SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-K
----------
(Mark One)
|X| Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the fiscal year ended December 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 0-22667
TSI International Software Ltd.
(Exact Name of Registrant as Specified in its Charter)
Delaware 06-1132156
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
45 Danbury Road 06897
Wilton, Connecticut (Zip Code)
(203) 761-8600
Registrant's Telephone Number, Including Area Code
----------
Securities Registered Pursuant to Section 12(b) of the Act:NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.01 per share
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such Reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
State the aggregate market value of the voting and non-voting equity held
by non-affiliates of the Registrant as of February 23, 1999:
$558,800,109
As of that date, there were 11,232,163 shares of the Registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to shareholders
in connection with the Annual Meeting of Stockholders to be held in March, 1999
are incorporated by reference into Part III.
TSI INTERNATIONAL SOFTWARE, LTD.
Annual Report on Form 10-K
For the fiscal year ended December 31, 1998
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business ....................................................... 2
Item 2. Properties ..................................................... 10
Item 3. Legal Proceedings .............................................. 10
Item 4. Submission of Matters to a Vote of Security Holders ............ 10
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters ............................................ 11
Item 6. Selected Financial Data ........................................ 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ...................................... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ..... 23
Item 8. Financial Statements and Supplementary Data .................... 23
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ............................ 23
PART III
Item 10. Directors and Executive Officers of the Registrant ............. 24
Item 11. Executive Compensation ......................................... 26
Item 12. Security Ownership of Certain Beneficial Owners and Management . 26
Item 13. Certain Relationships and Related Transactions ................. 26
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K ............................................ 27
Signatures ................................................................ 30
TSI, the TSI Software logo, Mercator, Trading Partner, OnCall and KEY/MASTER are
registered trademarks, and Mercator for R/3, Trading Partner EC, Trading Partner
PC, Trading Partner PC/32 and OnCall*EDI are trademarks of the Company. This
Report also contains trademarks and trade names of other companies.
1
PART I
Forward-Looking Information
This report contains or may contain certain forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934 as
amended, and Section 27A of the Securities Act of 1933, as amended, that involve
risks and uncertainties. When used in this report, words such as "anticipate,"
"believe," "estimate," "expect," "future," "intend," "plan," and similar
expressions as they relate to the Company or the Company's management, identify
forward-looking statements. All forward-looking statements included in this
document are based on information currently available to the Company, and the
Company assumes no obligation to update any forward-looking statement.
The Company's actual results may differ significantly from the results
discussed in the forward-looking statements. Factors that might cause such a
difference include, but are not limited to, (i) the effects of rapid
technological change and the need to make frequent product transitions, (ii) the
potential for software defects, (iii) the impact of competitive products and
pricing, (iv) less-than-anticipated growth in the market for the SAP R/3 system
and related services, (v) TSI Software's ability to increase sales of its
Mercator product for other EQP Systems or in other industry segments, (vi)
uncertainties in attracting and retaining needed management, marketing, sales,
professional services and product development personnel, (vii) the Company's
ability to manage growth, (viii) customer acceptance of TSI Software's services,
(ix) the success of the Company's Mercator product line, and (x) the Company's
ability to develop additional distribution channels for its products.
These are discussed in the Company's other reports with the Securities and
Exchange Commission, including but not limited to those discussed under the
heading "Risk Factors" in the Company's Registration Statement on Form S-1 (File
No. 333-27293). Should one or more of these risks or uncertainties materialize,
or should the underlying estimates or assumptions prove incorrect, actual
results or outcomes may vary significantly from those anticipated, believed,
estimated, expected, intended or planned.
