The accompanying notes are an integral part of these unaudited consolidated
financial statements.
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
On January 8, 1999, the plaintiffs
filed a Consolidated Amended Complaint applicable to all previously filed
actions. The Consolidated Amended Complaint alleged a class period of
October 22, 1997 through October 26, 1998 and principally claimed that the
Company and three of its former officers violated federal securities law by
purportedly making false and misleading statements (or omitting material
information) concerning the MDI acquisition and the Company's revenue during
the proposed class period, thereby allegedly causing the value of the
Company's common stock to be artificially inflated. Previously stated claims
against the Company and its underwriters alleging violations of the federal
securities laws as a result of purportedly inadequate or incorrect
disclosure in connection with the Company's initial public offering were not
included in the Consolidated Amended Complaint. The Company and the
individual defendants filed motions to dismiss the Consolidated Amended
Complaint on March 5, 1999. Oral arguments on the motions were held on April
21, 1999 and the Court granted the Company's and the individual defendants'
motions to dismiss the Consolidated Amended Complaint pursuant to an order
dated June 1, 1999. The plaintiffs appealed the Court's order of dismissal.
The Company contested the appeal and supported the Court's order of
dismissal. In December, 1999, the parties agreed to settle the lawsuit. The
Company received final approval on February 28, 2000 from the Court of the
settlement of the action. The $2.8 million settlement became effective and
the appeal period expired on March 29, 2000. The settlement was funded
entirely by the Company's directors and officers liability insurer and the
Company and the individual defendants received a full release and dismissal
of all claims brought by the class during the class period.
8
Item 2. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations
Overview and Current Financial Condition
Peritus
Software Services, Inc. ("Peritus" or the "Company") was
incorporated in Massachusetts in August 1991. The Company provides solutions
consisting of software products and services that enable organizations to
improve the productivity, quality and effectiveness of their information
technology, systems maintenance, or "software evolution"
functions. The Company derives its revenue from software maintenance
outsourcing services, software and methodology licensing and other services.
In the
second half of 1998 and in 1999, the overall market for the year 2000 tools
and services of Peritus contracted dramatically, resulting in substantial
financial losses. In response, the Company substantially reduced its
workforce in September and December of 1998 and again in April of 1999.
During the second and third quarters of 1999, the Company also settled its
leases for its facilities in Cincinnati, Ohio, Lisle, Illinois and
Billerica, Massachusetts and took other efforts to reduce its fixed costs.
As a result of the Company's degraded financial condition, the Company began
encountering major obstacles in obtaining new outsourcing business. Since
most outsourcing engagements are multi-year and involve critical
applications, prospective new clients, although interested in the
capabilities and technology of the Company, were reluctant or unwilling to
commit to contracts. Despite the significant reduction in the overall cost
structure as a result of the foregoing actions, the Company was unable to
achieve a cash flow break-even position in the year ended December 31,
1999.
On March
27, 2000, Rocket Software, Inc. ("Rocket"), a privately held
company, invested $4,000,000 in the Company in exchange for 10,000,000
shares ($.40 per share) of restricted common stock (37% of outstanding stock
after the investment). The Company granted Rocket certain registration
rights with respect to the shares. Based on the Company's current forecasted
cash expenditures, its cash on hand prior to the Rocket investment and the
$4,000,000 invested by Rocket, the Company expects to have sufficient cash
to finance its operations through the year 2000. The Company's future beyond
the year 2000 is dependent upon its ability to achieve a break-even cash
flow or raise additional financing. There can be no assurances that the
Company will be able to do so.
The
Company's current strategy is to continue to service its existing
outsourcing customers and to renew expiring contracts. At the same time, the
Company is pursuing new business through the licensing of, and associated
consulting and training for, its outsourcing methodology (technology
transfer services) and SAM Relay and SAM Workbench tools. The Company
anticipates using the proceeds from the Rocket investment to fund additional
investments in sales and marketing, research and development (particularly
the enhancement of the Company's SAM Workbench tool) and other general
corporate purposes. The Company also plans to develop other service
offerings.
Three Months Ended March 31, 2000 Compared To Three
Months Ended March 31, 1999
Revenue
Total
revenue decreased 66.5% to $1,565,000 in the three months ended March 31,
2000 from $4,667,000 in the three months ended March 31, 1999. This decrease
in revenue was primarily due to a decrease in other services and outsourcing
revenues and, to a lesser extent, in the licensing of the Company's software
products and tools.
The Company anticipates that total revenue
for the year 2000 will be substantially below the level achieved in 1999.
Outsourcing Services. Outsourcing services revenue decreased 56.3%
to $809,000 in the three months ended March 31, 2000 from $1,853,000 in the
three months ended March 31, 1999. As a percentage of total revenue,
outsourcing services revenue increased to 51.7% in the three months ended
March 31, 2000 from 39.7% for the three months ended March 31, 1999. The
increase in outsourcing services revenue as a percentage of total revenue
reflects the decreased contribution of other services revenue to total
revenue during the three months ended March 31, 2000 when compared to the
same period in the prior year. The decrease in outsourcing services revenue
in absolute dollars in the three months ended March 31, 2000, compared to
March 31, 1999, was attributable to recording lower amounts of revenue under
existing outsourcing engagements due to reduced workload or contract
terminations. During the first quarter of 2000, a contract with one client
reached the end of its term and was not renewed. During the first quarter of
2000, outsourcing services revenue
attributable to the client was $216,000. The Company did not sign any new
outsourcing contracts during the first quarter of 2000.
