,000 at December 31, 2002 of which $102,000 is for the year ending December 31, 2003, $59,000 is for the year ending December 31, 2004 and $49,000 is for the year ending December 31, 2005. 6. STOCKHOLDERS' EQUITY 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 578 and 1,008 shares, respectively, at prices ranging from $0.60 to $2.30 per share. At December 31, 2002 and 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, 2002, the Company has reserved 757,965 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, 2003 under the provisions of the Plan by 98,500 shares to 856,456 shares reserved. This excludes a maximum of 3,864 additional shares that may be transferred from the 1994 Stock Purchase Plan. The 1997 Stock Plan also provides for an automatic annual increase on the first day of 2003, 2004 and 2005 equal to the lesser of 98,500 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. Options granted under the 1997 Stock Plan generally vest over four years and expire ten years from the date of grant. 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 215,503 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 $12.30 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 50,000 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. Additional information with respect to options under the 1997 Stock Plan and the 1999 Directors' Stock Option Plan is as follows:
WEIGHTED AVERAGE NUMBER OF OPTION PRICE OPTIONS PER SHARE ------------- ----------- Outstanding, January 1, 2000 (27,972 exercisable at a weighted average exercise price of $33.30)............ 324,347 $ 96.50 Granted (weighted average fair value of $109.50)................................ 267,545 $ 135.33 Exercised....................................................................... (36,573) $ 70.20 Canceled........................................................................ (166,443) $ 108.13 ------------- ----------- Outstanding, December 31, 2000 (102,843 exercisable at a weighted average exercise price of $98.50)........... 388,876 $ 120.63 Granted (weighted average fair value of $13.60)................................. 469,684 $ 14.75 Exercised....................................................................... (19,209) $ 5.60 Canceled........................................................................ (505,703) $ 94.26 ------------- ----------- Outstanding, December 31, 2001 (104,145 exercisable at a weighted average exercise price of $35.05)........... 333,648 $ 18.15 Granted (weighted average fair value of $6.21).................................. 100,900 $ 7.01 Exercised....................................................................... (7,969) $ 6.30 Canceled........................................................................ (61,063) $ 26.97 ------------- ----------- Outstanding, December 31, 2002 365,516 $ 13.83 ============= ===========
Additional information regarding options outstanding as of December 31, 2002 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 --------------- ----------- ------------ -------------- ----------- ----- $ 0.10 to $ 5.00 57,698 8.53 $ 4.32 17,602 $ 4.11 $ 5.10 to $ 50.00 292,168 8.97 $ 10.14 126,919 $ 11.93 $ 50.10 to $100.00 9,500 6.97 $ 91.06 8,670 $ 92.28 $100.10 to $150.00 2,900 3.50 $138.47 2,830 $138.63 $150.10 to $200.00 2,350 4.60 $162.41 2,225 $162.86 $200.10 to $225.00 900 6.75 $216.32 827 $216.93 ----------- -------- --------- ---------- ------- 365,516 8.77 $ 13.83 159,073 $ 20.87 =========== ========== All share and per share amounts have been adjusted to reflect the 1-for-10 reverse stock split effected on June 12, 2003 (see Note 11).