ITEM 1. BUSINESS
General
TSI International Software Ltd.(the "Company") is a leading provider of
software and related services that enable organizations to integrate their
business applications both internally and with external business partners. The
Company's flagship product, Mercator, is an enterprise application integration
(EAI) product that permits enterprises to integrate their major business
systems, including ERP applications from companies such as SAP and PeopleSoft,
legacy systems, best-of-breed applications, data warehouses, databases,
electronic commerce data, and Web-based applications. Unlike messaging
middleware software tools, which focus on the connectivity aspects of
application integration, Mercator enables business-level by addressing a wide
range of integration issues, including cross-application process flow control,
application adaptation, data transformation, and messaging and transport
services. To date, the Company has directly licensed its products to over 11,000
customers worldwide, representing a broad range of industries. The Company's
customers include American Express Travel Related Services, Inc., Citibank,
N.A., Eli Lilly and Company, General Motors, Hershey Foods, Hewlett-Packard
Company, Hoechst AG, International Business Machines Corporation, Lucent
Technologies, Inc., Mitsui & Co. Ltd., Nestle, Prudential Insurance Company of
America and Texas Instruments.
2
Products and Services
The Company's application integration products include two software product
lines, the Mercator family and the Trading Partner family. The following table
depicts the Company's current business application integration product offerings
and suggested list prices:
Original Most
Product Name Release Date Recent Release US Suggested List Price
------------ ------------ -------------- -----------------------
Mercator Products:
Mercator for the Desktop 12/93 12/98 from $9,700 (Standard Edition) to $25,000 (S.W.I.F.T. Edition)
Mercator for the Enterprise 12/93 12/98 from $52,000 to $212,790, variable by platform and server
configuration
Trading Partner Products:
Trading Partner PC 6/88 3/98 $1,495
Trading Partner PC/32 10/96 8/98 $1,995
Trading Partner Kits 10/92 various from $249 to $995, variable by complexity of kit
Trading Partner EC 11/90 9/97 from $82,000 to $120,000, variable by server class
The terms and conditions, including sales prices and discounts from list
prices, of individual license transactions may be negotiated based on volumes
and commitments and may vary considerably from customer to customer.
Mercator Products.
The Company's flagship Mercator family of products is an integrated
software solution used by IT professionals to create interfaces between
different business applications. Mercator was initially released in December
1993 and, as of December 31, 1998, had been licensed to more than 1,900
customers worldwide.
Mercator. Mercator enables application integration by transforming
information between and among multiple business applications. The
Enterprise-level product also provides cross-application flow control and
adapters to major applications, databases and messaging systems. It provides a
Windows-based Design Client which is used to define data formats and integration
requirements including rules for data transformation, transaction routing and
event coordination. Solutions created by a Design Client are executed on
separate Integration Servers. Complete integration solutions can be created
without writing custom interface programs. Mercator requires no pre-processing
of any data to be integrated. It integrates data between multiple sources and
destinations in a single process, and supports integration execution on a wide
range of platforms. Customers who create solutions that run on multiple
platforms license an Integration Server for each platform. The Company currently
offers integration support for PC/Intel (DOS, Windows 3.1, Windows 95, Windows
98, Windows NT, SCO Open Server, SCO Unixware); IBM AS/400 (OS/400), RS/6000
(AIX) and mainframe (MVS, CICS, UNIX); HP9000 (HP-UX); Siemens-Nixdorf/Pyramid
(SINIX-Reliant); Sun SPARC (Solaris, OS); Digital Alpha (UNIX, Windows NT,
OpenVMS) and VAX (VMS); and Stratus R5 (FTX,VOS).
Mercator for R/3. Mercator for R/3 is a version of Mercator that includes
specific extensions to meet the requirements for application integration with
SAP's R/3 system. Mercator was the first software product to be certified by SAP
for use with its ALE architecture. In addition, SAP has certified Mercator for
EDI, the Data Migration Interface (DMI), the ALE Message Handling Systems (AMS)
and the Business Information Warehouse (BW). Mercator is thus the first product
to be certified by SAP for all five interfaces (ALE, EDI, DMI, AMS and BW).
Mercator for R/3 extends the core Mercator product by providing tools to
automatically capture R/3 data definitions, and adapters for integrating with
R/3's inter-application messaging system. In addition, Mercator for R/3 provides
application integration support for other R/3 data conversion and interfacing
requirements including the initial conversion of data to R/3 from existing
systems and interfaces with data warehouses.