License. License revenue decreased 52.6% to $644,000 in the three
months ended March 31, 2000, or 41.2% of total revenue, compared to
$1,359,000, or 29.1% of total revenue, in the three months ended March 31,
1999. The decrease in license revenue for 2000 in absolute dollars was
primarily attributable to a decrease in year 2000 related licensed revenue
from end users and value added integrators. The Company will continue to
pursue licenses of its outsourcing technology and SAM Relay and SAM
Workbench tools and future revenue is dependent on the success of such
efforts. The $644,000 of license revenue in the quarter ended March 31, 2000
was attributable to paid-up license revenue from two customers.
Other
Services. Other services revenue decreased 92.3% to $112,000 in
the three months ended March 31, 2000 from $1,455,000 in the three months
ended March 31, 1999. As a percentage of total revenue, other services
revenue decreased to 7.2% in the three months ended March 31, 2000 from
31.2% in the three months ended March 31, 1999. The decrease in other
services revenue in absolute dollars was primarily attributable to a
decrease in direct delivery, consulting and client support services relating
to the Company's year 2000 products and services. Future revenue from other
services is dependent on the Company's success in licensing its methodology,
and its SAM Workbench and SAM Relay tools, which would generate maintenance,
consulting and training revenue. Future revenue from other services is also
dependent on the development of other successful offerings.
Cost of Revenue
Cost
of Outsourcing Services Revenue. Cost of outsourcing services revenue
consists primarily of salaries, benefits and overhead costs associated with
delivering outsourcing services to clients. The cost of outsourcing services
revenue decreased 73.5% to $510,000 in the three months ended March 31, 2000
from $1,923,000 for the three months ended March 31, 1999. Cost of
outsourcing services revenue as a percentage of outsourcing services revenue
decreased to 63.0% in the three months ended March 31, 2000 from 103.8% in
the three months ended March 31, 1999. Costs in 1999 were negatively
impacted by expenditures in anticipation of and to generate new business
that did not materialize. In addition, the Company incurred costs in
connection with an agreement with Micah Technology Services, Inc.
("Micah") for which it received no payments. The Company has filed
a lawsuit against Micah to attempt to recover amounts due under such
agreement. See "Part II-Item 1. Legal Proceedings."
Cost
of License Revenue. Cost of license revenue consists primarily of
amortization of expense of intangibles related to the acquisition of
Millennium Dynamics, Inc. ("MDI") and salaries, benefits and
related overhead costs associated with license-related materials packaging
and freight. Cost of license revenue was $0 in the three months ended March
31, 2000. Cost of license revenue was $96,000, or 7.1% of license revenue,
in the three months ended March 31, 1999. The decrease in cost of license
revenue was primarily related to the termination (in the fourth quarter of
1999) of amoritization expense of intangibles related to the MDI
acquisition.
Cost
of Other Services Revenue. Cost of other services revenue consists
primarily of salaries, benefits and related overhead costs associated with
delivering other services to clients. Cost of other services revenue
decreased 93.2% to $70,000 in the three months ended March 31, 2000 from
$1,028,000 in the three months ended March 31, 1999. Cost of other services
revenue as a percentage of other services revenue decreased to 62.5% in the
three months ended March 31, 2000 from 70.7% in the three months ended March
31, 1999. Costs decreased in absolute dollars in the three months ended
March 31, 2000 due to reduced staffing for the Company's client support,
training and consulting organizations related to fewer customers for the
Company's year 2000 products and services, including year 2000 renovations
and renovation quality evaluation ("RQE") services.
Operating Expenses
Sales
and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related overhead costs for sales and marketing
personnel; sales referral fees to third parties; advertising programs; and
other promotional activities. Sales and marketing expenses decreased 94.6%
to $57,000 in the three months ended March 31, 2000 from $1,050,000 in the
three months ended March 31, 1999. As a percentage of total revenue, sales
and marketing expenses decreased to 3.6% in the three months ended March 31,
2000 from 22.5% in the three months ended March 31, 1999.
The decrease in expenses in absolute dollars and as a percentage of revenue
was primarily attributable to dramatically reduced staffing, commissions and
promotional activities. The Company plans to increase its sales resources
and marketing efforts in the future.
Research and Development. Research and development expenses
consist primarily of salaries, benefits and related overhead costs for
engineering and technical personnel and outside engineering consulting
services associated with developing new products and enhancing existing
products. Research and development expenses decreased 30.9% to $325,000 in
the three months ended March 31, 2000 from $470,000 in the three months
ended March 31, 1999. As a percentage of total revenue, research and
development expenses increased to 20.8% in the three months ended March 31,
2000 from 10.1% in the three months ended March 31, 1999. The decrease in
research and development expenses in absolute dollars was primarily
attributable to reduced staffing. The Company plans to continue maintenance
of and enhancements to its existing products (particularly the enhancement
of the Company's SAM Workbench tool) and may selectively develop new
products or services.
General and Administrative. General and administrative expenses
consist primarily of salaries and related costs for the finance and
accounting, human resources, legal services, information systems and other
administrative departments of the Company, as well as contracted legal and
accounting services. General and administrative expenses decreased 73.4% to
$472,000 in the three months ended March 31, 2000 from $1,776,000 in the
three months ended March 31, 1999. As a percentage of total revenue, general
and administrative expenses decreased to 30.2% in the three months ended
March 31, 2000 from 38.1% in the three months ended March 31, 1999. The
decrease in general and administrative expenses in absolute dollars was
primarily due to the reductions in staffing, the cost of excess space, and
legal and accounting fees incurred in the three months ended March 31, 2000.
