-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, L5jqZhUCNsBtWOzizJ19si22SEJEAUEdNz+qnauTpBZPPNp/bDHvjpPRRAeCF6De 86HmOLWTTPE6o7k5vtw9HA== 0000891618-98-002336.txt : 19980514 0000891618-98-002336.hdr.sgml : 19980514 ACCESSION NUMBER: 0000891618-98-002336 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980513 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PEOPLESOFT INC CENTRAL INDEX KEY: 0000875570 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 680137069 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-20710 FILM NUMBER: 98617773 BUSINESS ADDRESS: STREET 1: 4305 HACIENDA DR POST OFFICE BOX 8015 CITY: PLEASANTON STATE: CA ZIP: 945833-861 BUSINESS PHONE: 5102253000 MAIL ADDRESS: STREET 1: 4440 ROSEWOOD DRIVE CITY: PLEASANTON STATE: CA ZIP: 94588-3031 10-Q 1 FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 1998 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 1998 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: 0-20710 PEOPLESOFT, INC. (Exact name of registrant as specified in its charter) Delaware 68-0137069 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4440 Rosewood Drive, Pleasanton, CA 94588 (Address of principal executive officers) (Zip Code) Registrant's telephone number, including area code: (925) 694-3000 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: CLASS OUTSTANDING AT MARCH 31, 1998 ----- ----------------------------- Common Stock, par value $.01 226,654,724 ================================================================================ 2 PEOPLESOFT, INC. TABLE OF CONTENTS
PAGE NO. -------- PART I FINANCIAL INFORMATION ITEM 1 - Financial Statements (unaudited) Condensed Consolidated Balance Sheets as of December 31, 1997 and March 3 31, 1998 Condensed Consolidated Statements of Income for the Three Months Ended March 31, 1997 and March 31, 1998 4 Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 1997 and March 31, 1998 5 Notes to Condensed Consolidated Financial Statements 6 ITEM 2 - Management's Discussion and Analysis of Financial Condition and 8 Results of Operations PART II OTHER INFORMATION ITEM 1 - Legal Proceedings 23 ITEM 2 - Changes in Securities and Use of Proceeds 23 ITEM 3 - Defaults upon Senior Securities 23 ITEM 4 - Submission of Matters to a Vote of Security Holders 23 ITEM 5 - Other Information 23 ITEM 6 - Exhibits and Reports on Form 8 - K 23 SIGNATURES 24
2 3 PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS PEOPLESOFT, INC. ---------------- CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands) (unaudited)
DECEMBER 31, MARCH 31, 1997 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 267,897 $ 300,635 Short term investments 124,565 120,571 Accounts receivable, net 299,243 335,730 Deferred income taxes 25,320 26,482 Other current assets 9,021 18,389 ------------ ------------ Total current assets 726,046 801,807 Property and equipment, at cost 195,667 208,542 Less accumulated depreciation and amortization (78,492) (90,194) ------------ ------------ 117,175 118,348 Investments 26,783 43,310 Deferred income taxes 7,371 7,371 Capitalized software, less accumulated amortization 9,706 9,384 Other assets 11,255 10,560 ------------ ------------ $ 898,336 $ 990,780 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $ 63,508 $ 77,403 Accrued compensation and related expenses 67,486 72,106 Income taxes payable 22,370 10,860 Deferred revenue 327,668 359,085 ------------ ------------ Total current liabilities 481,032 519,454 Stockholders' equity: Common stock 2,237 2,267 Additional paid-in capital 219,005 239,534 Accumulated foreign currency translation adjustment (1,292) (1,583) Retained earnings 197,354 231,108 ------------ ------------ 417,304 471,326 ------------ ------------ $ 898,336 $ 990,780 ============ ============
See notes to condensed consolidated financial statements 3 4 PEOPLESOFT, INC. ---------------- CONDENSED CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts) (unaudited)
THREE MONTHS ENDED MARCH 31, -------------------------- 1997 1998 -------- -------- Revenues: License fees $ 83,413 $136,934 Services 70,241 140,740 -------- -------- Total revenues 153,654 277,674 Costs and expenses: Cost of license fees 4,441 11,196 Cost of services 43,609 86,704 Sales and marketing 44,418 72,690 Product development 25,258 42,861 General and administrative 8,724 13,228 -------- -------- Total costs and expenses 126,450 226,679 -------- -------- Operating income 27,204 50,995 Other income, interest expense and other 2,039 3,486 -------- -------- Income before income taxes 29,243 54,481 Provision for income taxes 11,405 20,727 -------- -------- Net income $ 17,838 $ 33,754 ======== ======== Basic income per share $ 0.08 $ 0.15 ======== ======== Shares used in basic per share computation 216,495 225,402 ======== ======== Diluted income per share $ 0.07 $ 0.13 ======== ======== Shares used in diluted per share computation 247,693 256,331 ======== ========
See notes to condensed consolidated financial statements 4 5 PEOPLESOFT, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
THREE MONTHS ENDED MARCH 31, ----------------------------- 1997 1998 --------- --------- OPERATING ACTIVITIES Net income $ 17,838 $ 33,754 Adjustments: Depreciation and amortization 9,181 12,760 Provision for doubtful accounts 160 1,771 Provision for deferred income taxes (3,730) 1,163 Changes in operating assets and liabilities: Accounts receivable (577) (38,258) Other current assets and noncurrent assets (4,513) (8,673) Accounts payable and accrued liabilities (8,361) 13,895 Accrued compensation and related expenses 135 4,620 Deferred revenue 21,641 31,417 Income taxes payable 7,783 (13,835) Tax benefits from employee stock transactions 866 2,177 --------- --------- Net cash provided by operating activities 40,423 40,791 INVESTING ACTIVITIES Purchase of investments (22,214) (66,185) Sale of investments 4,078 53,652 Purchase of property and equipment (8,821) (12,875) Additions to capitalized software, net (410) (736) --------- --------- Net cash used in investing activities (27,367) (26,144) FINANCING ACTIVITIES Net proceeds from sale of common stock and exercise of common stock options 7,508 18,382 --------- --------- Net cash provided by financing activities 7,508 18,382 Effect of foreign exchange rate changes on cash (870) (291) --------- --------- Net increase in cash and cash equivalents 19,694 32,738 Cash and cash equivalents at beginning of period 169,875 267,897 --------- --------- Cash and cash equivalents at end of period $ 189,569 $ 300,635 ========= =========
See notes to condensed consolidated financial statements 5 6 PEOPLESOFT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1998 (UNAUDITED) 1. BASIS OF PRESENTATION The information at March 31, 1997 and 1998 and for the three month periods then ended is unaudited, but includes all adjustments (consisting only of normal, recurring adjustments) which the Company's management believes to be necessary for the fair presentation of the financial position, results of operations, and changes in cash flows for the periods presented. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Despite management's best effort to establish good faith estimates and assumptions, and to manage the achievement of the same, actual results may differ. The accompanying interim financial statements should be read in conjunction with the financial statements and related notes included in the Company's Annual Report to Shareholders (Form 10-K) for the year ended December 31, 1997. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the Securities and Exchange Commission rules and regulations. Interim results of operations for the three month period ended March 31, 1998 are not necessarily indicative of operating results for the full fiscal year. 2. PER SHARE DATA Share amounts for all prior periods presented reflect restatement for the two-for-one stock split in December 1997. Basic income per share is computed using the weighted average number of common shares outstanding during the period. Diluted income per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of the shares issuable upon the exercise of stock options and warrants (using the treasury stock method). The following table sets forth the computation of basic and diluted income per share for the three months ended March 31, (in thousands except per share amounts):
1997 1998 -------- -------- Numerator: Net income $ 17,838 $ 33,754 ======== ======== Denominator: Denominator for basic income per share - weighted average shares 216,495 225,402 Employee stock options 28,787 27,026 Warrants 2,411 3,903 -------- -------- Denominator for diluted income per share - adjusted weighted average shares and assumed conversions 247,693 256,331 ======== ======== Basic income per share $ 0.08 $ 0.15 ======== ======== Diluted income per share $ 0.07 $ 0.13 ======== ========
6 7 3. ACCOUNTS RECEIVABLE Accounts receivable are comprised of billed receivables arising from recognized and deferred revenues, and unbilled receivables, which include accrued license fees for payments not yet due and accrued services. The principal components of accounts receivable at December 31, 1997 and March 31, 1998 were as follows (in thousands):
DEC. 31, MAR. 31, 1997 1998 ----------- ----------- Billed receivables $ 200,081 $ 226,218 Unbilled receivables 118,655 130,776 ----------- ----------- 318,736 356,994 Allowance for doubtful accounts (19,493) (21,264) ----------- ----------- $ 299,243 $ 335,730 =========== ===========
4. DEFERRED REVENUE Deferred revenue is comprised of deferrals for license fees, maintenance, training and other services. The principal components of deferred revenue at December 31, 1997 and March 31, 1998 were as follows (in thousands):
DEC. 31, MAR. 31, 1997 1998 ----------- ---------- License fees $ 71,168 $ 78,037 Maintenance 184,171 197,401 Training 46,201 52,759 Other services 26,128 30,888 ----------- ---------- $ 327,668 $ 359,085 =========== ==========
