10-Q 1 persistence_10q-063003.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission file number 000-25857 ================================================================================ PERSISTENCE SOFTWARE, INC. (Exact name of registrant as specified in its charter) DELAWARE 94-3138935 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 1720 SOUTH AMPHLETT BLVD., THIRD FLOOR SAN MATEO, CALIFORNIA 94402 (Address of principal executive offices, including zip code) (650) 372-3600 (Registrant's telephone number, including area code) NOT APPLICABLE (Former name, former address and former fiscal year, if changed since last report) ================================================================================ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in the Exchange Act Rule 12b-2). Yes [ ] No [X] As of July 31, 2003, there were 2,406,430 shares of the registrant's Common Stock outstanding. INDEX PART I. FINANCIAL INFORMATION. ITEM 1. FINANCIAL STATEMENTS. 3 CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2003 AND DECEMBER 31, 2002. 3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002. 4 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002. 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 9 ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK. 26 ITEM 4. CONTROLS AND PROCEDURES. 26 PART II. OTHER INFORMATION. ITEM 1. LEGAL PROCEEDINGS. 27 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 27 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 28 SIGNATURES 29 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. PERSISTENCE SOFTWARE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED)
JUNE 30, DECEMBER 31, 2003 2002 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 6,174 $ 8,903 Accounts receivable, net 1,948 1,252 Prepaid expenses and other current assets 222 392 ------------ ------------ Total current assets 8,344 10,547 Property and equipment, net 205 375 Purchased intangibles, net 78 123 Other assets 55 55 ------------ ------------ Total assets $ 8,682 $ 11,100 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 412 $ 325 Accrued compensation and related benefits 748 722 Other accrued liabilities 1,088 1,188 Deferred revenues net of long-term portion 2,257 2,529 Current portion of long-term obligations 713 841 ------------ ------------ Total current liabilities 5,218 5,605 Long-term liabilities: Long-term portion of deferred revenues 373 691 Long-term obligations 35 93 ------------ ------------ Total long-term liabilities 408 784 ------------ ------------ Total liabilities 5,626 6,389 ------------ ------------ Stockholders' equity: Preferred stock -- -- Common stock 66,085 66,103 Deferred stock compensation (23) (31) Accumulated deficit (63,002) (61,370) Accumulated other comprehensive loss (4) 9 ------------ ------------ Total stockholders' equity 3,056 4,711 ------------ ------------ Total liabilities and stockholders' equity $ 8,682 $ 11,100 ------------ ------------ See notes to condensed consolidated financial statements. 3
PERSISTENCE SOFTWARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED ----------------------------- ----------------------------- JUN. 30, JUN. 30, JUN. 30, JUN. 30, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Revenues: Licenses $ 1,656 $ 4,104 $ 2,950 $ 4,937 Service 1,220 1,626 2,449 2,954 ------------ ------------ ------------ ------------ Total revenues 2,876 5,730 5,399 7,891 ------------ ------------ ------------ ------------ Cost of revenues: Licenses 22 75 61 102 Service 459 759 936 1,527 ------------ ------------ ------------ ------------ Total cost of revenues 481 834 997 1,629 ------------ ------------ ------------ ------------ Gross profit 2,395 4,896 4,402 6,262 ------------ ------------ ------------ ------------ Operating expenses: Sales and marketing 1,545 2,586 3,076 5,020 Research and development, 803 1,038 1,652 2,156 General and administrative 657 919 1,300 1,846 Amortization and impairment of purchased intangibles -- 142 -- 354 ------------ ------------ ------------ ------------ Total operating expenses 3,005 4,685 6,028 9,376 ------------ ------------ ------------ ------------ Income/(Loss) from operations (610) 211 (1,626) (3,114) Interest income 16 21 35 55 Interest and other expense (11) (14) (22) (25) ------------ ------------ ------------ ------------ Income/(loss) before income taxes (605) 218 (1,613) (3,084) Income taxes (19) (3) (19) (10) ------------ ------------ ------------ ------------ Net income/(loss) $ (624) $ 215 $ (1,632) $ (3,094) ============ ============ ============ ============ Basic net income/(loss) per share $ (0.26) $ 0.11 $ (0.68) $ (1.54) ============ ============ ============ ============ Diluted net income/(loss) per share $ (0.26) $ 0.10 $ (0.68) $ (1.54) ============ ============ ============ ============ Shares used in calculating basic net income/(loss) per share 2,406 2,015 2,404 2,012 ============ ============ ============ ============ Shares used in calculating diluted net income/(loss) per share 2,406 2,048 2,404 2,012 ============ ============ ============ ============ See notes to condensed consolidated financial statements. 4
PERSISTENCE SOFTWARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ------------------------- 2003 2002 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (1,632) $ (3,094) Adjustments to reconcile net loss to net cash provided by/(used in) operating activities: Depreciation and amortization 237 688 Amortization of deferred stock compensation 8 54 Issuance of warrants and options to non-employees and other (4) -- Changes in operating assets and liabilities: Accounts receivable (net) (696) 512 Prepaid expenses and other current assets 170 132 Accounts payable 87 (487) Accrued compensation and related benefits 26 249 Other accrued liabilities (100) 478 Deferred revenues (590) 1,705 ---------- ---------- Net cash provided by/(used in) operating activities (2,494) 237 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Property and equipment additions (24) (48) Proceeds from sale of property and equipment 2 -- Purchased intangibles additions -- (45) Deposits and other assets -- (8) ---------- ---------- Net cash used in investing activities (22) (101) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Sale of common stock 20 76 Issuance costs - common stock offering (40) -- Borrowing under capital lease obligations -- 12 Repayment of obligations incurred to acquire purchased intangibles -- (110) Repayment under long term liabilities (180) (213) ---------- ---------- Net cash used in financing activities (200) (235) ---------- ---------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (13) 6 ---------- ---------- CASH AND CASH EQUIVALENTS: Net decrease (2,729) (93) Beginning of period 8,903 7,411 ---------- ---------- End of period $ 6,174 $ 7,318 ========== ========== NONCASH INVESTING AND FINANCING ACTIVITIES: Property and equipment acquired by capital leases -- (22) ========== ========== See notes to condensed consolidated financial statements. 5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS Persistence Software solves data access problems for distributed and real-time systems. The Company's software products help deliver better business visibility for applications which require current information about customers, products and suppliers. The Company 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, to position business information for more efficient access for users, dramatically reduce network traffic and data latency, and result in better application performance at a much lower infrastructure cost. 2. BASIS OF PRESENTATION The condensed consolidated financial statements included in this filing on Form 10-Q as of June 30, 2003 and for the three and six month periods ended June 30, 2003 and 2002 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial statements. Certain information and footnote disclosures normally included in complete financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The December 31, 2002 balance sheet was extracted from audited financial statements as of that date, but does not include all disclosures required by generally accepted accounting principles for complete financial statements. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the annual consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K as of and for year ended December 31, 2002 filed with the Securities and Exchange Commission. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the Company's condensed consolidated financial position as of June 30, 2003, its condensed consolidated results of operations for the three and six month periods ended June 30, 2003 and 2002, and its condensed consolidated cash flows for the six month periods ended June 30, 2003 and 2002, have been made. The results of operations and cash flows for any interim period are not necessarily indicative of the operating results and cash flows for any future interim or annual periods. 3. NET LOSS PER SHARE Basic net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. 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, with the exception of the three months ended June 30, 2002. The following is a reconciliation of the numerators and denominators used in computing basic and diluted net income/(loss) per share (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2003 2002 2003 2002 ---------- ---------- ----------- ----------- Net income/(loss) (numerator), basic and diluted $ (624) $ 215 $ (1,632) $ (3,094) ========== ========== =========== =========== Shares (denominator): Weighted average common shares outstanding used in computing basic earnings per share 2,406 2,015 2,404 2,012 Common stock equivalents related to employee stock options and warrants 0 33 0 0 ---------- ---------- ----------- ----------- Shares used in computation, diluted earnings per share 2,406 2,048 2,404 2,012 ========== ========== =========== =========== Basic net income/(loss) per share $ (0.26) $ 0.11 $ (0.68) $ (1.54) ========== ========== =========== =========== Diluted net income/(loss) per share $ (0.26) $ 0.10 $ (0.68) $ (1.54) ========== ========== =========== ===========
As of June 30, 2003, the Company had securities outstanding which could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net loss per share in the periods presented, as their effect would have been anti-dilutive. Such outstanding securities consist of the following (in thousands): 6 JUNE 30, JUNE 30, 2003 2002 -------- -------- Outstanding options 426 339 Warrants 134 8 -------- -------- Total 560 347 -------- -------- 4. ACCOUNTING FOR STOCK BASED COMPENSATION The Company accounts for stock based compensation granted to employees and directors under the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Statement of Financial Accounting Standards (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 for the three months ended June 30, 2003 and 2002 and 30 months following vesting for the six months ended June 30, 2003 and 2002; risk free interest rate of 1.81% for the three months ended June 30, 2003, 4.49% for the three months ended June 30, 2002, 1.81% for the six months ended June 30, 2003 and 4.71% for the six months ended June 30, 2002; volatility of 144% for the three months ended June 30, 2003, 146% for the three months ended June 30, 2002, 145% for the six months ended June 30, 2003 and 146% for the six months ended June 30, 2002; 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 six months ended June 30, 2003 and 2002) would have been approximately as follows (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------- -------------------------- 2003 2002 2003 2002 ---------- ---------- ----------- ----------- Net loss as reported ........................................ $ (624) $ 215 $ (1,632) $ (3,094) Add: Stock-based employee compensation expense included in reported loss ............................... 2 20 8 54 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards .......................................... (139) (244) (256) (692) ---------- ---------- ----------- ----------- Pro forma net loss .......................................... $ (761) $ (9) $ (1,880) $ (3,732) ========== ========== =========== =========== Basic net loss applicable to common shareholders per share: As reported ................................................. $ (0.26) $ 0.11 $ (0.68) $ (1.54) Pro forma ................................................... $ (0.32) $ 0.00 $ (0.78) $ (1.85) Diluted net loss applicable to common shareholders per share: As reported ................................................. $ (0.26) $ 0.10 $ (0.68) $ (1.54) Pro forma ................................................... $ (0.32) $ 0.00 $ (0.78) $ (1.85)
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. 7 5. COMPREHENSIVE INCOME The components of comprehensive loss, consisting of the Company's reported net loss and unrealized gains or losses in the translation of foreign currencies, are as follows (in thousands): SIX MONTHS ENDED JUNE 30, ------------------------- 2003 2002 ----------- ----------- Net loss.................................... $ (1,632) $ (3,094) Other comprehensive income (loss) .......... (13) 6 ----------- ----------- Total comprehensive loss.................... $ (1,645) $ (3,088) ----------- ----------- 6. RECENTLY ISSUED ACCOUNTING STANDARDS In June 2002, the Financial Accounting Standards Board (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 adopted 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 market 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 November 2002, the FASB issued FASB Interpretation No. 45, GUARANTOR'S ACCOUNTING FOR DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS. The Company has adopted the disclosure requirements of this standard with respect to obligations under guarantees. In November 2002, the EITF reached a consensus on Issue No. 00-21, REVENUE ARRANGEMENTS WITH MULTIPLE DELIVERABLES, or EITF 00-21. EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We do not believe the adoption of EITF 00-21 will have a material impact on our financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION, TRANSITION AND DISCLOSURE, AND 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. 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 January 2003, the FASB issued Interpretation No. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, CONSOLIDATED FINANCIAL STATEMENTS, for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest entities"). Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities creased after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company is currently evaluating the impact of adopting FIN 46. However, the Company does not believe that it is party to any arrangement that would fall within the scope of FIN 46. In April 2003, the FASB issued SFAS No. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and hedging relationships designated after June 30, 2003, except for those provisions of SFAS No. 149 which relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003. For those issues, the provisions that are currently in effect should continue to be 8 applied in accordance with their respective effective dates. In addition, certain provisions of SFAS No. 149, which relate to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The Company currently believes that the adoption of SFAS No. 149 will not have a material impact on its financial statements. In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within the scope of SFAS No. 150 as a liability. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for the Company beginning June 15, 2003. The Company currently believes that the adoption of SFAS No. 149 will not have a material impact on its financial statements. 7. INDEMNIFICATION In its agreements with customers, the Company generally warrants that its software products will perform in all material respects in accordance with its standard published specifications in effect at the time of delivery of the licensed products to the customer. The Company also typically warrants that its maintenance services will be performed consistently with its maintenance policy in effect at the time those services are delivered. The Company believes its maintenance policy is consistent with generally accepted industry standards. If necessary, the Company would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history, however, the Company has not incurred significant expense under its product or services warranties. As a result, the Company believes the estimated fair value of these warranty provisions is minimal. The Company's customer agreements customarily provide for indemnification of customers for intellectual property infringement claims. Such agreements generally limit the scope of the available remedies to a variety of industry-standard methods, including but not limited to product usage, a right to control the defense or settlement of any claim, and a right to replace or modify the infringing products to make them non-infringing. The Company has not incurred significant expenses related to these indemnification agreements and no material claim for such indemnifications is outstanding as of June 30, 2003. As a result, the Company believes the estimated fair value of these indemnification provisions is minimal. 8. REVERSE STOCK SPLIT On June 12, 2003, the Company effected a 1-for-10 reverse stock split that was previously approved at its Annual Meeting of Stockholders for the year ended December 31, 2002. Accordingly all share and per share amounts in this quarterly report on Form 10-Q have been adjusted to reflect the 1-for-10 reverse stock split. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements as of December 31, 2002 and 2001 and for each of the years ended December 31, 2002, 2001 and 2000, included in our Annual Report on Form 10-K as of and for the year ended December 31, 2002 filed with the Securities and Exchange Commission. In addition, this Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Words such as "anticipates," "believes," "plans," "expects," "future," "intends," "targeting," and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or forecasted. Factors that might cause such a difference include, but are not limited to, those discussed in the section entitled "Additional Factors That May Affect Future Results" and those appearing elsewhere in this Form 10-Q and our Annual Report on Form 10-K as of and for the year ended December 31, 2002 filed with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements. OVERVIEW 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 is designed to position 9 business information for more efficient access for users, to dramatically reduce network traffic and data latency, and to achieve better application performance at a much lower infrastructure cost. 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 is designed to ensure that these cached answers remain 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. We believe that our customers are able to more effectively manage enterprise data through re-architecting their IT infrastructure using Persistence data services products. Our products are designed to 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. Our EDGEXTEND product 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 and the first six months ended June 30, 2003 consisted of Adobe Systems, Air France, Applied Biosystems, Cablevision, Citadel, Citigroup Global Markets (formerly known as Salomon Smith Barney), Eurocontrol, Fiducia AG, Intershop, i2, JP Morgan Chase, Lucent, Motorola, NetJets, Nokia, Reuters Financial Software and Spirent Communications. Our revenues, which consist of software license revenues and service revenues, totaled $5.4 million in the six months ended June 30, 2003 and $7.9 million in the six months ended June 30, 2002. 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 central processing units deploying our software. 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 application server 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 $2.2 million in the six months ended June 30, 2003, $1.6 million in the six months ended June 30, 2002, $4.8 million in 2002, $7.4 million in 2001 and $7.2 million in 2000. The decrease in international revenues from 2001 to 2002 is primarily attributable to general economic conditions in Asia, which was a factor in our decision to close our sales office in Asia 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 revenue from product sales to a limited number of customers. Sales of products to our top five customers accounted for 58% of our total revenues in the six months ended June 30, 2003, 64% of our total revenues in the six months ended June 30, 2002, 55% of total revenues in 2002, 45% of total revenues in 2001, and 40% of total revenues in 2000. In addition, the identity of our top five customers has changed from year to year. In the future, it is likely that a relatively few large customers could continue to account for a relatively large proportion of our revenues 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, in particular those with expertise in consultative, technology and architecture-driven sales, in order to meet our sales goals. Likewise, our marketing resources will be reallocated in support of this sales process. In addition, our ability to achieve significant revenue growth will depend in large part on our success in establishing and leveraging relationships with systems integrators, independent software vendors, OEM partners and other resellers. 10 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. Since inception, we have incurred substantial research and development costs and have invested heavily in the expansion of our sales, marketing and professional services organizations to build an infrastructure to support our long-term growth strategy. We had 68 employees as of December 31, 2002 and 62 as of June 30, 2003, representing a decrease of 9%. This decrease was due primarily to a reduction in personnel during the quarter in order to maintain efficient staffing. We have incurred net losses in each quarter since 1996 with the exception of the three months ended June 30, 2002 and, as of June 30, 2003, had an accumulated deficit of $63.0 million. 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 beginning in the fourth quarter 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 growing 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. 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 June 30, 2004. 