Restructuring
Charge
On March 29,
1999, the Company announced its intention to restructure and recorded a
charge of $291,000 consisting of severance payments associated with the
termination of 40 employees. The Company had no restructuring charges in the
three months ended March 31, 2000.
Gain on the Sale of Assets
The gain on the sale of assets in the quarter ended
March 31, 2000 represented the excess of the sales proceeds over the net
book value of the fixed assets of the Company's India subsidiary that were
sold during the quarter.
Cost of Strategic Investment
On March 27,
2000, Rocket, a privately held company, invested $4,000,000 in the Company
in exchange for 10,000,000 shares ($.40 per share) of restricted common
stock (37% of outstanding stock after the investment). The Company recorded
a non-cash charge of $4,000,000 for the cost of this strategic investment
equal to the difference between the purchase price per share of $0.40 and
the market price per share of $0.80 on March 27, 2000.
Interest Income
(Expense), Net
Interest
income and expense consists primarily of interest income from cash balances,
partially offset by interest expense on debt. The Company had interest
income, net, of $35,000 in the three months ended March 31, 2000 compared to
interest income, net, of $8,000 in the three months ended March 31, 1999.
This change in interest income (expense), net, was primarily attributable to
increased interest income from higher interest bearing balances and higher
bank rates as well as lower interest expense.
Provision for Income
Taxes
The
Company's income tax provision was zero in each of the three months ended
March 31, 2000 and 1999. The Company did not record a tax provision or
benefit in either period due to losses incurred.
Liquidity and Capital Resources
The Company has financed
its operations and capital expenditures primarily with the proceeds from
sales of the Company's convertible preferred stock and common stock,
borrowings, and advance payments for services from clients. The Company's
cash balances were $6,866,000 and $2,475,000 at March 31, 2000 and December
31, 1999, respectively. The Company's working capital was $6,053,000 and
$1,640,000 at March 31, 2000 and December 31, 1999, respectively.
11
The Company's operating
activities provided cash of $310,000 and used cash of $63,000 during the
three months ended March 31, 2000 and 1999, respectively. The cash provided
during the three months ended March 31, 2000 was primarily caused by a net
loss of $3,810,000 (less the non-cash cost of the strategic investment of
$4,000,000 by Rocket, depreciation and amortization expense of $153,000, and
the gain from the sale of assets of $24,000). Other sources were a decrease
in accounts receivable of $226,000, a decrease in costs and estimated
earnings in excess of billings on uncompleted contracts of $91,000, a
decrease in prepaid expenses and other current assets of $72,000, an
increase in accounts payable of $36,000, and a decrease in other assets of
$13,000. These amounts were partially offset by a decrease in other accrued
liabilities of $323,000, a decrease in deferred revenue of $68,000, and a
decrease in billings in excess of costs and estimated earnings on
uncompleted contracts of $56,000.
The Company's investing
activities provided cash of $57,000 and used cash of $577,000 during the
three months ended March 31, 2000 and 1999, respectively. Proceeds from the
sale of property and equipment in the three months ended March 31, 2000
consisted of the proceeds from the sale of the remaining assets of the
Company's India subsidiary.
The Company's financing
activities provided cash of $4,024,000 and $270,000 during the three months
ended March 31, 2000 and 1999, respectively. Financing activities in the
three months ended March 31, 2000 primarily reflect an increase from the
proceeds of issuance of new common stock of $4,000,000 and the exercise of
stock options of $28,000, partially offset by payments on capital lease
obligations of $4,000.
The Company has an
accounts receivable purchase agreement with a lender to permit borrowing
against certain acceptable receivables at a rate of 80% of the face amount
of such receivables up to a maximum of $4,000,000. In exchange for such
agreement, the Company granted the lender security interest on substantially
all of its assets. There were no borrowings outstanding under the agreement
at March 31, 2000.
On March 27, 2000,
Rocket, a privately held company, invested $4,000,000 in the Company in
exchange for 10,000,000 shares ($.40 per share) of restricted common stock
(37% of outstanding stock after the investment). The Company granted Rocket
certain registration rights with respect to the shares. Based on the
Company's current forecasted cash expenditures, its cash on hand prior to
the Rocket investment and the $4,000,000 invested by Rocket, the Company
expects to have sufficient cash to finance its operations through the year
2000. The Company's future beyond the year 2000 is dependent upon its
ability to achieve a breakeven cash flow or raise additional financing.
There can be no assurances that the Company will be able to do so.
To date, the Company has
not invested in derivative securities or any other financial instruments
that involve a high level of complexity or risk. Excess cash has been, and
the Company contemplates that it will continue to be, invested in
interest-bearing, investment grade securities.
Foreign Currency
Assets and liabilities of
the Company's majority-owned foreign subsidiary are translated into U.S.
dollars at exchange rates in effect at the balance sheet date. Income and
expense items are translated at average exchange rates for the period.
Accumulated net translation adjustments are included in stockholders'
equity.
Inflation
To date, inflation has
not had a material impact on the Company's results of operations.
Recently Issued Accounting Standards
In March 2000, the
Financial Accounting Standard Board ("FASB") issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation, -an interpretation of APB Opinion 25" ("FIN
44"). FIN 44 clarifies the application of APB No. 25 and, among other
issues, clarifies the following: the definition of an employee for purposes
of applying APB Opinion No. 25; the criteria for determining whether a plan
qualifies as a non-compensatory plan; the accounting consequence of various
modifications to the terms of previously fixed stock options or awards; and
the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 is effective July 1, 2000, but certain conclusions in
FIN 44 cover specific events that occurred after either December 15, 1998 or
January 12,
2000. At this time, the Company does not expect the application of FIN 44 to
have a material impact on its financial position or results of
operations.