5. TRANSFER OF FINANCIAL ASSETS The Company finances certain software license and service agreements with customers through the sale, assignment and transfer of the future payments under those agreements to financing institutions, principally on a non-recourse basis. The Company records such transfers as sales of the related accounts receivable when it is considered to have surrendered control of such receivables under the provisions of Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." 6. COMPREHENSIVE INCOME Comprehensive income includes changes in the balances of items that are reported directly in a separate component of Stockholders' equity on the Consolidated Balance Sheets. The Company had comprehensive income comprised of accumulated foreign currency translation adjustments totaling $870,000 and $291,000 for the three months ended March 31, 1997 and March 31, 1998, respectively. 7 8 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Discussion and Analysis of Financial Condition and Results of Operations contains descriptions of the Company's expectations regarding future trends affecting its business. These forward-looking statements and other forward-looking statements made elsewhere in this document are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The following discussion sets forth certain factors the Company believes could cause actual results to differ materially from those contemplated by the forward-looking statements. Forward-looking statements include, but are not limited to, those items identified with a footnote (1) symbol. The Company undertakes no obligation to update the information contained herein. STATEMENT OF FUTURE DIRECTION: THIS DOCUMENT CONTAINS STATEMENTS OF FUTURE DIRECTION CONCERNING POSSIBLE FUNCTIONALITY FOR PEOPLESOFT'S SOFTWARE PRODUCTS AND TECHNOLOGY. ALL FUNCTIONALITY AND SOFTWARE PRODUCTS WILL BE AVAILABLE FOR LICENSE AND SHIPMENT FROM PEOPLESOFT ONLY IF AND WHEN GENERALLY COMMERCIALLY AVAILABLE. PEOPLESOFT DISCLAIMS ANY EXPRESS OR IMPLIED COMMITMENT TO DELIVER FUNCTIONALITY OR SOFTWARE UNLESS OR UNTIL ACTUAL SHIPMENT OF THE FUNCTIONALITY OR SOFTWARE OCCURS. THE STATEMENTS OF POSSIBLE FUTURE DIRECTION ARE FOR INFORMATIONAL PURPOSES ONLY AND PEOPLESOFT MAKES NO EXPRESS OR IMPLIED COMMITMENTS OR REPRESENTATIONS CONCERNING THE TIMING AND CONTENT OF ANY FUTURE FUNCTIONALITY OR RELEASES. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of total revenues and the percentage of period over period growth represented by certain line items in the Company's consolidated statements of income:
FOR THE THREE MONTHS ENDED MARCH 31, - --------------------------------------------------------------------------------------------------------------------------- PERCENTAGE OF TOTAL REVENUES PERCENTAGE OF - ---------------------------------------------------------- DOLLAR INCREASE 1997 1998 YEAR OVER YEAR - ------------------------ ------------------------------ --------------- Revenues: 54% 49% License fees 64% 46 51 Services 100 --- ---- ---- 100 100 Total revenues 81 Costs and expenses: 3 4 Cost of license fees 152 28 31 Cost of services 99 29 26 Sales and marketing 64 16 16 Product development 70 6 5 General and administrative 52 --- ---- ---- 82 82 Total costs and expenses 79 --- ---- ---- 18 18 Operating income 87 1 1 Other income 71 --- ---- ---- 19 19 Income before income taxes 86 7 7 Provision for income taxes 82 === ==== ==== 12% 12% Net income 89% === ==== ====
A substantial portion of the Company's cost structure is employee-related. The breakdown of employees by functional area is as follows:
EMPLOYEE COUNT PERCENTAGE OF TOTAL EMPLOYEES PERCENTAGE OF - ----------------------------------------- ---------------------------------------- INCREASE 12/31/97 3/31/98 12/31/97 3/31/98 SINCE 12/31/97 - ------------------- -------------------- ------------------ -------------------- ------------------ 2,114 2,456 Services 47% 48% 16% 1,006 1,206 Sales and marketing 23 23 20 918 1,004 Product development 21 20 9 414 456 General and administrative 9 9 10 ------ ------ ---- ---- -- 4,452 5,122 Total 100% 100% 15% ====== ====== === === ==
8 9 REVENUES The Company recognizes revenue when a non-cancelable license agreement has been signed, the software product has been shipped, there are no uncertainties surrounding product acceptance, the fees are fixed and determinable, and collection is considered probable. For customer license agreements which meet the Company's revenue recognition policy, the portion allocated to software license fees will generally be recognized in the current period, while the portion allocated to services is recognized as the services are performed. When the Company enters into a license agreement with a customer requiring significant customization of the software products, the Company recognizes revenue related to the license agreement using contract accounting. The total dollar amount of customer license agreements executed ("contracting activity") for software license fees and services increased from $145.6 million in the quarter ended March 31, 1997 to $218.0 million for the same period in 1998. Contracting activity with new customers which numbered 188 comprised approximately 66% of the total contracting activity executed for the quarter ended March 31, 1998, compared with 132 new customers and 65% for the same period in the prior year. Average contract size, computed by dividing the number of new customers into total contracting activity, increased to approximately $1.2 million in the first quarter of 1998 compared to $1.1 million in the first quarter of 1997, reflecting the ongoing emphasis the Company is placing on achieving more selective and larger, enterprise oriented transactions. Revenues from licensing fees increased by 64% from $83.4 million in the three month period ended March 31, 1997 to $136.9 million for the same period in 1998. The increase in license fee revenues was attributable to continued increased market acceptance of, and expanded breadth of, the Company's software product offerings and the increased capacity created by continued growth in the Company's sales, marketing and customer service organizations. Revenues from services increased by 100% from $70.2 million in the three month period ended March 31, 1997 to $140.7 million for the same period in 1998. The Company's customer license agreements provide for initial maintenance, training, and installation services for specified periods or amounts. Therefore increases in customer licensing agreements have resulted in increases in revenues from these services. Service revenues as a percentage of total revenues were 46% and 51% for the quarters ended March 31, 1997 and 1998, respectively. The increase in the relative percentage of service revenues to total revenues in these periods was attributable to two primary factors: increases in the installed base of customers receiving ongoing maintenance, training and other support services; and a significant increase in consulting revenue as a result of expanded demand for PeopleSoft's direct assistance during enterprise implementation projects. In response to strong market demand, the Company continues to rapidly expand its service delivery capacity, particularly for consulting services. Total revenues increased from $153.7 million in the three month period ended March 31, 1997 to $277.7 million for the same period in 1998. Total revenue growth period over period of 81% exceeded the Company's forecasted growth of 75%, and on a sequential basis, increased approximately 7% over the total revenues recorded in the fourth quarter of 1997. The higher than forecasted growth rate was due primarily to greater than forecasted service revenues. During the quarters ended March 31, 1997 and 1998, the Company's international revenues were approximately 17% and 15% of total revenues, respectively. Revenues from international operations increased 56% from $26.4 million in the three month period ended March 31, 1997 to $41.2 million in the same quarter in 1998. The dollar increase in international revenues resulted from expanded international operations and the introduction of Release 6 which incorporated additional global features and functionality. The Company expects international revenues to continue to grow in absolute dollars during 1998, and accordingly, continues to invest heavily in international infrastructure, global product functionality and translated versions of financial and other products(1). In particular, the upcoming Release 7.5 product (See Statement of Future Direction) is expected to provide stronger international functionality for European businesses, including both new country specific functionality and support for the European monetary unit(1). In the event international expansion and/or product globalization are not successful, the Company's business, operating results and financial condition may be adversely affected. COSTS AND EXPENSES Cost of license fees consists principally of royalties, technology access fees for certain third party software products and amortization of capitalized software costs. Cost of license fees increased 152% from $4.4 million in the three month period ended March 31, 1997 to $11.2 million for the same period in 1998, representing 3% and 4% of total revenues and 5% and 8% of license fee revenues in each quarter, respectively. Royalty costs in the first quarter of 1998 included a one time $2.5 million partial buy out of royalty fees related to the upcoming Release 7.5 product (See Statement of Future Direction). The Company's system solutions are based on a combination of internally developed technology and application products, as well as bundled third party software products and technology. Cost of license fees as a percentage of license fee revenues may fluctuate from period to period due principally to the mix of sales of royalty-bearing software products in each period and seasonal fluctuations in revenues contrasted with certain fixed expenses such as the amortization of capitalized - ---------- (1) Forward-Looking Statement 9 10 software. Royalties associated with certain software products currently under development by joint business arrangements and charges associated with software products and technologies acquired from various third party vendors may cause the cost of license fees as a percentage of license fee revenues to increase in future periods. Cost of services consists principally of account management field support, training, consulting and product support. These costs increased 99% from $43.6 million in the three month period ended March 31, 1997 to $86.7 million for the same period in 1998, representing 28% and 31% of total revenues in each quarter, respectively, and 62% of service revenues in those quarters. Cost of services increased as a percent of total revenues due to a mix shift toward relatively more service revenues, and due to certain non-recurring expenses including those associated with a meeting of its consulting organization. The dollar increase is due to significant expansion of the Company's customer service resources across all categories, including consulting, telephone support, training and account management staff. In particular, the Company has made a significant investment in its professional consulting services organization which has grown substantially over the past two years in response to customer demand. The Company anticipates cost of services will increase in dollar amount, and may increase as a percentage of total revenues, in future periods. Sales and marketing expenses increased by 64% from $44.4 million in the three month period ended March 31, 1997 to $72.7 million for the same period in 1998, representing 29% and 26% of total revenues in each period, respectively. As the Company's business mix shifts increasingly toward service revenue, the Company expects sales and marketing expenses to decline as a percentage of total revenues as these costs are primarily related to contracting activity. The increase in sales and marketing expenses is attributable to the Company's continued expansion of its direct sales force, increased commission expense associated with higher revenue, increased depreciation from related equipment and facility expenditures, continued investment in building an international direct sales force and increased marketing expenses for the Company's expanded software product offerings. The Company