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 11 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 4 of the "Notes to Condensed 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. RESULTS OF OPERATIONS THREE MONTHS (SECOND QUARTERS) ENDED JUNE 30, 2003 AND 2002 Revenues Our revenues were $2.9 million for the three months ended June 30, 2003 and $5.7 million for the three months ended June 30, 2002, representing a decrease of 50%. International revenues were $614,000 for the three months ended June 30, 2003 and $826,000 for the three months ended June 30, 2002, representing a decrease of 26%. For the three months ended June 30, 2003, Citigroup Global Markets (formerly known as Salomon Smith Barney) accounted for 52% of total revenues and sales of products and services to our top five customers accounted for 69% of total revenues. For the three months ended June 30, 2002, Cablevision and Citigroup Global Markets accounted for 43% and 21% of total revenues, respectively, and sales of products and services to our top five customers accounted for 75% 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 $1.7 million for the three months ended June 30, 2003 and $4.1 million for the three months ended June 30, 2002, representing a decrease of 60%. License revenues represented 58% of total revenues for the three months ended June 30, 2003 and 72% of total revenues for the three months ended June 30, 2002. The decrease in software license revenues was primarily due to the recognition in the second quarter of 2002 of deferred license revenue in the amount of $2.2 million from a major contract that was negotiated in the first quarter of 2002. Given the continuing industry-wide trend of dramatically reduced levels of information technology spending, license revenues may fluctuate substantially over the next several quarters. In addition, for the same reason, revenues may remain flat or decline for 2003 compared to 2002. Service Revenues. Service revenues consist of professional services consulting, customer support and training. Our service revenues were $1.2 million for the three months ended June 30, 2003 and $1.6 million for the three months ended June 30, 2002, representing a decrease of 25%. This decrease was primarily due to lower revenues from technical support contracts in the amount of $291,000 and to a reduced level of consulting services performed during the second quarter of 2003, which lowered revenues by $115,000. Service revenues represented 42% of total revenues for the three months ended June 30, 2003 and 28% of total revenues for the three months ended June 30, 2002. Cost of Revenues Cost of License Revenues. Cost of license revenues consists of royalties, packaging, documentation and associated shipping costs and the amortization of third party software embedded in our software for the three months ended June 30, 2003. Our cost of license revenues was $22,000 for the three months ended June 30, 2003 and $75,000 for the three months ended June 30, 2002. As a percentage of license revenues, cost of license revenues was 1% for the three months ended June 30, 2003 and 2% for the three months ended June 30, 2002. The decrease in cost of revenues was largely due to the lower sales of third party 12 software that required the payment of royalties. Cost of license revenues may vary between periods depending on the sales of any licensed third party products. Cost of Service Revenues. Cost of service revenues consists of personnel, contractors and other costs related to the provision of professional services consulting, customer support and training. Our cost of service revenues was $459,000 for the three months ended June 30, 2003 and $759,000 for the three months ended June 30, 2002, representing a decrease of 40%. This decrease was primarily due to a $233,000 reduction in staffing and personnel related costs and a $45,000 reduction in costs associated with our use of external consultants. As a percentage of service revenues, cost of service revenues was 38% for the three months ended June 30, 2003 and 47% for the three months ended June 30, 2002. 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 primarily of salaries, benefits, commissions and bonuses earned by sales and marketing personnel, travel, and marketing and promotional expenses. Our sales and marketing expenses were $1.5 million for the three months ended June 30, 2003 and $2.6 million for the three months ended June 30, 2002, representing a decrease of 40%. This decrease was due to a $760,000 reduction in staffing and personnel related costs, a decrease of $190,000 in commissions expensed due to lower revenues as compared to the three months ended June 30, 2002, as well as a $101,000 reduction in marketing and promotional expenses. Sales and marketing expenses represented 54% of total revenues for the three months ended June 30, 2003 and 45% of total revenues for the three months ended June 30, 2002. We are presently targeting that 2003 sales and marketing expense levels will be lower than comparable 2002 expense levels because as of August 2003 we had 19 sales and marketing employees as compared to an average of 35 such employees during 2002. Research and Development. Research and development expenses consist primarily of salaries and benefits for software developers, product managers and quality assurance personnel and payments to external software consultants. Our research and development expenses were $803,000 for the three months ended June 30, 2003 and $1.0 million for the three months ended June 30, 2002, representing a decrease of 23%. This decrease was due to a $208,000 reduction in staffing and personnel related costs and a $21,000 reduction in external contractors expenses. Research and development expenses represented 28% of total revenues for the three months ended June 30, 2003 and 18% of total revenues for the three months ended June 30, 2002. We are presently targeting that 2003 research and development expense levels will be lower than comparable 2002 expense levels because as of August 2003 we had 16 research and development employees as compared to an average of 27 such employees during 2002. General and Administrative. General and administrative expenses consist of salaries, benefits and related costs for our finance, administrative and executive management personnel, legal costs, bad debt write-offs and various costs associated with our status as a public company. Our general and administrative expenses were $657,000 for the three months ended June 30, 2003 and $919,000 for the three months ended June 30, 2002, representing a decrease of 29%. This decrease was primarily due to reductions of $99,000 of staffing and personnel related costs and a reduction of $189,000 of bad debt expenses that was due in part to the reversal of such expenses incurred in prior periods as a result of unexpected favorable collection efforts. General and administrative expenses represented 23% of total revenues for the three months ended June 30, 2003 and 16% of total revenues for the three months ended June 30, 2002. We are presently targeting that 2003 general and administrative expense levels will be lower than comparable 2002 expense levels because as of August 2003 we had 9 general and administrative employees as compared to an average of 13 such employees during 2002. Amortization of Purchased Intangibles. There was no amortization of purchased intangibles for the three months ended June 30, 2003, as such costs, which were $10,000, are now classified as cost of license revenues. Amortization of purchased intangibles was $142,000 for the three months ended June 30, 2002. The decrease in amortization expense was related to several intangible assets that were fully amortized in 2002 and due to a revaluation and impairment review in December 2002 which resulted in a write-off of purchased intangibles of $160,000. Interest and Other Income (Expense). Interest and other income (expense) consists of earnings on our cash and cash equivalents, offset by interest expense related to obligations under capital leases and other equipment related borrowings and other expenses. Interest and other income (expense) was ($14,000) for the three months ended June 30, 2003 and $4,000 for the three months ended June 30, 2002. Stock-Based Compensation. Certain options granted and common stock issued in the past have been considered to be compensatory, as the estimated fair value for accounting purposes was greater than the stock price as determined by the 13 Board of Directors on the date of grant or issuance. Total deferred stock compensation associated with equity transactions as of June 30, 2003 was $23,000, 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 $2,000 in the three months ended June 30, 2003 and $20,000 in the three months ended June 30, 2002. We expect to record amortization expense related to these securities of approximately $4,000 for the remainder of 2003. Provision for Income Taxes. Since inception, we have incurred net operating losses for federal and state tax purposes and have only recognized minimal tax provisions within our international subsidiaries. 