Mercator for EC. Mercator for EC is an enterprise application integration
product featuring support for distributed electronic commerce. It supports
distributed management and maintenance of the EC environment as well as
distributed processing of EC transactions. With Mercator for EC, numerous
business units within an enterprise can define and manage their own EC programs
and those programs can include the exchange of data in proprietary formats and
the new self-defining formats such as XML as well as traditional x12 and EDIFACT
data.
3
They can include Web e-mail and FTP-based communications as well as the
use of EDI VANs. In addition to inter-enterprise integration through EC,
Mercator for EC fully supports application integration within the enterprise.
Mercator for EC thus extends the underlying power of Mercator to the world of
electronic commerce by providing a flexible, open architecture for creating
robust inter-enterprise and intra-enterprise integration solutions for today's
event-driven enterprises.
Trading Partner Products.
The Company's Trading Partner products consist of a set of electronic data
interchange or EDI management software products and include Trading Partner PC,
a Windows-based product, and Trading Partner EC, a mainframe-based product. The
Trading Partner products can be sold as stand-alone EDI products, but are often
sold in conjunction with Mercator products to enable businesses both to manage
their EDI relationships and to integrate their EDI data into enterprise
applications. Trading Partner products allow customers to communicate with their
partners through direct connections, value-added networks or VANs or the
Internet.
Trading Partner PC. Introduced in 1989, Trading Partner PC was the first
Windows-based EDI translator in the United States and has been licensed to more
than 5,900 businesses worldwide. In October 1996, the Company introduced Trading
Partner PC/32, the first Windows 95 desktop solution in the market. The Company
has developed more than 100 "kits" which support a particular trading partner's
EDI specifications and provide "plug and play" solutions for EDI trading. The
Company markets kits for many major EDI trading partners including Compaq
Computer Corporation, Floor Link/Carpet One, Hewlett-Packard, International
Business Machines Corporation, J.C. Penney Company, Inc., Kohler Company, Kaiser
Permanente, Sears, Roebuck and Company, and Target Stores. In 1998, the Company
introduced important kits for the automotive industry -- for General Motors,
Chrysler and Ford, plus a new facility enabling customers to download kits from
the company's Web site. The Company's OnCall*EDI products are a series of EDI
kits for electronic purchasing for the healthcare provider market and have been
licensed to more than 1,300 hospitals.
Trading Partner EC. Trading Partner EC is a mainframe-based EDI management
product which provides EDI management capability for companies with large EDI
programs. It includes Mercator as its core application integration engine and
offers the user the means to integrate EDI data directly into applications
without the need to write custom interface programs commonly required by other
translator products. Using Mercator, customers who plan to migrate their EDI
program from the mainframe can do so without incurring additional cost and
effort for recreating their application interfaces. Trading Partner EC and its
predecessor product have been licensed to more than 200 businesses worldwide.
KEY/MASTER
In addition to the Company's applications integration products described
above, the Company licenses and supports KEY/MASTER, a legacy data entry product
which is used on mainframe terminals or PCs on local area networks, and is the
leading software product for automating the key entry of high-volume, repetitive
data from business documents. KEY/MASTER has been licensed to more than 900
customers worldwide. Because KEY/MASTER is a mature product, revenues derived
from KEY/MASTER are primarily maintenance-related and the Company expects in the
future to make only minor investments in KEY/MASTER.
Services
Professional Services. The Company offers consulting and professional
services to customers who wish to have the Company's professionals plan, design
or implement their application integration projects, or provide consulting or
implementation assistance for SAP and ERP system integration. The Company has
expanded the number of service professionals and the scope of the services
offered to address the enterprise application integration needs of large
organizations. The Company believes that enterprises implementing the R/3 system
in particular represent a significant opportunity for the Company to market its
professional services in support of Mercator for R/3.
Training. In order to ensure that its customers are successful in using its
products, the Company provides training in its four training centers, at
customer locations and at SAP training facilities. The Company offers a number
of courses ranging from two to five days in length with educational content
including basic product functionality and hands-on use of the product. The
Company recommends that its Mercator customers attend a basic three-day training
course and believes that a majority of its Mercator customers elect to
participate in such training.