continues to increase its direct sales and marketing expenditures to address certain international markets, establish an industry focused enterprise sales force structure and fund both cross industry and industry specific marketing and sales activities. Consequently, such expenses may increase as a percentage of total revenues in future periods. Product development expenses increased by 70% from $25.3 million in the three month period ended March 31, 1997 to $42.9 million for the same period in 1998, representing 16% of total revenues in each quarter. Software product development expenditure increases are directly attributable to increases in the Company's staff of software engineers and consultants, and the associated infrastructure costs required to support software product development initiatives in the following areas: (i) expansion and enhancement of the Company's core software product offerings in the areas of HRMS, Financial Management Systems, and Distribution/Materials Management Systems and Supply Chain Management software; (ii) the enhancement of the Company's platform development, certification, software product testing and overall release management capabilities; (iii) the continued enhancement of the Company's client/server architecture including its software development tools and the integration of these tools with various third party purchased or licensed technologies; (iv) the localization and translation of certain versions of the Company's software products for specific foreign markets; and, (v) the development of certain vertical market products and versions of its core products suitable to the unique needs of customers within certain industries. In particular, the Company's development expenditure increases during 1998 are being driven by expenditures associated with the Company's next major enterprise application release (PeopleSoft 7.5 - See Statement of Future Direction), expected to be available in the first half of 1998(1). The Company intends to continue to invest significant resources in upcoming releases, and anticipates software product development expenditures will significantly increase in future periods due to continued incremental investment in all of the above areas, and overall development expenditures may increase as a percentage of revenues. General and administrative expenses increased 52% from $8.7 million in the three month period ended March 31, 1997 to $13.2 million for the same period in 1998, representing 6% and 5% of total revenues in each quarter, respectively. The dollar increase in general and administrative expenses resulted primarily from increases in staffing and related infrastructure to support the Company's growth, and increases in administrative expenses associated with the operation of foreign subsidiaries. Operating margins for the three month period ended March 31, 1998 increased to 18.4% compared to 17.7% for the same period last year. The 1998 first quarter operating margin percentage was higher than forecasted in the Company's business outlook for the fourth quarter of 1997 due to lower expense growth, primarily from lower than planned hiring, and higher revenue growth as discussed above. Other income, consisting primarily of interest, increased from $2.0 million in the three month period ended March 31, 1997 to $3.5 million for the same period in 1998, primarily due to a higher balance of cash, cash equivalents and investments. In January 1998, the Company initiated a foreign currency transactions hedging program. The net of hedging transactions offset by foreign currency transactions was not significant for the quarter. - ---------- (1) Forward-Looking Statement 10 11 PROVISION FOR INCOME TAXES The Company's income tax provision increased from $11.4 million in the three month period ended March 31, 1997 to $20.7 million for the same period in 1998. The provision for income taxes was 38% of income before taxes for the three months ended March 31, 1998, which represents a .5% decline from the 1997 annual effective income tax rate of 38.5%. The effective tax rate is based on management's current estimates and forecasts of the Company's taxable income in multiple domestic and foreign taxing jurisdictions. The estimated annual effective tax rate is relatively sensitive to the results of operations in various jurisdictions, and because such projections may change in future periods, the actual effective tax rate could differ from this estimate. The Company has recorded $33.9 million in net deferred tax assets at March 31, 1998. EARNINGS PER SHARE The Company's earnings per share are calculated in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share", consistent with reporting for the fourth quarter of 1997. The new method requires calculation of both a basic earnings per share and a diluted earnings per share. The basic earnings per share excludes the dilutive effect of common stock equivalents such as stock options and warrants, while the diluted earnings per share includes such dilutive effects. Diluted earnings per share increased from $ .07 in the three month period ended March 31, 1997 to $ .13 for the same period in 1998. Earnings per share increased as a result of the 89% increase in net income from $17.8 million for the three month period ended March 31, 1997 to $33.8 million for the same period of 1998, partially offset by a 3% increase in the number of shares used in the diluted per share computation from 247.7 million shares as of March 31, 1997 to 256.3 million shares as of the same date in 1998. The increase in weighted average shares outstanding was due to the exercise of stock options and the issuance of shares under the employee stock purchase plan. Shares outstanding during 1998 will be impacted by the following factors: (i) the ongoing issuance of common stock associated with stock option exercises; (ii) the anticipated exercise during 1998 of warrants for approximately 3.2 million shares; (iii) the issuance of common shares associated with the Company's employee stock purchase program; (iv) any fluctuations in the Company's stock price, which could cause changes in the number of common stock equivalents included in the earnings per share computation; and, (v) the issuance of common stock to affect business combinations should the Company enter into such transactions. LIQUIDITY AND CAPITAL RESOURCES The Company's operating activities provided cash of $40.8 million during the three month period ended March 30, 1998, compared to $40.4 million in the same period in 1997. In both periods, cash provided by operating activities was due principally to earnings and increases in deferred revenue which were partially offset by increases in other assets and receivables. In the first quarter of 1998, cash from operations was also provided by increases in accounts payable and other accrued liabilities. From December 31, 1997 to March 31, 1998, net accounts receivable increased from $299.2 million to $335.7 million, respectively, and deferred revenues increased from $327.7 million to $359.1 million over the same period. The increase in net accounts receivable resulted from the growth in customer licensing activity offset by cash collections. Deferred revenue has increased as a result of the growth in customer licensing activity and the associated deferrals of revenues related to services to be provided to new licensees. In addition, the Company's expanded installed base has resulted in increased deferred revenues related to ongoing maintenance and other services. Increases in payables and other assets were due to general growth in the Company's operations. The Company calculates accounts receivable days sales outstanding ("DSO") as the ratio of quarter-end accounts receivable to the sum of quarterly revenues and the net change in quarter-end deferred revenues, multiplied by 90. The Company believes this calculation is appropriate because license fees are typically billable regardless of whether revenue has been recognized or deferred. Under this method, DSO was 84 days as of March 31, 1997, 88 days as of December 31, 1997, and 98 days as of March 31, 1998. The increase in the first quarter of 1998 was due primarily to: (i) certain organizational and administrative process issues, which the Company believes can be addressed within a relatively short time frame. These issues were primarily related to a lack of well-defined collection processes for a particular set of customers; (ii) a relative decrease in contract execution payments received within the quarter; and, (iii) slower collections of receivables in the Company's Asia/Pacific region. Since billing terms of the Company's agreements typically are spread out over a sequence of events (including contract execution through standard acceptance) or dates that generally span four to nine months, and contracting activity is concentrated at the end of each quarter, the Company anticipates that its DSO will continue to be substantial in future periods. During the first three months of 1997 and 1998, the Company's principal use of cash for investing activities included investments and the purchase of property and equipment, comprised of computer and network equipment, to accommodate employee and facility expansions and to support the Company's growing training capacity requirements. 11 12 Financing activity for the first quarter of 1997 and 1998 related to the proceeds from the exercise of common stock options by employees and stock issuances under the employee stock purchase program. The Company believes granting stock options is essential in attracting and retaining key employees who are critical to the Company's success. The Company anticipates that it will continue to grant a significant number of options each year. The actual number of options granted each year is based on a variety of factors including the Company's historical and anticipated employee count, the level of hiring activity, competitive factors associated with the labor market, and comparison of the Company's compensation philosophy and practice to other similar technology companies. There can be no assurance that employee stock activity will continue to generate substantial funds in the future. As of March 31, 1998, the Company had $282.4 million in working capital, including $300.6 million in cash and cash equivalents, $120.6 million in short term investments, and $43.3 million in long term investments, consisting primarily of high quality municipal bonds and tax-advantaged money market funds. The Company believes that existing cash and short term investment balances, proceeds from sales of stock under the employee purchase plan and stock option exercises, potential proceeds from issuance of stock for warrants, and potential cash flow from operations will be sufficient to meet its operating cash requirements, at least through March 1999(1) . FINANCIAL RISK MANAGEMENT FOREIGN EXCHANGE PeopleSoft's revenue originating outside the United States was 15% of total revenues in the first quarter of 1998, the same as for the full year in 1997. International sales are made mostly from the Company's foreign sales subsidiaries in the local countries and are typically denominated