Factors That May Affect Future Results
Failure to Achieve Cash
Flow Breakeven/Strategic Initiatives
The Company's ability to achieve a cash flow breakeven
position is critical for achieving financial stability. There can be no
assurance that the Company will achieve a cash flow breakeven position in
the future.
Financing
There can
be no assurance that the Company will be able to obtain additional funds in
the future through equity and/or debt financings or borrow against its
accounts receivable financing agreement.
Over the Counter Listing
Trading
of the common stock is conducted in the over-the-counter market which could
make it more difficult for an investor to dispose of, or obtain accurate
quotations as to the market value of, the common stock. In addition, there
are additional sales practice requirements on broker-dealers who sell such
securities to persons other than established customers and accredited
investors. For transactions covered by this rule, the broker-dealer must
make a special suitability determination for the purchaser and must have
received the purchaser's written consent to the transaction prior to sale.
In addition, if the trading price of the common stock is below $5.00 per
share, trading in the common stock would also be subject to the requirements
of certain rules promulgated under the Securities Exchange Act of 1934,
which require additional disclosure by broker-dealers in connection with any
trades involving a stock defined as a penny stock (generally any non-NASDAQ
equity security that has a market price of less than $5.00 per share,
subject to certain exceptions). Such rules require the delivery, prior to
any penny stock transaction, of a disclosure schedule explaining the penny
stock market and the risks associate therewith, and impose various sales
practice requirements on broker-dealers who sell penny stocks to persons
other than established customers and accredited investors (generally
institutions). For these types of transactions, the broker-dealer must make
a special suitability determination for the purchaser and have received the
purchaser's written consent to the transaction prior to sale. The additional
burdens imposed upon broker-dealers by such requirements may discourage
broker-dealers from effecting transactions in the common stock, which could
severely limit the market liquidity of the common stock and the ability of
purchasers in this offering to sell the common stock in the secondary
market.
Risk of Current Strategy
In the
past, the Company generated significant revenues from marketing and selling
products and services that addressed the year 2000 problem. The demand for
such products and services has ended and the Company no longer actively
markets and sells year 2000 products and services. The Company's current
strategy is to continue to service its existing outsourcing customers and to
renew expiring contracts. At the same time, the Company is pursuing new
business through the licensing of, and associated consulting and training
for, its outsourcing methodology (technology transfer services) and SAM
Relay and SAM Workbench tools. The Company plans to continue maintenance of
and enhancements to its existing products (particularly the enhancements of
the Company's SAM Workbench tool) and may selectively develop new products
or services. The Company is planning to increase its sales resources and
marketing efforts in the future. There can be no assurance that this current
strategy will generate revenues sufficient for the Company to achieve a cash
flow breakeven position.
Potential Fluctuations in
Quarterly Performance
The
Company's revenue and operating results have varied significantly in the
past and are likely to vary significantly from quarter to quarter in the
future. The Company's quarterly operating results may continue to fluctuate
due to a number of factors, including the timing, size and nature of the
Company's individual outsourcing, technology transfer,
insourcing and licensing transactions; unforeseen difficulties in performing
such transactions; the performance of the Company's value added integrators
and distributors; the timing of the introduction and the market acceptance
of new services, products or product enhancements by the Company or its
competitors; the relative proportions of revenue derived from license fees
and professional services; changes in the Company's operating expenses;
personnel changes; foreign currency exchange rates and fluctuations in
economic and financial market conditions.
The
timing, size and nature of individual outsourcing, technology transfer,
insourcing and licensing transactions are important factors in the Company's
quarterly operating results. Many such transactions involve large dollar
amounts, and the sales cycle for these transactions is often lengthy and
unpredictable. In addition, the sales cycle associated with these
transactions is subject to a number of uncertainties, including clients'
budgetary constraints, the timing of clients' budget cycles and clients'
internal approval processes. There can be no assurance that the Company will
be successful in closing such large transactions on a timely basis or at
all. Most of the Company's outsourcing engagements are performed on a
fixed-price basis and, therefore, the Company bears the risk of cost
overruns and inflation. A significant percentage of the Company's revenue
derived from these engagements is recognized on the percentage-of-completion
method, which requires revenue to be recorded over the term of a client
contract. A loss is recorded at the time when current estimates of project
costs exceed unrecognized revenue. The Company's operating results may be
adversely affected by inaccurate estimates of contract completion costs.
The
Company's expense levels are based, in part, on its expectations as to
future revenue and are fixed, to a large extent, in the short term. As a
result, the Company has been and may continue to be unable to adjust
spending in a timely manner to compensate for any further unexpected revenue
shortfall. Accordingly, any significant shortfall in revenue, in addition to
those already experienced in relation to the Company's expectations, would
have an immediate and material adverse effect on the Company's business,
financial condition and results of operations.
Due to
all of the foregoing factors, the Company believes that period-to-period
comparisons of its operating results are not necessarily meaningful and that
such comparisons cannot be relied upon as indicators of future performance.
There can be no assurance that future revenue and operating results will not
continue to vary substantially. It is also possible that in a quarter the
Company's operating results will be below the expectations of public market
analysts and investors. In either case, the price of the Company's Common
Stock has been and could continue to be materially adversely affected.