4
Customers
As of December 31, 1998, the Company had directly licensed its software to
more than 11,000 customers worldwide. Numerous others have licensed the
Company's products through Value Added Resellers (VARs), Independent Software
Vendors (ISVs), Systems Integrators (SIs) or other third parties who distribute
its products to business partners to facilitate the integration of their
respective business applications.
The Company's customer base includes businesses from many industries,
including finance, banking, healthcare, technology, government, retail,
manufacturing, automotive, oil and gas, utilities, communications, insurance,
and transportation. The following is a partial list of the Company's end-user
and third-party Mercator customers who have purchased Mercator:
End User Customers
End-User Customers VARs, ISVs and SIs
------------------ ------------------
American Express Abaton.com
American Family Insurance Allenbrook
Apria Healthcare American Express Travel Related Services, Inc.
Baker Hughes Inc. American Software, Inc.
Banamex Anderson Consulting
Betz Dearborn Arbour Group, Inc.
Bell Atlantic BEA Systems, Inc.
Blue Cross Blue Shield of Massachusetts Candle Corporation
Canadian National Railway Company CAS-Nord
Chase Manhattan Bank Catalyst International
Citicorp CEBRA Inc.
Coors Brewing Company Citibank, N.A.
Deere & Company Compaq Computer Corporation
Dun & Bradstreet Connect, Inc.
EDS Cross Worlds
Eastman Kodak Company DMR Consulting Group
Eli Lilly Federal Express Corporation
First Chicago NBD Corporation HBO & Company
General Motors HK Systems
Georgia-Pacific Corporation Hewlett-Packard Company
GTE ICL Retail Systems
Hershey Foods Indus International
Hoechst AG IBM
Home Savings of America Logility
IBM Logix
Johnson and Johnson Manhattan Associates
Lockheed Martin Corporation Mitsui & Co. Ltd.
Lucent Technologies Inc. Netscape
MCI Nippon Telephone & Telegraph
Merck-Medco Omnilogic
Nestle Canada, Inc. Optum. Inc.
Nestle, U.K. Osprey Consulting
Nestle, U.S. Pivotpoint, Inc.
NYNEX Corporation PriceWaterhouse Coopers
Pacificare Research Triangle Associates
Perrier Group of America Robocom Software
Petroleos de Venezuela, S.A. Saratoga Systems
Phillips Consumer Products Synergistics
Pioneer Hi-Bred International TIBCO Software, Inc.
Prudential Insurance Company of America
Royal Canadian Mounted Police
Sara Lee Hosiery, Inc.
Tennaco Packaging
Texas Instruments
The Toronto Dominion Bank
Whirlpool Corporation
The World Bank
U.S. Surgical
No one customer accounted for more than 10% of TSI Software's sales in 1998,
1997 or 1996.
5
Sales and Marketing
Sales
The Company markets its products and services through both direct and
third-party channels. The Company's goal is to achieve broad market penetration
by pursuing multiple channels of distribution.
As of December 31, 1998, the Company's sales organization consisted of 86
employees. The Company's direct field sales force focuses on sales of Mercator
products to Fortune 2000 companies. The Company also maintains as part of its
direct sales force, a telesales organization which generally targets smaller
businesses. The field sales force also includes alternate channel managers who
are responsible for sales through third parties. The sales organization includes
systems engineers who assist with both pre- and post-sales activities.
An important part of the Company's sales strategy is to continue to develop
its indirect distribution channels such as VARs, ISVs, SIs and distributors. As
of December 31, 1998, over 200 third parties had agreements with the Company to
resell, embed or otherwise bundle the Company's products with their offerings in
the United States.
The Company markets its products and services outside of North America
through sales offices located in the United Kingdom and France as well as
through indirect channels. Revenues from international customers were
approximately 11.8% of the Company's total revenues during 1998. The
international market is important to the Company, and it intends to continue to
expand its sales and marketing efforts outside North America by adding
additional sales staff and distributors.