in the local currency of each country. These subsidiaries also incur most of their expenses in the local currency. Accordingly, all foreign subsidiaries use the local currency as their functional currency. The Company's international business is subject to risks typical of an international business, including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, the Company's future results could be materially adversely impacted by changes in these or other factors. The Company's exposure to foreign exchange rate fluctuations arise in part from intercompany accounts in which cost of software, including certain development costs, incurred in the United States is charged to the Company's foreign sales subsidiaries. These intercompany accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the United States. The Company is also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. Dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability. In the first quarter of 1998, the Company initiated a hedging program designed to mitigate the potential for future adverse impact due to changes in foreign exchange rates. The program uses forward foreign exchange contracts as the vehicle for hedging these intercompany balances. In general, these forward foreign exchange contracts have three months or less to maturity. Gains and losses on these hedges are recorded in Other income and offset against losses and gains on the underlying exposures. Management of the foreign exchange hedging program is done in accordance with a corporate policy approved by the Company's Board of Directors. At March 31, 1998, hedge positions totaled U.S. Dollar 11.6 million equivalent. All hedge positions are carried at fair value and all hedge positions had maturity dates within three months. INTEREST RATES The Company invests its cash in a variety of financial instruments, including bank time deposits, and taxable and tax-advantaged variable rate and fixed rate obligations of corporations, municipalities, and local, state and national governmental entities and agencies. These investments are denominated in U.S. Dollars. Cash balances in foreign currencies overseas are operating balances and are invested in short term time deposits of the local operating bank. Interest income on the Company's investments is carried in Other income. The Company accounts for its investment instruments in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity - ---------- (1) Forward-Looking Statement 12 13 Securities" ("SFAS 115"). All of the cash equivalent, short term, and long term investments are treated as available-for-sale under SFAS 115. Investments in both fixed rate and floating rate interest earning instruments carries a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company's future investment income may fall short of expectations due to changes in interest rates or the Company may suffer losses in principal if forced to sell securities which have seen a decline in market value due to changes in interest rates. The Company's investments are made in accordance with an investment policy approved by the Board of Directors. At March 31, 1998, the average maturity of the Company's investment securities was roughly four months. No investment securities had maturities exceeding two years. The following table presents certain information about the Company's financial instruments held at March 31, 1998 that are sensitive to changes in interest rates. These instruments are not leveraged and are held for purposes other than trading. For available-for-sale investment securities, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. The Company believes its available-for-sale securities, comprised of highly liquid debt securities of corporations, municipalities, and the U.S. Government, are similar enough to aggregate. Because of the Company's effective tax rate, the Company finds it advantageous to invest largely in tax-advantaged securities, therefore the average interest rates below are most comparable to tax-exempt interest rates. Below is a tabular presentation of the maturity profile of the available-for-sale investment securities held by the Company at March 31, 1998:
INTEREST RATE SENSITIVITY PRINCIPAL AMOUNT BY EXPECTED MATURITY WEIGHTED AVERAGE INTEREST RATE FAIR VALUE (DOLLARS IN MILLIONS) 1 YEAR OR LESS MORE THAN 1 YEAR TOTAL 3/31/98 - ---------------------------------------------- ------------------ ------------------ -------------- ------------------ Available-for-sale securities $257.1 $43.3 $300.4 $300.4 Weighted average interest rate 4.0% 4.0%
The Company is not an issuer of any corporate debt nor does it have any bank borrowings outstanding. BUSINESS OUTLOOK The following forward-looking statements are based on current expectations which are subject to material change due to a variety of factors including but not limited to, those which are listed below and in the section titled "Factors That May Affect Future Results". These forward-looking statements and other forward-looking statements made elsewhere in this document are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, those items identified with a footnote (1) symbol. The Company undertakes no obligation to update the information contained herein. - Based on its current expectations of contracting activity, and an analysis of the Company's service delivery capacity and the expected customer utilization of such services, the Company expects total revenues for the second quarter of 1998 to increase approximately 65% over total revenues recorded in the same quarter of the prior year(1). For the 1998 calendar year, the Company expects total revenues to increase between 55% and 65% over the total revenues recorded in the 1997 calendar year(1). As with any forecast, actual results could vary within a few percentage points on either side of these estimates even if there are no material changes to the underlying assumptions, and longer term forecasts can be expected to have relatively higher variability. The key assumptions on which this forecast is based include, but are not limited to, the following: (i) total actual available market opportunities must be reasonably consistent with those forecasted by certain major information technology market research firms; (ii) the preservation of the Company's ability to generate a sufficient number of qualified leads through its ongoing marketing programs; (iii) an increase in the Company's direct sales capacity through the successful recruitment, hiring, training and retention of additional sales and sales support personnel; (iv) no significant adverse changes in the competitive landscape; and (v) the continued demand for the Company's applications as an alternative to modification of legacy systems where prospects have issues relating to data processing in the Year 2000. In addition, the achievement of expected contracting activity and total revenues is highly dependent upon the Company's ability to successfully manage the potential risks detailed below in the section titled "Factors That May Affect Future Results" including, but not limited to, fluctuations in quarterly operating results; changes in customer demand; the timing and complexity of large transactions including the bundling of significant amounts of professional services; ability to recognize contracting activity in - ---------- (1) Forward-Looking Statement 13 14 the current quarter under revenue recognition accounting rules; success of international operations; reliance on third parties for sales, marketing and implementation assistance; timing and acceptance of software products and product development; and the ability to execute hiring and facility expansion plans. - The Company's operating model is based on a rolling four quarter target operating margin of between 18% and 20%. The Company expects that the 1998 full year results will fall within this range and anticipates that the second quarter operating margin, consistent with seasonal patterns, will come in around the low end of this range(1). Due to the significant operating leverage which is characteristic of the software industry, any deviation in the expected revenues could significantly impact the Company's ability to meet the target operating margins. Achievement of forecasted operating margins is highly dependent upon the Company's ability to successfully manage the potential risks detailed below in the section titled "Factors That May Affect Future Results" including, but not limited to, achievement of revenue forecasts as discussed above; continued introduction and marketing of new and enhanced versions of software products; successful penetration of international markets; continued acceptance of the Company's software products, particularly its proprietary software development tools; successful porting and acceptance of its software products on a variety of platforms; continued acceptance of its application security architecture and intellectual property, preservation of its proprietary rights and product liability protections; and continued success in hiring, training and retaining key personnel and completing expansion of facilities. - Based on projected cash and investment balances, constant interest rates and no unusual items of other income or expense, the Company expects other income on a quarterly basis to remain flat to slightly higher in absolute dollars compared to the first quarter of 1998(1). The achievement of forecasted other income targets is dependent on: (i) stable financial markets which preclude a significant overall decline in investment yields, or a significant fluctuation in foreign currency exchange rates, and (ii) avoidance of default on any individual significant investment. Should the Company decide to utilize a significant portion of its current cash and investments to acquire complementary businesses, products, technologies or to acquire additional facilities through purchase of land and/or buildings, interest income may decline significantly causing other income to deviate from forecasted amounts. - Based on current tax law and the Company's present forecast of operating results by country, the effective tax rate in 1998 is expected not to exceed 38%(1) . The estimated annual effective tax rate is relatively sensitive to the results of operations in various foreign legal entities, and because such projections may change in future periods, the actual effective tax rate could differ from this estimate. Please read the section below titled "Factors That May Affect Future Results" for additional information and discussion of conditions which the Company believes could cause actual results to differ materially from those contemplated by forward-looking statements. FACTORS THAT MAY AFFECT FUTURE RESULTS The Company has identified certain forward-looking statements in the Management's Discussion and Analysis of Financial Condition and Results of Operations (which includes the Business Outlook Section) with a footnote (1) symbol. The Company may also make oral forward-looking statements from time to time. Actual results may differ materially from those projected in any such forward-looking statements due to a number of factors, including