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. SIX MONTHS ENDED JUNE 30, 2003 AND 2002 Revenues Our total revenues were $5.4 million for the six months ended June 30, 2003 and $7.9 million for the six months ended June 30, 2002 representing a decrease of 32%. International revenues were $2.2 million for the six months ended June 30, 2003 and $1.6 million for the six months ended June 30, 2002, representing an increase of 37%. The increase was primarily due to a $730,000 sale to Adobe Systems in Germany. In the six months ended June 30, 2003, sales to Citigroup Global Markets accounted for 30% of total revenues and sales to Adobe Systems accounted for 14% of total revenues. For the six months ended June 30, 2002, sales to Cablevision accounted for 33% of total revenues and sales to Citigroup Global Markets accounted for 19% of total revenues. License Revenues. License revenues were $3.0 million for the six months ended June 30, 2003 and $4.9 million for the six months ended June 30, 2002, representing a decrease of 40%. The decrease in software license revenues was primarily due to continued industry-wide downturn in spending on IT infrastructure products. License revenues represented 55% of total revenues for the six months ended June 30, 2003 and 63% of total revenues for the six months ended June 30, 2002. Service Revenues. Our service revenues were $2.4 million for the six months ended June 30, 2003 and $3.0 million for the six months ended June 30, 2002, representing a decrease of 17%. The decrease in service revenues was primarily due to lower revenues from technical support contracts in the amount of $356,000 and to a reduced level of consulting services performed which lowered revenues by $149,000. Service revenues represented 45% of total revenues for the six months ended June 30, 2003 and 37% of total revenues for the six months ended June 30, 2002. Cost of Revenues Cost of License Revenues. Cost of license revenues consists of royalties, packaging, documentation and associated shipping costs and the amortization of third party software embedded in our software for the six months ended June 30, 2003. Our cost of license revenues was $61,000 for the six months ended June 30, 2003 and $102,000 for the six months ended June 30, 2002. As a percentage of license revenues, cost of license revenues was 2% for the six months ended June 30, 2003 and 2% for the six months ended June 30, 2002. The decrease in cost of revenues was largely due to the lower sales of third party software that required the payment of royalties. Cost of Service Revenues. Cost of service revenues consists of personnel, contractors and other costs related to the provision of professional services consulting, customer support and training. Our cost of service revenues was $936,000 for the six months ended June 30, 2003 and $1.5 million for the six months ended June 30, 2002, representing a decrease of 39%. This decrease was primarily due to a $476,000 reduction in staffing and personnel related costs and a $100,000 reduction in costs associated with our use of external consultants. As a percentage of service revenues, cost of service revenues were 38% for the six months ended June 30, 2003 and 52% for the six months ended June 30, 2002. Operating Expenses Sales and Marketing. Sales and marketing expenses consist primarily of salaries, benefits, commissions and bonuses earned by sales and marketing personnel, travel, and marketing and promotional expenses. Our sales and marketing expenses were $3.1 million for the six months ended June 30, 2003 and $5.0 million for the six months ended June 30, 2002, representing a decrease of 14 39%. This decrease was primarily due to a $1.4 million reduction in staffing and personnel related costs, a decrease of $428,000 in commissions expensed due to lower revenues as compared to the six months ended June 30,2002 as well as a $165,000 reduction in marketing and promotional expenses. Sales and marketing expenses represented 57% of total revenues for the six months ended June 30, 2003 and 64% of total revenues for the six months ended June 30, 2002. We are presently targeting that 2003 sales and marketing expense levels will be lower than comparable 2002 expense levels because as of August 2003 we had 19 sales and marketing employees as compared to an average of 35 such employees during 2002. Research and Development. Research and development expenses consist primarily of salaries and benefits for software developers, product managers and quality assurance personnel and payments to external software consultants. Our research and development expenses were $1.7 million for the six months ended June 30, 2003 and $2.2 million for the six months ended June 30, 2002, representing a decrease of 23%. This decrease was primarily due to a $433,000 reduction in staffing and personnel related costs. Research and development expenses represented 31% of total revenues for the six months ended June 30, 2003 and 27% of total revenues for the six months ended June 30, 2002. We are presently targeting that 2003 research and development expense levels will be lower than comparable 2002 expense levels because as of August 2003 we had 16 research and development employees as compared to an average of 27 such employees during 2002. General and Administrative. General and administrative expenses consist of salaries, benefits and related costs for our finance, administrative and executive management personnel, legal costs, bad debt write-offs and various costs associated with our status as a public company. Our general and administrative expenses were $1.3 million for the six months ended June 30, 2003 and $1.8 million for the six months ended June 30, 2002, representing a decrease of 30%. This decrease was primarily due to reductions of $158,000 in staffing, personnel related costs and general administrative expenses, and a reduction of $268,000 of bad debt expenses that was due in part to the reversal of such expenses incurred in prior periods as a result of unexpected favorable collection efforts. General and administrative expenses represented 24% of total revenues for the six months ended June 30, 2003 and 23% of total revenues for the six months ended June 30, 2002. We are presently targeting that 2003 general and administrative expense levels will be lower than comparable 2002 expense levels because as of August 2003 we had 9 general and administrative employees as compared to an average of 13 such employees during 2002. Amortization and Impairment of Purchased Intangibles. There was no amortization of purchased intangibles for the six months ended June 30, 2003 as such costs, which were $46,000, are now classified as cost of license revenues. Amortization of purchased intangibles was $354,000 for the six months ended June 30, 2002. The decrease in amortization expense was related to several intangible assets that were fully amortized in 2002 and due to a revaluation and impairment review in December 2002, which