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 250 shares in any one purchase period. A total of 119,185 shares of common stock has been reserved for issuance under the ESPP as of December 31, 2002. The ESPP allows for an automatic annual increase on the first day of 2003 and 2004 equal to the lesser of 25,000 shares or 1% of outstanding common stock on the last day of the immediately preceding fiscal year. During 2002, 11,498 shares were issued under the ESPP at prices ranging from $3.70 to $6.00 per share resulting in aggregate proceeds of $45,000. During 2001, 9,036 shares were issued under the ESPP at prices ranging from $4.10 to $32.90 per share resulting in aggregate proceeds of $178,000. During 2000, 10,407 shares were issued under the ESPP at prices ranging from $93.50 to $145.60 per share and aggregate proceeds of $1,037,000. F-14 DEFERRED STOCK COMPENSATION In connection with grants of certain stock options and issuance of common stock in 2001 and 2000 the Company recorded nil (net of terminations of $281,000) and, $85,000 (net of terminations of $283,000), 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, 2002, 2001, and 2000 was $88,000, $245,000, and $416,000 respectively. ISSUANCE OF STOCK WARRANTS During 2002, the Company issued certain affiliated investors warrants for the purchase of 120,513 shares of common stock at an exercise price of $7.50 in connection with a common stock purchase agreement. Such warrants vested immediately. The Company recorded fair value of the warrants of $576,000 using the Black-Scholes pricing model using a risk free interest rate of 4.8%, contractual life of five years and volatility of 135%. This was recorded as part of the common stock offering costs. During 2002, the Company issued stock warrants to a non-employee for consulting services for the purchase of 5,000 shares of common stock at an exercise price of $3.80. Such warrants vested immediately. The Company recorded compensation expense equal to the fair value of the vested warrants using the Black-Scholes pricing model using a risk free interest rate of 4.8%, contractual life of five years and volatility of 130%. The compensation expense recorded in 2002 was $17,000 and was recognized in the accompanying statement of operations in accordance with the related service being performed. During 2001, the Company issued stock warrants to a nonemployee for consulting services for the purchase of 8,000 shares of common stock at an exercise price of $5.70. Such warrants vest over a period of four years. The Company recorded compensation expense equal to the fair value of the vested warrants using the Black-Scholes pricing model using a risk free interest rate of 5.0%, contractual life of five years and volatility of 162%. The compensation expense recorded in 2001 was $53,000. 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):
YEAE ENDED DECEMBER 31, ------------------------------------ 2002 2001 2000 ---------- ---------- ---------- Net loss (numerator), basic and diluted........................ $ (5,440) $ (15,132) $ (16,726) Shares (denominator): Weighted average common shares outstanding................... 2,053 1,994 1,962 Weighted average common shares outstanding subject to repurchase............................................. -- (2) (29) ---------- ---------- ---------- Shares used in computation, basic and diluted................ 2,053 1,992 1,933 ========== ========== ========== Net loss per share, basic and diluted.......................... $ (2.65) $ (7.60) $ (8.65) ========== ========== ==========
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, ------------------------------------------ 2002 2001 2000 ------------ ------------ ------------ Shares of common stock subject to repurchase............... -- -- 18,416 Outstanding options........................................ 365,511 333,648 388,876 Warrants................................................... 133,513 8,000 -- ------------ ------------ ------------ Total............................................ 499,024 341,648 407,292 ============ ============ ============ Weighted average exercise price of options................. $ 13.83 $ 18.13 $ 120.70 ============ ============ ============ Weighted average exercise price of warrants................ $ 7.25 $ 5.70 $ -- ============ ============ ============
F-15 8. INCOME TAXES The Company's deferred income tax assets are comprised of the following at December 31: 2002 2001 ---------- ---------- (IN THOUSANDS) Net deferred tax assets: Net operating loss carryforwards..................... $ 20,330 $ 17,491 Accruals deductible in different periods............. 595 179 General business credits............................. 3,593 2,469 Depreciation and amortization........................ 3,308 3,485 ---------- ---------- 27,826 23,624 Valuation allowance.................................. (27,826) (23,624) ---------- ---------- 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, 2002 and 2001, the Company has fully reserved its net deferred tax assets of approximately $27.8 million and $23.6 million, respectively. The Company's effective rate differs from the expected benefit at the federal statutory tax rate at December 31 as follows: 2002 2001 2000 -------- -------- -------- 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 Other......................................... 0.3 0.1 0.4 Valuation allowance........................... 