those set forth below and elsewhere in this Form 10-Q. The Company operates in a dynamic and rapidly changing environment that involves numerous risks and uncertainties. The following section lists some, but not all, of these risks and uncertainties which may have a material adverse effect on the Company's business, financial condition or results of operations. This section should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes thereto included in Part I -- Item 1 of this Quarterly Report and the audited Consolidated Financial Statements and Notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 1997, contained in the Company's 1997 Annual Report to Stockholders (Form 10-K). FLUCTUATIONS IN QUARTERLY OPERATING RESULTS The Company's revenues and operating results can vary substantially from quarter to quarter. License revenues in any quarter are substantially dependent on aggregate contracting activity and the Company's ability to recognize revenue in that quarter in accordance with its revenue recognition policies. - ---------- (1) Forward-Looking Statement 14 15 Contracting activity is difficult to forecast for a variety of reasons including: (i) a significant portion of the Company's license agreements are completed within the last few weeks of each quarter; (ii) the duration of the Company's sales cycle is relatively long and increasingly variable because the Company has broadened its marketing emphasis to encompass software product solutions for the customer's overall enterprise, thereby increasing the financial value of individual transactions and the complexity of the customer selection, negotiation and approval process; (iii) the size of license transactions can vary significantly; (iv) system replacement projects and new system evaluations may be postponed or canceled at any time due to changes in a customer's project, company management, budgetary constraints or strategic priorities; (v) customer evaluations and procurement processes vary significantly from company to company, and a customer's internal approval and expenditure authorization process can be arduous, even subsequent to actual vendor selection; (vi) the number, timing and significance of software product enhancements and new software product announcements by the Company and its competitors; (vii) as the Year 2000 approaches, many potential customers are evaluating their legacy systems and must decide whether to repair or replace existing applications which have Year 2000 operability issues. While the Company believes that such evaluations are favorably impacting demand for its applications, such demand is subject to change as the Year 2000 draws closer since lead times required to complete systems implementations preclude system replacement as a timely solution to the Year 2000 issue. Given the lack of precedent for an issue of this magnitude, the Company's ability to accurately forecast the impact of the issue on quarter to quarter revenue achievement is limited; (viii) changes in the Company's sales incentive plans have had and may continue to have an unpredictable impact on seasonal business patterns; and (ix) changes in economic, political and market conditions can adversely impact business opportunities without any notice. The correlation between license fee revenues recognized and contracting activity can vary significantly because of factors which may cause revenue to be initially deferred including: (i) the license agreement may be entirely related to then currently undeliverable software products; (ii) enterprise transactions may include software products that are then currently deliverable, as well as software products that are still under development. To the extent the Company enters into a license agreement for the provision of both software product categories, the Company must have established separate values for all elements under the license agreement, and the license agreement and supporting schedules to the license agreement must contain very precise contractual provisions consistent with generally accepted accounting principles to permit any revenue recognition under the license agreement; (iii) the customer may demand services that include significant modifications, customizations or complex interfaces; (iv) the license agreement may include non-standard acceptance criteria which may preclude revenue recognition prior to customer acceptance; and, (v) the license agreement may include fees with extended payment terms or fees that are dependent upon acceptance of services or other contingencies. All of the above factors, as well as other specific requirements under recently published generally accepted accounting standards for software revenue recognition, create circumstances under which the Company must have very precise contractual agreements in order to recognize revenue upon initial software product delivery. Although the Company has a standard license agreement which meets the demanding criteria under generally accepted accounting principles, the Company must often negotiate and revise certain terms and conditions in large enterprise transactions. Negotiation of mutually acceptable language can extend the sales cycle, and in certain situations, the Company does not always obtain terms and conditions which permit recognition of revenue at the time of delivery or ratably using contract accounting. Services revenues may vary from quarter to quarter due to variances in prior quarter contracting activity which impacts consulting services revenue on a lag. The Company's ability to increase services revenue is dependent on its ability to grow licensing activity which provides opportunities for consulting, training, and subsequent maintenance revenues. Additionally the Company may not be able to recruit, hire, and train sufficient numbers of qualified consultants to perform such services. Due to the foregoing, it is likely that in one or more future quarters the Company's operating results will be below the expectations of public securities market analysts. In such event, the price of the Company's common stock would likely be materially adversely affected. POSSIBLE ADVERSE IMPACT OF RECENT ACCOUNTING PRONOUNCEMENT Statement of Position ("SOP") 97-2, "Software Revenue Recognition" was issued in October 1997 and addresses software revenue recognition matters. The SOP supersedes SOP 91-1 and is effective for transactions entered into for fiscal years beginning after December 15, 1997. Based upon its reading and interpretation of SOP 97-2 the Company believes its current revenue recognition policies and practices are materially consistent with the SOP. However, implementation guidelines for this standard have not yet been issued and a wide range of potential interpretations are being discussed by the accounting profession. Once available, such implementation guidance could lead to unanticipated changes in the Company's current revenue accounting practices, and such changes could materially adversely affect the Company's future revenue and earnings. Such implementation guidance may necessitate substantial changes in the Company's business practices in order for the Company to continue to recognize a substantial portion of its license fee revenue upon delivery of its software products. Such changes may reduce 15 16 demand, extend sales cycles, increase administrative costs and otherwise adversely affect operations. In addition, the Company may be put at a competitive disadvantage relative to foreign based competitors not subject to U.S. generally accepted accounting principles. OPERATING LEVERAGE Consistent with many companies in the software industry, the Company's business model is characterized by a very high degree of operating leverage. Employee and facility related expenditures comprise a significant portion of the Company's operating costs and expenses, and over the short term are relatively fixed. In addition, the Company's expense levels and hiring plans are based, in significant part, on the Company's projections of future revenue levels. If revenue levels fall below expectations, net income is likely to be disproportionately adversely affected. There can be no assurance that the Company will be able to increase or even maintain its current level of profitability on a quarterly or annual basis in the future. FUTURE OPERATING RESULTS UNCERTAIN Segments of the software industry have experienced significant economic downturns characterized by decreased product demand, price erosion, technological shifts, work slowdowns and layoffs. The Company's operations may, in the future, experience substantial fluctuations from period to period as a consequence of such industry patterns, general economic conditions affecting the timing of orders from customers, and other factors affecting capital spending. There can be no assurance that such factors will not have a materially adverse effect on the Company's business, operating results or financial condition. Although the Company's 1998 operating budget is based on projections of a material increase in total revenues over the corresponding actual results for 1997, the Company does not believe that the percentage increases in revenues achieved in prior periods should be anticipated in future periods. The operating results of many software companies reflect seasonal trends, and the Company has been, and expects to continue to be, affected by such trends in the future. The Company's seasonal patterns of revenue achievement, which are typically characterized by relatively weaker first and second quarters and relatively stronger third and fourth quarters, can be caused by a variety of factors, including sales incentives, customer demand based on available capital budgets and release of new technologies. INTERNATIONAL OPERATIONS The Company has utilized, and will continue to utilize substantial resources and funding to build its international service and support infrastructure. Operating costs in many countries, including many of those in which the Company operates, are higher than in the United States. In order to increase international sales in 1998 and subsequent periods, the Company must continue to globalize its software product lines, expand existing and establish additional foreign operations, hire additional personnel, identify suitable locations for sales, marketing, customer service and development, and recruit international distributors and resellers in selected territories. In the event international expansion and/or product globalization are not successful, it is likely to have a negative impact on the Company's operating results. The Company's sales through its foreign operations are generally denominated in each respective subsidiary's functional currency. Unexpected changes in the exchange rates for these foreign currencies could result in significant fluctuations in the foreign currency transaction and translation gains and losses in future periods. The Company implemented a hedging program designed to mitigate the potential impact of exchange rate fluctuations in January 1998. In addition to hedging existing transaction exposures, the Company's foreign exchange management policy allows for the