Marketing
The Company utilizes a wide variety of marketing programs which are
intended to attract potential customers and to promote the Company and its brand
names. The Company uses a mix of market research, analyst updates, seminars,
direct mail, print advertising, trade shows, speaking engagements, public
relations, customer newsletters, and Web-site marketing in order to achieve
these goals. The marketing department also produces collateral material for
distribution to prospects including demonstrations, presentation materials,
white papers, brochures, fact sheets, and materials that are specific to the
area of interest. The Company also hosts an annual conference for its customers
and maintains an Alliance Program designed to support its channel partners with
a variety of programs, incentives, support plans, and an annual conference. As
of December 31, 1998, there were 13 employees in the Company's marketing
organization.
Technology
The Company's core Mercator technology provides a platform for creating
application integration solutions which satisfy requirements across a variety of
computing environments. The architecture of the Mercator platform is based on
object concepts, providing reusability, interoperability, and scalability during
the design process and in the resulting solutions. The Mercator platform permits
the Company to efficiently construct and deliver integration solutions for
specific markets and also allows ISVs and SIs to embed Mercator functionality
within their own offerings.
Among the central components of the Mercator platform are a Windows-based
Design Client for creating integration "maps" and systems of maps for data
validation, transformation, and content-based routing, and one or more run-time
Integration Servers for execution. A map is an executable module that describes
the required validation, transformation and integration of data between source
and destination objects such as files, databases, applications and messages. The
Design Client provides an intuitive drag-and-drop environment for defining the
source and destination data objects, creating the integration rules between the
sources and the destinations, and building the resulting map object. Map objects
built using Mercator can be ported automatically to any of 22 different
execution environments.
Through Mercator's graphical interface, users enter descriptions of source
and destination objects are entered by the user. To simplify data definition,
the Company provides pre-packaged objects for a number of commonly used data
standards and the Company also provides importers for creating objects from
higher level (meta) data definitions. Data object definitions within Mercator
include information regarding their format, structure and business rules,
eliminating the need to explicitly identify the context of a data object during
map construction and maintaining the logical integrity of the resulting
integration solution.
6
Once the source and destination objects have been defined, the user creates
an integration map by specifying the rules for transforming data from the
sources to the destinations. For many integration tasks, the user need only
"drag" a source object and "drop" it on the destination object. Multiple data
sources can be transformed to multiple destinations in a single operation. The
user has point-and-click access to a variety of pre-built functions to enhance
the integration rules including support. Selection, extraction, computation,
logical operations, parsing, substitution, re-ordering, validation, and
conversion are all fully supported.
At a higher level, the System Editor, Mercator's graphical process flow
manager and another component of the Design Client, enables the user to define a
set of logically related integration solutions called a system. With the System
Editor, the user defines interactions among maps and systems of maps, and
specifies the events that trigger the execution of an integration solution.
Using Mercator`s Design Client, integration objects are built and tested in
the Windows environment. The resulting Mercator integration object can be
implemented using a Mercator Integration Server appropriate to the target
platform. Target platforms currently supported include PC/Intel (DOS, Windows
3.1, Windows 95, Windows 98, Windows NT, SCO Open Server, SCO Unixware); IBM
AS/400 (OS/400), RS/6000 (AIX) and mainframe (MVS, CICS, UNIX); HP9000 (HP-UX);
Siemens-Nixdorf/Pyramid (SINIX-Reliant); Sun SPARC (Solaris, OS); Digital Alpha
(UNIX, Windows NT, OpenVMS) and VAX (VMS); and Stratus R5 (FTX, VOS).