resulted in a write-off of purchased intangibles of $160,000. Interest and Other Income (Expense). Interest and other income (expense) consists of earnings on our cash, cash equivalents, offset by interest expense related to obligations under capital leases and other equipment related borrowings and other expenses. Interest and other income (expense) was ($6,000) for the six months ended June 30, 2003 and $20,000 for the six months ended June 30, 2002. The decrease in income was primarily due to a reduction of $21,000 in interest income yielded from our cash balances. Stock-Based Compensation. Certain options granted and common stock issued in the past have been considered to be compensatory, as the estimated fair value for accounting purposes was greater than the stock price as determined by the Board of Directors on the date of grant or issuance. Total deferred stock compensation associated with equity transactions as of June 30, 2002 was $23,000, 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 $8,000 in the six months ended June 30, 2003 and $54,000 in the six months ended June 30, 2002. Provision for Income Tax. Since inception, we have incurred net operating losses for federal and state tax purposes and have only recognized minimal tax provisions within our international subsidiaries. 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. QUARTERLY RESULTS OF OPERATIONS Our quarterly operating results have fluctuated significantly in the past, and may continue to fluctuate in the future, as a result of a number of factors, many of which are outside our control. These factors include: 15 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 market; 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. 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 a private placement of our 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 also are financing our business through loans as described below and capital leases. As of June 30, 2003, we had $6.2 million of cash and cash equivalents and our working capital was $3.1 million. Net cash used in operating activities was $2.6 million for the six months ended June 30, 2003 and net cash provided by operating activities was $237,000 for the six months ended June 30, 2002. For the six months ended June 30, 2003, cash used in operating activities was attributable primarily to net losses, an increase in accounts receivable and a decrease in deferred revenues. For the six months ended June 30, 2002, cash provided by operating activities was attributable primarily to a decrease in accounts receivable and an increase in deferred revenues that was mainly due to one large sale on which revenue was recognized in the third quarter of 2002. Cash was also provided by an increase in other accrued liabilities and depreciation and amortization, offset by net losses and a decrease in accounts payable. Net cash used in investing activities was $22,000 for the six months ended June 31, 2003 and $123,000 for the six months ended June 30, 2002. For the six months ended June 30, 2003, net cash used in investing activities was attributable primarily to the purchase of property and equipment. For the six months ended June 30, 2002, net cash used in investing activities was attributable primarily to the purchase of fixed assets and intangibles. 16 Net cash used in financing activities was $160,000 for the six months ended June 30, 2003 and $213,000 for the six months ended June 30, 2002. For the six months ended June 30, 2003, net cash used in financing activities was attributable primarily to loan repayments. For the six months ended June 30, 2002, net cash used in financing activities was attributable primarily to loan repayments partially offset by sales of common stock as a result of option exercises. We have credit facilities with Comerica Bank. We have a $2.5 million revolving line of credit facility at June 30, 2003 available through April 30, 2004 under which no borrowings were outstanding as of June 30, 2003. We also have a $655,000 equipment term loan under which $109,000 was outstanding as of June 30, 2003. 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. We also have an additional $149,000 equipment term loan under which $108,000 was outstanding as of June 30, 2003. This facility is 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. 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 $250,000 for the quarter ending September 30, 2003, and we must show a profit of at least one dollar for each quarter thereafter. As of June 30, 2003 we were in compliance with our debt covenants and we expect to meet these covenants in the future, provided that we meet our targets with respect to revenues and accounts receivable collections. 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 June 30, 2004, provided that we meet our targets with respect to revenues and accounts receivable collections. If we experience difficulties in achieving our targets with respect to revenues and accounts receivable collections, 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 an additional 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. ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS An investment in our common stock involves significant risks. You should carefully consider the risks and uncertainties described below and the other information in or incorporated by reference into this prospectus including our financial statements before deciding whether to buy shares of our common stock. 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. The trading price of our common stock could decline due to any of these and other risks and uncertainties, and you could lose part or all of your investment. WE MAY NOT ACHIEVE OUR SALES TARGETS. Because we only commenced selling our products 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; 17 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 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. As of June 30, 2003, we had an accumulated deficit of $63.0 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. IF WE ARE NOT ABLE TO GENERATE SUFFICIENT CASH FROM OPERATIONS TO FUND OUR BUSINESS AND FAIL TO RAISE ADDITIONAL CAPITAL IN THE FUTURE, OUR OPERATING PLANS COULD BE RESTRICTED. 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. We are currently targeting that our current cash and cash equivalents will be sufficient to meet our anticipated cash needs through at least June 30, 2004 provided that we meet our targets with respect to revenues and accounts receivable collections. If we experience difficulties in achieving our revenue and accounts receivable 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 DEPRESS 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. The timing of our sales is governed in part by our customers' capital spending budgets and thus we may experience an absolute decline in revenues from quarter to quarter. If our future quarterly operating results are below the expectations of securities analysts or investors, the price of our common stock would likely decline. In addition to the other risk factors described in this prospectus, additional 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 the level of product competition in the application server and data services markets; 18 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. OUR SALES CYCLE IS LONG AND UNPREDICTABLE, SO IT IS DIFFICULT TO FORECAST OUR REVENUES. 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. 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. 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. 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 several of our top five customers has changed from period to period, including year to year.