Need to Develop
Additional Products and Services
In the
past, the Company generated significant revenue from, and devoted
significant resources to, products and services that address the year 2000
problem. The demand for such products and services has ended and the Company
no longer actively markets and sells year 2000 products and services. The
Company's current strategy is to continue to service its existing
outsourcing customers and to renew expiring contracts. At the same time, the
Company is pursuing new business through the licensing of and associated
consulting and training for, its outsourcing methodology (technology
transfer services) and SAM Relay and SAM Workbench tools. The Company plans
to continue maintenance of and enhancements to its existing products
(particularly the enhancements of the Company's SAM Workbench Tool) and may
selectively develop new products or services. There can be no assurance that
the Company will be able to grow or maintain its outsourcing business or
sell its other products or services. The failure to diversify, develop and
sell additional products and services (and/or sell existing products or
services) would have a material adverse effect on the Company's business,
financial condition and results of operations.
Concentration of
Clients
The
Company's revenue is highly concentrated among a small number of clients.
During the year ended December 31, 1999, revenue from three clients
accounted for 40.5% of the year's revenue, with one client representing
21.7%. The contracts for two of these three clients (representing 18.8% of
the revenue for the year ended December 31, 1999) terminated in November
1999 and March 2000. During the quarter ended March 31, 2000, $644,000 of
license revenue was attributable to paid-up license revenue from two
customers. The loss of, or a significant reduction in revenue from, any of
the Company's major clients could have a material adverse impact on the
Company's business, financial condition and results of operations. In
addition, with such a large percentage of the Company's revenue attributable
to a small number of clients, the loss of one or more major clients could
have a material adverse impact on the Company's liquidity.
14
Competition
The
market for the Company's products and services is intensely competitive and
is characterized by rapid changes in technology and user needs and the
frequent introduction of new products. In addition, the Company faces
competition in the software maintenance outsourcing services market and the
software maintenance tools market. A number of the Company's competitors are
more established, benefit from greater name recognition and have
substantially greater financial, technical and marketing resources than
those of the Company. As a result, there can be no assurance that the
Company's products and services, will compete effectively with those of
their respective competitors.
Competitive Market for
Technical Personnel
The
Company depends, to a significant extent, on its ability to attract, train,
motivate and retain highly skilled software professionals, particularly
project managers, software engineers and other senior technical personnel.
The Company believes that there is a shortage of, and significant
competition for, software development professionals with the skills and
experience necessary to perform the services offered by the Company. The
Company's ability to develop new products and services, maintain and renew
existing engagements and obtain new business depends, in large part, on its
ability to hire and retain technical personnel with the IT and other skills
that keep pace with continuing changes in software evolution, industry
standards and technologies, client preferences and the Company's business
strategy. The inability to hire additional qualified personnel could impair
the Company's ability to satisfy its client base and to develop new products
and services, requiring an increase in the level of responsibility for both
existing and new personnel. There can be no assurance that the Company will
be successful in retaining current or future employees.
Fixed-Price, Fixed-Time
Contracts
Part of
the Company's business is to offer its outsourcing and technology transfer
services on fixed-price, fixed-time frame contracts, rather than contracts
in which payment to the Company is determined solely on a time-and-materials
basis. These contracts are terminable by either party generally upon prior
written notice. Although the Company uses its proprietary tools and
methodologies and its past project experience to reduce the risks associated
with estimating, planning and performing the fixed-price projects, the
Company's standard outsourcing and technology transfer agreements provide
for a fixed-fee based on projected reductions in a client's maintenance
costs and increases in a client's maintenance productivity. The Company's
failure to estimate accurately the resources, costs and time required for a
project or its failure to complete its contractual obligations within the
time frame committed could have a material adverse effect on the Company's
business, financial condition and results of operations.
Potential for Contract
Liability
The
Company's products and services relating to software maintenance, involve
key aspects of its clients' computer systems. A failure in a client's system
could result in a claim for substantial damages against the Company,
regardless of the Company's responsibility for such failure. The Company
attempts to limit contractually its liability for damages arising from
negligent acts, errors, mistakes or omissions in rendering its products and
services. Despite this precaution, there can be no assurance that the
limitations of liability set forth in its contracts would be enforceable or
would otherwise protect the Company from liability for damages.
Additionally, the Company maintains general liability insurance coverage,
including coverage for errors and omissions. However, there can be no
assurance that such coverage will continue to be available on acceptable
terms, or will be available in sufficient amounts to cover one or more large
claims, or that the insurer will not disclaim coverage as to any future
claim. The successful assertion of one or more large claims against the
Company that exceed available insurance coverage or changes in the Company's
insurance policies, including premium increases or the imposition of large
deductible or co-insurance requirements, could have a material adverse
effect on the Company's business, financial
condition and results of operations. Furthermore, litigation, regardless of
its outcome, could result in substantial cost to the Company and divert
management's attention from the Company's operations. Any contract liability
claim or litigation against the Company could, therefore, have a material
adverse effect on the Company's business, financial conditions and results
of operations.
Software Errors or Bugs
The
Company's software products and tools are highly complex and sophisticated
and could from time to time contain design defects or software errors that
could be difficult to detect and correct. Errors, bugs or viruses may result
in loss of or delay in market acceptance, a failure in a client's system or
loss or corruption of client data. Although the Company has not experienced
material adverse effects resulting from any software defects or errors,
there can be no assurance that, despite testing by the Company and its
clients, errors will not be found in new products, which errors could have a
material adverse effect upon the Company's business, financial condition and
results of operations.