hedging of anticipated transactions, and exposure resulting from the translation of foreign subsidiary financial results into U.S. Dollars. Such hedges can only be undertaken to the extent that the exposures are highly certain, reasonably estimable, and significant in amount. These hedges will only be undertaken should the Company deem them necessary to protect the U.S. Dollar value of the underlying exposure. The Company foresees that hedges of such anticipated transactions and translation exposures will be done in the future using forward and option contracts(1), however in the event the Company is unable to hedge potential significant exposures due to lack of certainty or ability to reasonably estimate the foreign exchange exposure, there could be a material adverse impact to the Company's operating results. COMPETITION The market for business application software is intensely competitive. The Company faces competition from a variety of software vendors including enterprise application software vendors, manufacturing application software vendors, enterprise resource optimization application software vendors, financial management systems and HRMS application software vendors and software tools vendors. Although the Company believes its success has been due in part to its early emphasis on the client/server architecture, virtually all of the Company's - -------------- (1) Forward-Looking Statement 16 17 competitors now offer software products based on a client/server architecture. Consequently, competitive differentiators now include more subtle architectural and technological factors, such as web enablement, enterprise software product breadth and individual product features, service reputation, product flexibility, ease of implementation, international software product version availability and support, and price. In the enterprise application software market, PeopleSoft faces significant competition from SAP AG and Oracle Corporation and to a lesser degree, Geac Computer Systems, Inc., Computer Associates International, Inc. and other companies such as System Software Associates who previously focused primarily on the AS/400 marketplace. In this market, the chief competitive factors include the breadth and completeness of the enterprise solution offered by each vendor, the extent of software product integration across the enterprise solution and the availability of localized software products and technical support in key markets outside the United States. Primarily due to their significant worldwide presence and longer operating and product development history, both SAP and Oracle have certain competitive advantages over PeopleSoft in each of these areas. In addition, both SAP and Oracle have substantially greater financial, technical and marketing resources, and a larger installed base than PeopleSoft. Furthermore, Oracle's RDBMS (relational database management system) is a supported platform underlying a significant share of PeopleSoft's installed applications. In the manufacturing software application market, in which PeopleSoft recently began competing, PeopleSoft faces competition from several of its existing competitors including those listed immediately above and others such as Baan Company N.V., QAD, Ross Systems and J.D. Edwards and a large number of niche competitors already in the manufacturing market. In the emerging enterprise resource optimization software solutions market, in which the Company now competes since its acquisition of Red Pepper Software during the fourth quarter of 1996, PeopleSoft faces several current and potential competitors including: (i) companies such as i2 Technologies, Manugistics and Numetrix Software which have developed or are attempting to develop advanced planning and scheduling software products which complement or compete with MRP (material requirements planning) solutions; (ii) other companies that provide specialized planning and scheduling software for niche markets, including Chesapeake Systems, Waterloo Manufacturing Software, MAPICS, Inc. (formerly Marcam Corporation), Marcam Solutions, Inc. and Cap Logistics; (iii) other business application software vendors that may broaden their product offerings by internally developing (such as SAP's recently announced initiatives in this area), or by acquiring (such as Baan's acquisitions of Berclain Group, Inc. and Antalys, Inc.) or partnering with independent developers of advanced planning and scheduling software; (iv) internal development efforts by corporate information technology departments; and (v) companies offering standardized or customized products on mainframe and/or mid-range computer systems. PeopleSoft also faces competition from providers of HRMS software products including Cyborg, Lawson, Integral Systems, Inc., InPower and Ceridian, and from providers of financial management systems software products including Hyperion, Computron Software, Inc., Lawson Associates and other smaller companies. In addition, ADP, Inc. and Shared Medical Systems, Inc. ("SMS") have the right to sublicense selected PeopleSoft software products in competition with PeopleSoft's marketing efforts in selected markets. Pursuant to the terms of the SMS agreement, PeopleSoft provided termination notice to SMS on March 19, 1998. As of March 27, 1998, SMS contested the notice of termination. In addition, as the Year 2000 approaches, enterprises may consider outsourcing options including data center outsourcing and service bureaus as viable alternatives to purchasing the Company's software products which may result in increased competition from outsource services including Computer Science Corporation, Electronic Data Systems Corporation, IBM, ADP, Ceridian, and other smaller companies. Intense competition could potentially lead to increased price competition in the market, forcing the Company to reduce prices which may result in reduced gross margins and loss of market share by the Company which therefore, could materially adversely affect the Company's business, operating results and financial condition. In recent quarters the Company has observed increasingly aggressive pricing practices on the part of its competitors. There can be no assurance that the Company will continue to compete successfully with its existing competitors or will be able to compete successfully with new competitors. CERTAIN RISKS ASSOCIATED WITH ACQUISITIONS As part of its overall strategy, the Company plans to continue to acquire or invest in complementary companies, products, or technologies and to enter into joint ventures and strategic alliances with other companies. Risks commonly encountered in such transactions include the difficulty of assimilating the operations and personnel of the combined companies, the potential disruption of the Company's ongoing business, the inability to retain key technical and managerial personnel, the inability of management to maximize the financial and strategic position of the Company through the successful integration of acquired businesses, decreases in reported earnings as a result of charges for in-process research and development and amortization of acquired intangible assets, adverse impact on the Company's annual effective tax rate, dilution of existing equity holders, difficulty in maintaining controls, procedures, and policies, and the impairment of relationships with employees and customers as a result of any integration of new personnel. There can be no assurance that the Company would be successful 17 18 in overcoming these risks or any other problems encountered in connection with such business combinations, investments, or joint ventures, or that such transactions will not materially adversely affect the Company's business, financial condition, or operating results. RELIANCE ON PROPRIETARY SOFTWARE DEVELOPMENT TOOLS The Company's software products include a suite of proprietary software development tools known as "PeopleTools," which are fundamental to the effective use of the Company's software products. While no industry standard exists for software development tools, several companies are focused specifically on providing software development tools and are attempting to establish their software development tools as accepted industry standards. In the event that a software product other than the Company's PeopleTools software product becomes the clearly established and widely accepted industry standard, the Company may need to abandon or modify PeopleTools in favor of such an established standard, may be forced to redesign its software products to operate with such third party's software development tools, or may be faced with the potential sales obstacle of marketing a proprietary software product against other vendors' software products incorporating a standardized software development toolset or components. Accordingly, in any of these cases, the Company's results of operations could be materially adversely affected. RELIANCE ON THIRD PARTIES FOR SALES AND MARKETING A key aspect of the sales and marketing strategy for the Company is to build and maintain strong working relationships with businesses the Company believes play an important role in the successful marketing of its software products. The Company's customers and potential customers often rely on third party system integrators to develop, deploy and manage client/server applications. These include: (i) RDBMS software vendors; (ii) hardware vendors which offer both hardware platforms and, in the case of IBM, proprietary RDBMS products on which the Company's software products run; (iii) technology consulting firms and systems integrators, some of which are active in the selection and implementation of large information systems for the information-intensive organizations that comprise the Company's principal customer base; and (iv) benefits consulting firms that are active in the implementation of HRMS. The Company believes that its marketing and sales efforts are enhanced by the worldwide presence of these companies. However, there can be no assurance that these companies, most of which have significantly greater financial and marketing resources than PeopleSoft, will not start, or in some cases increase, the marketing of business application software in competition with PeopleSoft, or will not otherwise discontinue their relationships with or support of PeopleSoft. If the Company or its partners are unable to recruit and adequately train a sufficient number of consulting personnel to support the implementation of the Company's software products, demand for these software products could subsequently be materially adversely affected. In addition, PeopleSoft's software application architecture, including PeopleTools, may facilitate reduced implementation efforts for customers compared to the competitive alternatives. Consequently, PeopleSoft's software products may be a less desirable recommendation alternative for integrators who both provide selection advice and generate consulting fees from customers by providing implementation services. If PeopleSoft's relationship with its partners were to deteriorate, the Company's business and operating results could be materially adversely