40.7 40.9 39.6 -------- -------- -------- Effective tax rate............................. --% --% --% ======== ======== ========= Substantially all of the Company's loss from operations for all periods presented is generated from domestic operations. At December 31, 2002, the Company has net operating loss (NOL) carryforwards of approximately $55.9 million and $8.6 million for federal and state income tax purposes, respectively. The federal NOL carryforwards expire through 2022, while the state NOL carryforwards expire through 2012. 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, 2002, the Company also has research and development credit carryforwards of approximately $1.7 million and $1.6 million available to offset future federal and state income taxes, respectively. The federal credit carryforward expires in 2022, 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. 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 No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. F-16 GEOGRAPHIC INFORMATION
YEARS ENDED DECEMBER 31, ---------------------------------------------------------------------------- 2002 2001 2000 ----------------------- ----------------------- ------------------------ LONG-LIVED LONG-LIVED LONG-LIVED REVENUES(1) ASSETS REVENUES(1) ASSETS REVENUES(1) ASSETS ----------- ------ ----------- ------ ----------- ------ (IN THOUSANDS) United States............ $ 9,764 $ 538 $ 11,989 $ 1,526 $ 18,107 $ 6,054 Europe................... 4,550 14 5,505 54 4,755 73 Rest of the world........ 272 1 1,877 2 2,415 72 -------- ------- -------- ------- -------- ------- $ 14,586 $ 553 $ 19,371 $ 1,582 $ 25,277 $ 6,199 ======== ======= ======== ======= ======== ======= __________
(1) Revenues are broken out geographically by the ship-to location of the customer. SIGNIFICANT CUSTOMERS During 2002, one customer accounted for 26% of the Company's total revenues and another customer accounted for 13% of the Company's total revenues. 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 customer (a common stockholder) accounted for 5% of the Company's total revenues. At December 31, 2002, two customers accounted for 25% of accounts receivable. At December 31, 2001, two customers accounted for 11% of accounts receivable. 10. 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. 11. SUBSEQUENT EVENTS On March 20, 2003, the Company has 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 $2.5 million available through April 30, 2004. The banks renewed credit facilities require the Company, among other things, to maintain certain working capital, tangible net worth and profitability covenants. We expect to meet these covenants. Borrowings under the facility are collateralized by substantially all of the Company's assets. On June 12, 2003, the Company effected a 1-for-10 reverse stock split that was previously approved at the Annual Meeting of Stockholders. Accordingly all share and per share amounts in this annual report on Form 10-K/A have been adjusted to reflect the 1-for-10 reverse stock split. F-17 PERSISTENCE SOFTWARE, INC. 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, 2002, 2001 and 2000........ 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, 2002 and 2001, and for each of the three years in the period ended December 31, 2002, and have issued our report thereon dated January 24, 2003 (March 20, 2003 as to the first paragraph of Note 11 and June 12, 2003 as to the second paragraph of Note 11). Our audits also included the consolidated financial statement schedule of the Company listed in the Index at Item 15(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. /s/ DELOITTE & TOUCHE LLP San Jose, California January 24, 2003 S-2 SCHEDULE II PERSISTENCE SOFTWARE, INC. CONSOLIDATED SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT $000'S BEGINNING CHARGED TO COST DEDUCTIONS/ BALANCE AT OF YEAR AND EXPENSES WRITE-OFFS END OF YEAR ------- ------------ ---------- ----------- 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 Year ended December 31, 2002 Allowance for doubtful accounts............................... $ 152 $ 353 $ (285) $ 220
S-3 EX-23.1 3 pers_10ka2ex23-1.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 24, 2003 (March 20, 2003 as to the first paragraph of Note 11 and June 12, 2003 as to the second paragraph of Note 11) appearing in this Annual Report on Form 10-K/A of Persistence Software, Inc. for the year ended December 31, 2002. /s/ DELOITTE & TOUCHE LLP San Jose, California August 12, 2003 EX-99.1 4 pers_10ka2ex99-1.txt EXHIBIT 99.1 PERSISTENCE SOFTWARE, INC. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Persistence Software, Inc. (the "Company") on Form 10-K/A for the year ended December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Christopher T. Keene, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ CHRISTOPHER T. KEENE - -------------------------------- Christopher T. Keene Chief Executive Officer August 12, 2003 EX-99.2 5 pers_10ka2ex99-2.txt EXHIBIT 99.2 PERSISTENCE SOFTWARE, INC. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Persistence Software, Inc. (the "Company") on Form 10-K/A for the year ended December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Christine Russell, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ CHRISTINE RUSSELL - ---------------------------- Christine Russell Chief Financial Officer August 12, 2003 -----END PRIVACY-ENHANCED MESSAGE-----