Limited Protection of
Proprietary Rights
The
Company relies on a combination of patent, copyright, trademark and trade
secret laws and license agreements to establish and protect its rights in
its software products and proprietary technology. In addition, the Company
currently requires its employees and consultants to enter into nondisclosure
and assignment of invention agreements to limit use of, access to and
distribution of its proprietary information. There can be no assurance that
the Company's means of protecting its proprietary rights in the United
States or abroad will be adequate. The laws of some foreign countries may
not protect the Company's proprietary rights as fully or in the same manner
as do the laws of the United States. Also, despite the steps taken by the
Company to protect its proprietary rights, it may be possible for
unauthorized third parties to copy aspects of the Company's products,
reverse engineer, develop similar technology independently or obtain and use
information that the Company regards as proprietary. Furthermore, there can
be no assurance that others will not develop technologies similar or
superior to the Company's technology or design around the proprietary rights
owned by the Company.
The
Company has entered into license agreements with clients that allow these
clients access to and use of the Company's AutoEnhancer/2000, Vantage YR
2000 software, SAM Relay and RQE Tools source code for certain purposes.
Access to the Company's source code may increase the likelihood of
misappropriation or misuse by third parties.
There can
be no assurance that any patent will be issued pursuant to any pending
patent applications or that, if granted, such patents would survive a legal
challenge to their validity or provide meaningful or significant protection
to the Company. In addition, the Company may decide to abandon a patent
application if, among other things, it determines that continued prosecution
of an application would be too costly, the technologies, processes or
methodologies are not critical to the Company's business in the foreseeable
future or it is unlikely that a patent will issue with regard to a
particular application. Certain of the Company's technology incorporated in
some of its products may infringe on patents held by others. Any
infringement claim or litigation against the Company could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The
Company maintains trademarks and service marks to identify its various
service offerings, products and software. Although the Company has
registered certain trademarks and service marks with the United States
Patent and Trademark Office ("PTO") and has several trademark and
service mark applications pending in the United States and foreign
jurisdictions, not all of the applications have been granted and, even if
granted, there can be no assurance that a particular trademark or service
mark will survive a legal challenge to its validity or provide meaningful or
significant protection to the Company. In addition, the Company has
abandoned the applications of certain trademarks or service marks that it
believes are not critical to its business in the future. In some cases,
entities other than the Company are using certai
16
different manner than a third party. There may be some
risk of infringement claims against the Company in the event that a service
or product of the Company is too similar to that of another entity that is
using a similar mark.
Dependence on Third-Party
Technology
The
Company's proprietary software is currently designed, and may in the future
be designed, to work on or in conjunction with certain third-party hardware
and/or software products. If any of these current or future third-party
vendors were to discontinue making their products available to the Company
or to licensees of the Company's software or to increase materially the cost
to the Company or its licensees to acquire, license or purchase the
third-party vendors' products, or if a material problem were to arise in
connection with the ability of the Company to design its software to
properly use or operate with third-party hardware and/or software products,
the Company would be required to redesign its software to function with or
on alternative third-party products or attempt to develop internally a
replacement for the third-party products. In such an event, interruptions in
the availability or functioning of the Company's software and delays in the
introduction of new products and services may occur until equivalent
technology is obtained. There can be no assurance that an alternative source
of suitable technology would be available or that the Company would be able
to develop an alternative product in sufficient time or at a reasonable
cost. The failure of the Company to obtain or develop alternative
technologies or products on a timely basis and at a reasonable cost could
have a material adverse effect on the Company's business, financial
condition and results of operations.
Rapid Technological
Change
The
market for the Company's products and services is characterized by rapidly
changing technology, evolving industry standards and new product
introductions and enhancements that may render existing products obsolete.
As a result, the Company's market position could erode further due to
unforeseen changes in the features and functionality of competing products.
The process of developing products and services such as those offered by the
Company is extremely complex and is expected to become increasingly complex
and expensive in the future with the introduction of new platforms and
technologies. There can be no assurance that the Company will develop any
new products or services in a timely fashion or that the Company's current
or future products or services will satisfy the needs of its target
market.
Potential Adverse
Effects of Anti-Takeover Provisions; Possible Issuance of Preferred Stock
The
Company's Amended and Restated Articles of Organization and Amended and
Restated By-laws contain provisions that may make it more difficult for a
third party to acquire, or discourage acquisition bids for, the Company. For
instance, the Company's Amended and Restated By-laws provide that special
meetings of stockholders may be called only by the President, the Board of
Directors or the holders of at least 80% of the voting securities of the
Company. In addition, the Massachusetts General Laws provide that
stockholders may take action without a meeting only by the unanimous written
consent of all stockholders. The Company's Board of Directors is also
divided into three classes, as nearly equal in size as possible, with
staggered three-year terms. The Company is also subject to an anti-takeover
provision of the Massachusetts General Laws which prohibits, subject to
certain exceptions, a holder of 5% or more of the outstanding voting stock
of the Company from engaging in certain activities with the Company,
including a merger, stock or asset sale. The foregoing provisions could
limit the price that certain investors might be willing to pay in the future
for shares of the Company's Common Stock. In addition, shares of the
Company's Preferred Stock may be issued in the future without further
stockholder approval and upon such terms and conditions, and having such
rights, privileges and preferences, as the Board of Directors may determine.