The Company provides adapters and importers which interface to and from
specific databases, messaging systems, and applications, enabling connectivity
to a specific source or destination. Database adapters are currently available
for ODBC-compliant databases and several specific databases including Oracle7,
Microsoft SQL Server, IBM DB2, and Sybase. Messaging adapters are available for
SAP's ALE, IBM's MQSeries, Microsoft MSMQ, TIBCO Rendezvous, BEA MessageQ and
Tuxedo, and Oracle AQ. Importers are currently available for COBOL copybooks;
database tables for ODBC-compliant and Oracle7, Microsoft SQL Server, IBM DB2,
and Sybase databases; SAP R/3 IDocs, BAPIs, DXOB and BDC. In addition, the
Company provides pre-packaged data objects for national and international
standards for EDI, HL7 (for health care), and S.W.I.F.T. (for banking and
financial services).
Mercator was architected so that adapters and importers can be added
without modifying the core Mercator technology. Mercator for R/3, for example,
is a packaged offering which leverages the core Mercator Design Client and
Integration Servers by providing adapters for communicating with SAP's ALE and
BAPI/RFC architectures and importers for R/3 data definitions (IDocs, BAPIs,
DXOB and BDC). The Company's other products also leverage Mercator's core
technology. The underlying EDI translation support for OnCall*EDI is provided by
Mercator, and Trading Partner EC incorporates Mercator as the data integration
component for integrating EDI data with existing applications. In addition, the
Company's customers can use Mercator to create their own applications where
embedded data validation, transformation, or content-based routing is a
requirement.
Product Development
Since inception, the Company has made substantial investments in research
and development through both internal development and technology acquisition.
The Company expects that most of its enhancements to existing products and new
products will be developed internally. However, the Company will evaluate on an
ongoing basis externally-developed technologies for integration into its product
lines.
The Company expects that a substantial majority of its research and
development activities will be related to developing enhancements and extensions
to its Mercator and Trading Partner product lines. Following Mercator's
introduction, product development was initially driven by demand for additional
mapping functionality and support for additional execution platforms. Later,
development focus shifted to automating Mercator support for specific sources
and destinations through an expanded set of adapters and importers, and
development of additional pre-packaged integration solutions for specific
markets. In 1997, the Company added a graphical management tool for cross
application process workflow to the core set of Mercator capabilities. In 1998,
the Company extended the Mercator product by adding SAP r/3 adapters for BAPI's,
DXOB,and BDC, by adding database adapters for DB2 and Sybase, and by introducing
pre-built definitions for S.W.I.F.T. messages.
The Company's products may be rendered obsolete if the Company fails to
anticipate or react to change. Development of enhancements to existing products
and new products depends, in part, on the timing of releases of new versions of
applications systems by vendors, the introduction of new applications, systems
or computing platforms, the timing of changes in platforms, the release of new
standards or changes to existing standards, and
7
changing customer requirements, among other factors. The Company may not be
successful in developing and marketing product enhancements or new products that
respond to technological change, evolving industry standards and changing
customer requirements. The Company does not anticipate that it will experience
difficulties that could delay or prevent the successful development,
introduction and marketing of these products or product enhancements.
Furthermore, its product enhancements or new products may not adequately meet
the requirements of the marketplace and achieve any significant degree of market
acceptance. The Company has in the past experienced delays in the introduction
of product enhancements and new products and may experience such delays in the
future. Furthermore, as the number of applications, systems and platforms
supported by the Company's products increases, the Company could experience
difficulties in developing on a timely basis product enhancements which address
the increased number of new versions of applications, systems or platforms
served by its existing products. Failure of the Company, for any reason, to
develop and introduce product enhancements or new products in a timely and
cost-effective manner or to anticipate and respond adequately to changing market
conditions could cause customers to delay or decide against purchases of the
Company's products.
As of December 31, 1998, there were 57 employees in the Company's research
and development organization, more than half of which were dedicated to
Mercator. The Company's product development expenditures for 1996, 1997 and 1998
were $3.5 million, $4.5 million, and $5.7 million, respectively. The Company
expects that it will continue to commit significant resources to product
development in the future. To date, all product development expenses were
expensed as incurred.
The market for the Company's products and services is characterized by
extremely rapid technological change, frequent new product introductions and
enhancements, evolving industry standards, and rapidly changing customer
requirements. The introduction of products incorporating new technologies and
the emergence of new industry standards could render existing products obsolete
and unmarketable. The Company's future success will depend in part upon its
ability to anticipate changes, enhance its current products and develop and
introduce new products that keep pace with technological advancements and
address the increasingly sophisticated needs of its customers.