% OF TOTAL REVENUES IDENTITY AND % OF TOTAL REVENUES OF TOP PERIOD OF TOP 5 CUSTOMERS 2 CUSTOMERS ------ ------------------ ----------- Six months ended June 30, 2003 58% Citigroup Global Markets.............30% Adobe Systems........................14 Six months ended June 30, 2002 64 Cablevision..........................33 Citigroup Global Markets.............19 Year ended December 31, 2002 55 Cablevision..........................26 Citigroup Global Markets.............13 Year ended December 31, 2001 45 Citigroup Global Markets.............15 Cablevision..........................11 Year ended December 31, 2000 40 Citigroup Global Markets.............16 Lucent Technologies...................6
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. DECLINES IN SALES REVENUE MAY RESTRICT OUR GROWTH AND HARM OUR BUSINESS AND OUR ABILITY TO ACHIEVE OUR FINANCIAL OBJECTIVES. For the three years from 1997 through 2000, our sales revenues grew over the previous year by 88%, 42% and 75%, respectively. In 2001 sales declined from the previous year by 23%, in 2002 our sales revenues declined by 25% and in the six months ended June 30, 2003 our sales revenues declined by 32% from the six 19 months ended June 30, 2002. We believe a substantial portion of the decline in sales of our products is due to the general downturn in information technology spending by our prospective customers, many of whom are Fortune 500 companies. If our prospective customers continue to defer spending on IT Infrastructure products, such as our products, our product sales may continue to decline. Our declining sales may also negatively affect our reputation with the investment community, which may lead to a decline in our stock price and may also discourage investors from purchasing our stock. 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 services product, any failure in market adoption of this product could result in our failure to meet our revenue goals. 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 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. 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. 20 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. 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; 21 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, WE MAY NOT BE ABLE TO ACHIEVE OUR PLANNED REVENUE TARGETS. 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. OUR FAILURE TO MANAGE OUR RESOURCES COULD RESULT IN OUR FAILURE TO ACHIEVE OUR FINANCIAL OBJECTIVES. 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. 22 OUR SALES AND DEVELOPMENT EFFORTS 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 41% of our total revenues came from sales of products and services outside of the United States for the six months ended June 30, 2003 and approximately 21% of our total revenues came from sales of products and services outside of the United States for the six months ended June 30, 2002. 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, and approximately 38% of our total revenues came from sales of products and services outside of the United States for the year ended December 31, 2001. We expect international revenues to continue to represent a significant portion of our total revenues. To date, almost all of our international revenues have resulted from our direct sales efforts. In international markets, however, we expect that we will depend more heavily on third party distributors to sell our products in the future. The success of our international strategy will depend on our ability to develop and maintain productive relationships with these third parties. The failure to develop key international markets for our products could cause a reduction in our revenues. Additional risks related to our international expansion and operation include: o difficulties of staffing, funding and managing foreign operations; o future dependence on the sales efforts of 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; 23 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, WHICH COULD BE TIME CONSUMING AND EXPENSIVE, AND, IF SUCCESSFUL, COULD REQUIRE US TO CEASE SELLING OR MATERIALLY CHANGE OUR PRODUCTS. The software industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement and the violation of other intellectual property rights. As the number of entrants into our market increases, the possibility of an intellectual property claim against us grows. For example, we may be inadvertently infringing a patent of which we are unaware. In addition, because patent applications can take many years to issue, there may be a patent application now pending of which we are unaware, which will cause us to be infringing when it issues in the future. To address these patent infringement claims, we may have to enter into royalty or licensing agreements on disadvantageous commercial terms. Alternatively, we may be unable to obtain a necessary license. A successful claim of product infringement against us, and our failure to license the infringed or similar technology, would harm our business. In addition, any infringement claims, with or without merit, would be time-consuming and expensive to litigate or settle and would divert management attention from administering our core business. FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE. If our current stockholders sell substantial amounts of common stock, including shares issued upon the exercise of outstanding options and warrants, and unregistered shares to be registered in the future, the market price of our common stock could fall. As of July 31, 2003, we had approximately 2,406,430 shares of common stock outstanding. Virtually all of our shares, other than shares held of affiliates, are freely tradable. Shares held by affiliates are tradable, subject to volume and other restrictions of Rule 144. In addition, we filed a registration statement on Form S-3 with the SEC on April 30, 2003 covering the resale of 375,869 shares of our common stock and 133,513 shares of common stock issued upon exercise of outstanding warrants on behalf of certain stockholders, including funds affiliated with Needham Capital Partners. We have also agreed to file an additional registration statement on the request of the stockholders affiliated with Needham Capital Partners under certain circumstances. Upon the effectiveness of the registration statement filed on April 30, 2003, the stockholders included in the registration statement may freely trade their registered shares in the public market (subject to certain restrictions as a result of the status of the stockholders as affiliates on the Company) which could result in a decrease of the price of our stock. These sales of common stock could impede our ability to raise funds at an advantageous price, or at all, through the sale of securities. 