The rights of the holders of Common Stock will be subject to, and may be
adversely affected by, the rights of any holders of Preferred Stock that may
be issued in the future. The issuance of Preferred Stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire, or discouraging a third party from acquiring, a
majority of the outstanding voting stock of the Company.
Year 2000 Matters
To date, the Company
has not experienced any material problems with its internal computer systems
relating to the inability of such systems to recognize appropriate dates
associated with the year 2000. The Company is also not aware of any material
year 2000 problems experienced by customers that have licensed the Company's
products or have received its services, or vendors that have provided
products or services to the Company. Accordingly, the Company does not
presently anticipate incurring material expenses or damages or experiencing
any material operational disruptions as a result of any year 2000 problems.
However, there can be no assurance that the Company may not experience
unanticipated expenses or damages or be adversely impacted by any year 2000
problems.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
17
As of
March 31, 2000, the Company was exposed to market risks which primarily
included changes in U.S. interest rates. The Company maintains a significant
portion of its cash and cash equivalents in financial instruments with
purchased maturities of three months or less. These financial instruments
are subject to interest rate risk and will decline in value if interest
rates increase. Due to the short duration of these financial instruments, an
immediate increase in interest rates would not have a material effect of the
Company's financial condition or results of operations.
18
PART II. OTHER INFORMATION
| Item 1. |
|
Legal Proceedings |
The Company and certain
of its officers and directors were named as defendants in purported class
action lawsuits filed in the United States District Court for the District
of Massachusetts by Robert Downey on April 1, 1998, by Scott Cohen on April
7, 1998, by Timothy Bonnett on April 9, 1998, by Peter Lindsay on April 17,
1998, by Harry Teague on April 21, 1998, by Jesse Wijntjes on April 29,
1998, by H. Vance Johnson and H. Vance Johnson as Trustee for the I.O.R.D.
Profit-Sharing Plan on May 6, 1998, by John B. Howard, M.D. on May 21, 1998
and by Helen Lee on May 28, 1998 (collectively, the "complaints").
The complaints principally alleged that the defendants violated federal
securities laws by making false and misleading statements and by failing to
disclose material information concerning the Company's December 1997
acquisition of substantially all of the assets and assumption of certain
liabilities of the Millennium Dynamics, Inc. business from American Premier
Underwriters, Inc., thereby allegedly causing the value of the Company's
common stock to be artificially inflated during the purported class periods.
In addition, the Howard complaint alleged violation of federal securities
laws as a result of the Company's purported failure to disclose material
information in connection with the Company's initial public offering on July
2, 1997, and also named Montgomery Securities, Inc., Wessels, Arnold &
Henderson, and H.C. Wainwright & Co., Inc. as defendants. The complaints
further alleged that certain officers and/or directors of the Company sold
stock in the open market during the class periods and sought unspecified
damages.
On or about June 1, 1998, all of the named plaintiffs
and additional purported class members filed a motion for the appointment of
several of those individuals as lead plaintiffs, for approval of lead and
liaison plaintiffs' counsel and for consolidation of the actions. The Court
granted the motion on June 18, 1998.
On January 8, 1999, the plaintiffs
filed a Consolidated Amended Complaint applicable to all previously filed
actions. The Consolidated Amended Complaint alleged a class period of
October 22, 1997 through October 26, 1998 and principally claimed that the
Company and three of its former officers violated federal securities law by
purportedly making false and misleading statements (or omitting material
information) concerning the MDI acquisition and the Company's revenue during
the proposed class period, thereby allegedly causing the value of the
Company's common stock to be artificially inflated. Previously stated claims
against the Company and its underwriters alleging violations of the federal
securities laws as a result of purportedly inadequate or incorrect
disclosure in connection with the Company's initial public offering were not
included in the Consolidated Amended Complaint. The Company and the
individual defendants filed motions to dismiss the Consolidated Amended
Complaint on March 5, 1999. Oral arguments on the motions were held on April
21, 1999 and the Court granted the Company's and the individual defendants'
motions to dismiss the Consolidated Amended Complaint pursuant to an order
dated June 1, 1999. The plaintiffs appealed the Court's order of dismissal.
The Company contested the appeal and supported the Court's order of
dismissal. In December, 1999, the parties agreed to settle the lawsuit. The
Company received final approval on February 28, 2000 from the Court of the
settlement of the action. The $2.8 million settlement became effective and
the appeal period expired on March 29, 2000. The settlement was funded
entirely by the Company's directors and officers liability insurer and the
Company and the individual defendants received a full release and dismissal
of all claims brought by the class during the class period.
On or about April 28,
1999, the Company filed a lawsuit in the United States District Court for
the District of Massachusetts against Micah Technology Services, Inc. and
Affiliated Computer Services, Inc. (collectively, "Micah"). The
lawsuit principally alleges that Micah breached its contract with the
Company by failing to pay for services performed by the Company under such
contract. The lawsuit further alleges that since Micah was unjustly enriched
by the services performed by the Company, the Company is entitled to
recovery based on quantum meruit, and that Micah engaged in unfair and/or
deceptive trade practices or acts in violation of Massachusetts General Laws
("M.G.L.") Chapter 93A by allowing the Company to perform services
when Micah did not pay for such services. The lawsuit seeks unspecified
damages on the breach of contract and quantum meruit claims and double or
triple damages on the Chapter 93A claim. Micah has denied the Company's
allegations and has filed a counterclaim against the Company principally
alleging fraud, negligent misrepresentations, breach of contract and that
the Company engaged in unfair and/or deceptive trade practices or acts in
violation of M.G.L. Chapter 93A by its misrepresentations and breach of
contract. The Company denied the allegations contained in Micah's
counterclaim and intends to contest the counterclaim vigorously. The parties
are in the initial discovery phase of the litigation. A non-binding
mediation hearing was held on March 17, 2000 and no settlement was
reached.