impacted. COMPLEXITY OF SOFTWARE PRODUCTS AND PRODUCT DEVELOPMENT The market for the Company's software products is characterized by rapid technological change, evolving industry standards, changes in customer requirements and frequent new product introductions and enhancements. The Company's future success will depend in part upon its ability to continue to enhance and expand its core applications, to continue to provide enterprise solutions, to enter new markets and to develop and introduce new products that keep pace with technological developments, satisfy increasingly sophisticated customer requirements and achieve market acceptance. If the Company is unable to enhance existing products or develop and introduce new products in a timely manner, the Company's business and results of operations could be materially adversely affected. PeopleSoft's software products can be licensed for use with a variety of popular industry standard RDBMSs. There may be future or existing RDBMS platforms which achieve popularity within the business application marketplace and on which PeopleSoft may desire to offer its applications. Such future or existing RDBMS products may or may not be architecturally compatible with PeopleSoft's software product design. No assurance can be given concerning the successful development of PeopleSoft software products on additional platforms, the specific timing of the releases of any future software products, the performance characteristics of PeopleSoft applications on additional platforms or their acceptance in the marketplace. Beginning with Release 6, the Company integrated certain features of BEA's Tuxedo product into its applications. Over the next several releases, additional Tuxedo features will be integrated to allow applications to run on a distributed basis using a multi-tiered client/server architecture(1) . Cognos' Powerplay product and Arbor's Essbase product will be bundled to incorporate desktop on-line analytical processing - -------------- (1) Forward-Looking Statement 18 19 ("OLAP") capabilities(1). Such enhancements may be critical to the competitiveness of the Company's software products in the future. Integration of these and other products is complex and no assurance can be made that these efforts will be successful or result in significant software product enhancements (see Statement of Future Direction). Software programs as complex as those offered by the Company are likely to contain a number of undetected errors or "bugs" when they are first introduced or as new releases are thereafter released. Despite testing by the Company and by third parties, errors or system performance issues may arise with the possible result of reduced acceptance of the Company's software products in the marketplace. Due to the increasing number of possible combinations of vendor hardware platforms, operating systems and updated versions, PeopleSoft application software products and updated versions, and RDBMS platforms and updated versions, the effort and expense of developing, testing and maintaining these software product lines in an increasing number of combinations will increase, and the ability to develop consistent software product performance characteristics across all of these combinations could place a significant strain on the Company's development resources and software product release schedules. RELIANCE ON CLIENT PLATFORMS At the present time, the Company supports client platforms utilizing browsers certified to run our Java based Web client, or Microsoft's Windows family of software products, including Windows 3.1 (PeopleSoft releases prior to Release 6 only), Windows NT and Windows 95. If Microsoft were to fundamentally change the architecture of its software product such that users of PeopleSoft's software applications experienced significant performance degradation or were rendered incompatible with future versions of Microsoft's Windows Operating System, the Company's results of operations could be materially adversely affected. The use of a Web browser (running on either a PC or network computer) to access client/server systems is emerging as an alternative client to the traditional desktop access through Microsoft Windows based personal computers. Such client access via the Internet will be subject to numerous risks inherent in utilizing the Internet including security, availability and reliability. There may be future or existing client platforms which achieve popularity within the business application marketplace and on which PeopleSoft may desire to offer its applications. Such future or existing client platforms may or may not be architecturally compatible with PeopleSoft's software product design. No assurance can be given concerning the Company's successful support for new client platforms, the specific timing of their availability or their acceptance in the marketplace. RELIANCE ON JOINT BUSINESS ARRANGEMENTS The Company has, and may in the future, enter into various development or joint business arrangements for the purpose of developing new software products or extensions to existing software products. Under these development arrangements, the Company is generally the exclusive remarketer of the developed software products and pays a royalty to the funding entities based on license fees received from end user licenses of these software products. Under joint business arrangements, the Company may distribute or jointly sell with its business partner an integrated software product offering. While the intent of such arrangements is to develop business applications which are integrated with the Company's software products, there can be no assurance that such software products will in fact be integrated or that an integrated enterprise solution will be accepted by the market. In addition, should such arrangements require additional investments from third parties or business partners to complete development or enhance the software product, there can be no assurance that investments will be available on terms mutually acceptable to the Company and the business partner, or the existing or other potential third party funding source(s). Should PeopleSoft acquire title to the software products or technology from the third party entity, such an acquisition might be accounted for using the purchase method which is likely to result in either or both of the following accounting treatments: (i) a charge to earnings for in-process research and development which would be recorded in the Statement of Income in the period such acquisition was completed; or (ii) the creation of significant intangible assets by virtue of an allocation of a substantial portion of the purchase price to the acquired technology or other intangible assets. Such intangible assets would be amortized in future periods as a cost of operations. Should either of these scenarios occur, the results of operations of one or more future periods could be materially adversely impacted. For example, in connection with its acquisition of PeopleSoft Manufacturing, Inc. in 1996, the Company incurred a one time charge to earnings of $22.5 million for in-process research and development. APPLICATION SECURITY ARCHITECTURE The Company's application software products incorporate extensive security features designed to protect certain sensitive data managed by these applications from unauthorized retrieval or modification. The Company has developed a security architecture utilizing the capabilities of its own applications, the client operating system software, some of the security features contained in the RDBMS platforms on which the applications run, as well as certain third party security products. To date, the Company is not aware of any violations of its application security architecture within its installed base. Although these security features are subject to constant review and enhancement, - ---------- (1) Forward-Looking Statement 19 20 no assurances can be given concerning the successful implementation of these security features and their effectiveness within a particular customer's operating environment. Should a breach of security or a suspected breach of security occur, the accompanying publicity or any subsequent claims against the Company could have an adverse impact on the demand for the Company's software products and/or cause a decline in the market price of the Company's stock and/or adversely impact the Company's financial results due to lost or delayed closing of software licensing opportunities. INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS The Company regards certain aspects of its internal operations, software and documentation as proprietary, and relies on a combination of contract, patent, copyright, trademark and trade secret laws and other measures to protect its proprietary information. The Company received its first patent in June 1995 and its second patent in August 1995. In July 1995, the Company received title to a third patent as part of a teaming and development agreement. The Company also has four additional patent applications pending. There can be no assurance that any issued patents will result from such applications or that, if issued, such patents will provide any meaningful competitive advantage. Existing copyright laws afford only limited protection. The Company believes that, because of the rapid pace of technological change in the computer software industry, patent, trade secret and copyright protection are less significant than factors such as the knowledge, ability and experience of the Company's employees, frequent software product enhancements and the timeliness and quality of support services. There can be no assurance that these protections will be adequate or that PeopleSoft's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. Many customers of PeopleSoft are beneficiaries of a source code escrow arrangement to enable the customer to acquire a future limited right to use the Company's source code solely for their internal provision of maintenance services. This possible access to the Company's source code may increase the likelihood of misappropriation or other misuse of the Company's intellectual property. In addition, the laws of certain countries in which the Company's software products are or may be licensed do not protect the Company's software products and intellectual property rights to the same extent as the laws of the United States. The Company does not believe that its software products, third party software products the Company offers under sublicense agreements, Company trademarks or other Company proprietary rights infringe the property rights of any third parties. However, there can be no assurance that third parties will not assert infringement claims against the Company in the future with respect to current or future software products or that any such assertion may not require the Company to enter into royalty arrangements or result in costly litigation. PRODUCT LIABILITY The Company's license agreements with its customers contain provisions designed to limit the exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in such license agreements may not be valid as a result of