Customer Support
The Company believes that a high level of customer service and support is
important to its success, and the Company provides a range of support services
to its customers. The Company maintains product and technology experts on call
at all times and has support call centers located at its offices in Wilton,
Connecticut; Bannockburn, Illinois; and Boca Raton, Florida, in the United
States, and in its United Kingdom office. The Company has also implemented an
automated Company-wide help desk system to augment its customer support efforts.
This system allows for the optimization of the Company's resources and knowledge
base at all locations and offers the customer improved service through one point
of contact.
Competition
The market for the Company's products and services is extremely competitive
and subject to rapid change. Because there are relatively low barriers to entry
in the software market, the Company expects additional competition from other
established and emerging companies. The Company believes that the competitive
factors affecting the market for the Company's products and services include
product functionality and features; quality of professional services offerings;
product quality, performance and price; ease of product implementation; quality
of customer support services; customer training and documentation; and vendor
and product reputation. The relative importance of each of these factors depends
upon the specific customer environment. Although the Company believes that its
products and services currently compete favorably with respect to factors, the
Company may not be able to maintain its competitive position against current and
potential competitors.
In the enterprise application integration market, the Company's Mercator
products and related services compete primarily against solutions developed
internally by individual businesses to meet their specific business application
integration requirements. As a result, the Company must educate prospective
customers as to the advantages of the Company's products and services as opposed
to internally-developed solutions, and be able to adequately educate potential
customers to the benefits provided by the Company's products and services.
8
In the EDI market, the Company's Trading Partner products compete with
products offered by companies offering proprietary VAN services as part of their
EDI solution, and the Company's PC-based Trading Partner products also compete
with PC-based products offered by a number of other EDI software vendors.
Some of the Company's current and potential competitors have longer
operating histories, significantly greater financial, technical, product
development and marketing resources, greater name recognition and larger
customer bases than the Company. The Company's present or future competitors may
be able to develop products comparable or superior to those offered by the
Company, adapt more quickly than the Company to new technologies, evolving
industry trends or customer requirements, or devote greater resources to the
development, promotion and sale of their products. Accordingly, the company may
not be able to compete effectively in its markets and competition could
intensify or future competition could have a material adverse effect on the
Company's business.
The Company expects that it will face increasing pricing pressures from its
current competitors and new market entrants. The Company's competitors may
engage in pricing practices that reduce the average selling prices of the
Company's products and related services. To offset declining average selling
prices, the Company believes that it must successfully introduce and sell
enhancements to existing products and new products on a timely basis and develop
enhancements to existing products and new products that incorporate features
that can be sold at higher average selling prices. To the extent that
enhancements to existing products and new products are not developed in a timely
manner, do not achieve customer acceptance or do not generate higher average
selling prices, the Company's gross margins may decline.
Proprietary Technology
The Company's success depends upon its proprietary software technology. The
Company does not currently have any patents and relies principally on trade
secret, copyright and trademark laws, nondisclosure and other contractual
agreements and technical measures to protect its technology. The Company also
believes that factors such as the technological and creative skills of its
personnel, product enhancements and new product developments are essential to
establishing and maintaining a technology leadership position. The Company
enters into confidentiality and/or license agreements with its employees,
distributors and customers, and limits access to and distribution of its
software, documentation and other proprietary information. The steps taken by
the Company may not be sufficient to prevent misappropriation of its technology,
and such protections do not preclude competitors from developing products with
functionality or features similar to the Company's products. Furthermore, it is
possible that third parties will independently develop competing technologies
that are substantially equivalent or superior to the Company's technologies. In
addition, effective copyright and trade secret protection may be unavailable or
limited in certain foreign countries which could pose additional risks of
infringement as TSI Software expands internationally. Any failure by or
inability of the Company to protect its proprietary technology could have a
material adverse effect on the Company's business.