On April 13,
2000, without admitting or denying any findings, the Company consented to
the issuance of an administrative cease and desist Order with the Securities
and Exchange Commission concerning its previously announced revenue
restatements in the first and second quarters of 1998, the third quarter of
1997 and the year ended December 31, 1997. The Order requires the Company to
cease and desist from committing future violations of the public company
reporting, record keeping and internal control provisions of the Securities
Exchange Act of 1934.
In addition
to the matters noted above, the Company is from time to time subject to
legal proceedings and claims which arise in the normal course of its
business. In the opinion of management, the amount of ultimate liability
with respect to these other actions, currently known, will not have a
material adverse effect on the Company's financial position or results of
operations.
| Item 2. |
|
Changes in Securities and Use of Proceeds
|
On March 27, 2000, the Company
issued and sold 10,000,000 shares of Peritus common stock, $.01 par value
per share, to Rocket Software, Inc. for $4,000,000 in cash. These shares
were offered and sold in reliance upon Rule 506 under the Securities Act of
1933, as amended, relating to sales by an issuer not involving a public
offering. Rocket Software represented to the Company, among other things,
that it is an "accredited investor" as defined in Rule 501(a)
under the Securities Act. On April 4, 2000, the Company filed a Notice of
Sale of Securities Pursuant to Regulation D on Form D with the Securities
and Exchange Commission. No underwriters were involved in the sale of these
shares.
| Item 6. |
|
Exhibits And Reports On Form 8-K |
(a) Exhibits:
Documents listed below,
except for documents identified by footnotes, are being filed as exhibits
herewith. Documents identified by footnotes, if any, are not being filed
herewith and, pursuant to Rule 12b-32 of the General Rules and Regulations
promulgated by the Commission under the Securities Exchange Act of 1934 (the
''Exchange Act''), reference is made to such documents as previously filed
as exhibits with the Commission. The Company's file number under the
Exchange Act is 000-22647.
| Exhibit
10.1
|
|
1997 Director Stock Option Plan as Amended and
Restated |
| 10.2(1) |
|
Addendum to Employment Agreement between the Company
and John Giordano
dated January 21, 2000. |
| 10.3(1) |
|
Amended Employment Agreement between the Company and
John Giordano dated
January 21, 2000.
|
| 10.4(1) |
|
Asset Purchase Agreement dated as of January 31,
2000, as amended, by and among Peritus Software Services
(India) Private Limited, LTP (India) Pvt. Ltd. and Lisle Technology
Partners L.L.C. |
| 10.5(1) |
|
Common Stock Purchase Agreement dated as of March 27,
2000 by and between the Company and Rocket Software,
Inc. |
| 10.6(1) |
|
Registration Rights Agreement dated as of March 27,
2000 by and between
the Company and Rocket Software, Inc. |
| Exhibit 27
|
|
Financial Data Schedule |
| (1) |
|
Incorporated by reference to the Registrant's Annual
Report on Form 10-K dated
March 30, 2000 |
(b) Reports
on Form 8-K:
A Current
Report Form 8-K dated March 27, 2000 was filed by the Company on March 29,
2000. The Company reported under item 5 (Other Events) that Rocket Software,
Inc. ("Rocket"), a privately held software company, invested
$4,000,000 in Peritus. Under terms of the agreement, Rocket invested
$4,000,000 in cash in exchange for 10,000,000 restricted shares of Peritus
common stock ($0.40 per share). The shares represented approximately 37% of
the total shares outstanding after the investment and the Company granted
Rocket certain registration rights with respect to the shares.
19
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 15, 2000
| |
Peritus Software Services, Inc. |
| |
|
| |
By: /s/ John D. Giordano |
| |
|
| |
John D. Giordano
President, Chief Executive Officer and Chief
Financial Officer
(Principal Financial Officer) |
| |
|
| |
|
| |
Peritus Software Services, Inc. |
| |
|
| |
By: /s/ Patrick Manning |
| |
|
| |
Patrick Manning
Corporate Controller
(Principal Accounting Officer) |
| |
|
20
Peritus Software Services, Inc.
FORM 10-Q
For the Quarterly Period Ended March 31, 2000
Exhibit Index
| Exhibit No.
|
|
Description
|
| 10.1
|
|
1997 Director Stock Option Plan as Amended and
Restated |
| 10.2(1) |
|
Addendum to Employment Agreement between the Company
and John Giordano dated January 21, 2000. |
| 10.3(1) |
|
Amended Employment Agreement between the Company and
John Giordano dated
January 21, 2000.
|
| 10.4(1) |
|
Asset Purchase Agreement dated as of January 31,
2000, as amended, by and among Peritus Software Services
(India) Private Limited, LTP (India) Pvt. Ltd. and Lisle Technology
Partners L.L.C. |
| 10.5(1) |
|
Common Stock Purchase Agreement dated as of March 27,
2000 by and between the Company and Rocket Software,
Inc. |
| 10.6(1) |
|
Registration Rights Agreement dated as of March 27,
2000 by and between the Company and Rocket Software, Inc.
|
| 27
|
Financial Data Schedule |
| (1) |
|
Incorporated by reference to the Registrant's Annual
Report on Form 10-K dated March 30, 2000 |