federal, state, local laws or ordinances or unfavorable judicial decisions. Although the Company has not experienced any product liability claims to date, the license and support of its software for use in mission critical applications creates the risk of a claim being pursued against the Company. Damage or injunctive relief resulting under such a successful claim could cause a materially adverse impact on the Company's business, operating results and financial condition. In addition, as PeopleSoft begins to compete in the manufacturing software application market, the mission critical nature of such software products may increase PeopleSoft's exposure to product liability claims against the Company. GROWTH IN OPERATIONS The Company has experienced an extended period of significant revenue growth, growth in the Company's customer base, expansion of its software product lines and supported platforms both through internal development and merger and acquisition, a significant expansion in the number of its employees, and expansion in the geographic scope of its operations. This growth has resulted in new and increased responsibilities for management personnel, and has placed and is expected to continue to place a significant strain upon the Company's management, operating, and financial controls and resources. To accommodate recent growth, compete effectively, and manage potential future growth, the Company must continue to implement and improve its operational and financial systems, procedures and controls. In addition, the Company must continue to expand, train and manage its employee base. There can be no assurance that the Company will be able to manage this expansion effectively, or that the Company's personnel, procedures, systems and controls will be adequate to support the Company's future operations. KEY PERSONNEL PeopleSoft believes that its continued success will depend in large part upon its ability to attract, train and retain highly-skilled technical, managerial and marketing personnel. The Company continues to hire a significant number of additional sales, services and technical 20 21 personnel. Competition for the hiring of such personnel in the software industry is intense, and the Company from time to time experiences difficulty in locating candidates with appropriate qualifications within various desired geographic locations, or with certain industry specific domain expertise. Growth in contracting activity could be impacted by the Company's ability to attract, train, retain and manage productive sales and sales support personnel. The loss of services of one or more of the Company's key employees could have a materially adverse effect on the Company's business, operating results and financial condition. The Company has historically experienced a very low attrition rate amongst all of its employees, especially those in critical positions. The Company has several retention programs in place to retain such key personnel including granting of stock with annual vesting periods over five years. A number of key employees have vested stock options which have a relatively low price when compared to the Company's current stock price. These potential gains provide these employees the economic freedom to explore personal objectives both within and outside the Company which may result in the loss of one or more key employees during the coming years. It is widely held that the technology industry is at or beyond a condition of full employment. There can be no assurance that the Company will be successful in attracting, training and retaining the personnel it requires to develop, market, sell and support new or existing software or to continue to grow. In addition, the Company's success in penetrating key vertical markets is dependent upon its ability to attract, train and retain personnel with industry specific domain expertise. YEAR 2000 COMPLIANCE The Company's internal business information systems are primarily comprised of the same commercial application software products generally offered for license by the Company to end user customers. These applications have been tested for Year 2000 compliance and are certified by the Information Technology Association of America (ITAA) as Year 2000 compliant, therefore the Company does not expect any Year 2000 compliance issues to arise related to its primary internal business information systems. PeopleSoft is not aware of any material operational issues or costs associated with preparing internal systems for the Year 2000. However, the Company utilizes other third party vendor network equipment, telecommunication products, and other third party software products which may or may not be Year 2000 compliant. Although the Company is currently taking steps to address the impact, if any, of the Year 2000 issue surrounding such third party products, failure of any critical technology components to operate properly in the Year 2000 may have an adverse impact on business operations or require the Company to incur unanticipated expenses to remedy any problems. EXPANSION OF FACILITIES The Company has experienced an extended period of growth which has resulted in a significant expansion in the number of its employees. Commercial building vacancy rates have significantly dropped in many of the markets where the Company has significant operations. As a consequence, the Company expects to experience increasing difficulty in obtaining additional space within which to expand its operations. Failure to either obtain space, or obtain it on reasonably attractive commercial terms, may inhibit the Company's ability to grow, or otherwise adversely affect the Company's operations and financial results. Additionally, the Company may commit to real estate projects in order to expand its operations to accommodate expected growth. Such real estate projects typically have a lead time of over one year from commit date to occupancy. There can be no assurance that the anticipated growth projections will be realized, and therefore, the Company may be subject to increased fixed costs which cannot be recovered from operations, resulting in material reductions to net income and cash flows. VOLATILITY OF STOCK PRICE As is frequently the case with stock of high technology companies, the market price of PeopleSoft's stock has been and may continue to be quite volatile. Factors such as quarterly fluctuations in results of operations, announcements of technological innovations by the Company or its competitors or the introduction of new software products by PeopleSoft or its competitors, and macroeconomic conditions in the computer hardware and software industries generally, may have a significant impact on the market price of the stock of PeopleSoft. If revenue or earnings in any quarter fail to meet the expectations (published or otherwise) of the investment community, there could be an immediate impact on PeopleSoft's stock price. In addition, as described in the Possible Adverse Effects of Recent Securities Issuances section below, the Company has issued shares, stock options and warrants which, if sold directly or exercised and sold on the open market in large concentrations, could cause the Company's stock price to decline in the short term. The Company makes no assurance as to when and if such a short term stock price decline may recover. Furthermore, the stock market has from time to time experienced extreme price and volume fluctuations which have particularly affected the market price for many high technology companies and which, on occasion, have 21 22 been unrelated to the operating performance of those companies. These broad market fluctuations may materially adversely affect the market price of the stock of PeopleSoft. POSSIBLE ADVERSE EFFECTS OF RECENT SECURITIES ISSUANCES The Company has outstanding warrants to purchase 6,400,000 shares of its common stock which have exercise prices below the current market price of the common stock. The exercise of these warrants and resale of the underlying shares could adversely affect the market price of the Company's common stock. At December 31, 1997 the Company had 13,121,129 outstanding exercisable options to purchase common stock issued pursuant to employee stock plans which have exercise prices below the current market price of the common stock. The exercise of such stock options and sale of a significant number of the underlying shares could adversely affect the market price of the Company's common stock. INVESTMENTS AND LIQUIDITY The Company's short term and long term investments consist primarily of high quality municipal bonds, U.S. government securities, corporate debt securities and tax-advantaged money market funds. Despite favorable credit ratings on these investments there can be no assurance the issuing agencies will not default on their obligations which may result in losses of principal and accrued interest by PeopleSoft. While operating activities may provide cash in certain periods, to the extent the Company experiences growth in the future, operating and investing activities may use cash, and, consequently, such growth may require the Company to obtain additional sources of financing. In addition, material acquisitions of complementary businesses, products or technologies and capital expenditures may require additional sources of financing. There can be no assurance that the Company would be able to obtain additional sources of financing or additional financing at terms favorable to the Company. 22 23 PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is a party to various legal disputes and proceedings arising from the ordinary course of general business activities. In the opinion of management, resolution of these matters is not expected to have a material adverse effect on the financial position, results of operations and cash flows of the Company. However, depending on the amount and timing, an unfavorable resolution of some or all of these matters could materially affect the Company's future results of operations or cash flows in a particular period. Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8 - K (a) Exhibits 27.1 Financial Data Schedule - Three months ended March 31, 1998 (b) Reports on Form 8 - K No reports on Form 8 - K were filed during the quarter ended March 31, 1998. 23 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: May 13, 1998 PEOPLESOFT, INC. By: /s/ ALFRED J. CASTINO --------------------------------------------- Alfred J. Castino Vice President of Finance and Corporate Controller (Principal Accounting Officer) 24 25 PEOPLESOFT, INC. INDEX OF EXHIBITS EXHIBIT # EXHIBIT TITLE - --------- ------------- 27.1 Financial Data Schedule - March 31, 1998 25 EX-27.1 2 FINANCIAL DATA SCHEDULE - MARCH 31, 1998
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS AND RELATED NOTES CONTAINED IN THIS FILING AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL INFORMATION. 1,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 300,635 120,571 356,994 21,264 0 801,807 208,542 90,194 990,780 519,454 0 0 0 2,267 469,059 990,780 0 277,674 0 226,679 0 1,771 69 54,481 20,727 33,754 0 0 0 33,754 .15 .13
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