24 OUR STOCK PRICE HAS BEEN, AND MAY CONTINUE TO BE, VOLATILE. Our common stock price has been and may continue to be highly volatile, and we expect that the market price of our common stock will continue to be subject to significant fluctuations, as a result of variations in our quarterly operating results and the overall volatility of the Nasdaq 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. 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. 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. IF WE DEFAULT ON OUR BANK COVENANTS, THE BANK MAY, AMONG OTHER THINGS, CEASE ADVANCING FUNDS, DEMAND IMMEDIATE REPAYMENT AND EXERCISE ALL OTHER RIGHTS AS A CREDITOR UNDER OUR AGREEMENTS. We have not been able to comply with tangible net worth covenants of our line of credit with Comerica Bank in the past, and we may not be able remain in compliance with our renegotiated terms with the bank in the future if we continue to have significant net losses. Our renegotiated terms 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 $250,000 for the quarter ending September 30, 2003, and we must show a profit of at least one dollar for each quarter thereafter. Borrowings under this facility are secured by substantially all of our assets, including our intellectual property. If we violate any covenant in our agreements with Comerica Bank, the bank may declare us in default of our obligations and could, among other things, refuse to advance us any additional funds under the line of credit, accelerate our repayment obligations under all our facilities, and exercise all of its other rights as a creditor under our facilities, including the sale of our assets, including our intellectual property. THE ANTITAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND UNDER DELAWARE LAW COULD DISCOURAGE A TAKEOVER THAT CERTAIN OF OUR STOCKHOLDERS MAY CONSIDER DESIRABLE. 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: 25 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. ITEM 3. 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 the six months ended June 30, 2003, our operating results would not have changed materially. As of June 30, 2003, 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 June 30, 2003. We estimate that a hypothetical ten percent change in foreign currency rates in the six months ended June 30, 2003 would not have impacted our financial results of operations materially. We do not hedge any of our foreign currency exposure. ITEM 4. CONTROLS AND PROCEDURES 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 in Exchange Act Rules 13a-14(c) and 15d-14(c), as of June 30, 2003. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures are effective as of June 30, 2003. 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 their evaluation. 26 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. The Company is not currently subject to any material legal proceedings, though it may from time to time become a party to various legal proceedings that arise in the ordinary course of business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. On June 5, 2003, we held our annual meeting of stockholders for the year ended December 31, 2002. The following summarizes the matters submitted to a vote of the stockholders: 1. The election of two (2) Class I directors to serve until the Annual Meeting of the stockholders for the year ending December 31, 2005:
BROKER NON- NOMINEE IN FAVOR OPPOSED ABSTAIN VOTES ------- -------- ------- ------- ----- Christopher Paisley 22,228,021 0 316,412 0 Lawrence Owen Brown 22,228,021 0 316,412 0 2. To approve proposals to amend the Company's Certificate of Incorporation to enable the Company to effect one of five different reverse stock splits during the 12 months following approval by the stockholders of such proposals, if the Board of Directors determines that any such action is necessary and appropriate, and in the best interests of the Company and its stockholders, to seek to maintain the listing of the Company's Common Stock on the Nasdaq SmallCap Market. BROKER NON- PROPOSAL IN FAVOR OPPOSED ABSTAIN VOTES -------- -------- ------- ------- ----- 1-for-5 20,882,725 1,478,968 182,740 0 1-for-8 20,744,186 1,613,507 186,740 0 1-for-10 20,769,374 1,588,119 186,940 0 1-for-12 20,692,811 1,660,782 190,840 0 1-for-15 20,856,651 1,658,042 29,740 0 3. To ratify the appointment of Deloitte & Touche LLP as the independent auditors of the Company for the fiscal year ending December 31, 2003. BROKER NON- IN FAVOR OPPOSED ABSTAIN VOTES -------- ------- ------- ----- 21,113,918 346,680 1,083,835 0
27 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS: 31.1 Certificate of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certificate of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certificate of Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certificate of Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) REPORTS ON FORM 8-K: A report on Form 8-K filed July 24, 2003, reporting under Item 9 the announcement that on July 24, 2003, the Company issued a press release regarding its financial results for the six months ended June 30, 2003. In accordance with Securities and Exchange Commission Release No. 33-8216, the information contained in the Form 8-K, which was intended to be furnished under Item 12, "Results of Operations and Financial Condition," was instead furnished under Item 9, "Regulation FD Disclosure." 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PERSISTENCE SOFTWARE, INC. By: /s/ Christine Russell ---------------------- CHRISTINE RUSSELL CHIEF FINANCIAL OFFICER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER) Date: August 14, 2003 29 EXHIBIT INDEX Exhibit No. Description --- ----------- 31.1 Certificate of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certificate of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certificate of Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certificate of Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.