Although the Company does not believe its products infringe the proprietary
rights of any third parties, infringement claims could be asserted against the
Company or its customers in the future. Furthermore, as described under "Legal
Proceedings" the Company may initiate claims or litigation against third parties
for infringement of the Company's proprietary rights, or for purposes of
establishing the validity of the Company's proprietary rights. Litigation,
either as plaintiff or defendant, would cause the Company to incur substantial
costs and divert management resources from productive tasks whether or not such
litigation is resolved in the Company's favor, which could have a material
adverse effect on the Company's business. Parties making claims against the
Company could secure substantial damages, as well as injunctive or other
equitable relief which could effectively block the Company's ability to license
its products in the United States or abroad. Such a judgment could have a
material adverse effect on the Company's business. If it appears necessary or
desirable, the Company may seek licenses to intellectual property that it is
allegedly infringing. Licenses may not be obtainable on commercially reasonable
terms, if at all. The terms of any offered licensed also may not be acceptable
to the Company. The failure to obtain the necessary licenses or other rights
could have a material adverse effect on the Company's business. As the number of
software products in the industry increases and the functionality of these
products further overlaps, the Company believes that software developers may
become increasingly subject to infringement claims. Any such claims, with or
without merit, can be time-consuming and expensive to defend and could adversely
affect the Company's business. The Company is not aware of any currently pending
claims that the Company's products, trademarks or other proprietary rights
infringe upon the proprietary rights of third parties.
9
Employees
As of December 31, 1998, the Company had 298 full-time employees, including
57 in research and development, 107 in professional services and customer
support, 99 in sales and marketing and 35 in finance and administration. The
Company's employees are not represented by any union. TSI Software believes that
its relations with employees are good.
The Company's future success depends in large part on the continued service
of its key technical, professional services and sales personnel, as well as
senior management. The loss of the services of any of one or more of the
Company's key employees could have a material adverse effect on the Company's
business. All employees are employed at-will and the Company has no fixed-term
employment agreements with its employees. The Company's future success also
depends on its ability to attract, train and retain highly qualified sales,
technical, professional services and managerial personnel, particularly sales,
professional services and technical personnel with expertise in the SAP R/3
system. An increase in the Company's sales staff is required to expand both the
Company's direct and indirect sales activities and to achieve revenue growth.
Competition for these personnel is intense, particularly for personnel with
expertise in the ERP market. The Company has at times experienced and continues
to experience difficulty in recruiting qualified technical and sales personnel,
and anticipates such difficulties in the future. The Company has in the past
experienced and in the future expects to continue to experience a time lag
between the date technical, professional services and sales personnel are hired
and the date such personnel become fully productive. If the Company is unable to
hire and train on a timely basis and subsequently retain such personnel in the
future, this could have an adverse affect on the Company's business.
ITEM 2. PROPERTIES
The Company's principal executive offices are located in Wilton,
Connecticut, and consist of approximately 25,000 square feet under a lease
expiring in 2001. The Company also leases approximately 12,000 square feet of
office space in Bannockburn, Illinois, which is used primarily for its telesales
operations; approximately 13,000 square feet of office space in Boca Raton,
Florida, which is used primarily for research and development activities;
approximately 4,500 square feet of office space in the United Kingdom; and small
offices in Paris, France, and Landover, Maryland. During 1998, in connection
with the purchase of SCP, TSI assumed an additional lease of 3,500 square feet
of office space in Media, Pennsylvania to house employees in its professional
services organization.
ITEM 3. LEGAL PROCEEDINGS
In December 1997 the Company filed a complaint in the United States
District Court for the district of Connecticut (Case No. 397CV02628) against
Transition Systems Inc. for trademark infringement and unfair competition and
trade practices, including using the trademark "TSI". Transition Systems Inc. is
a software company in the healthcare industry and is located in Massachusetts.
The Company is seeking to enjoin Transition Systems Inc. from using any of the
Company's trademarks and to pay the Company all profits derived from using the
Company's trademarks and to pay additional damages sustained by the Company. The
Company has offered to settle this claim for $100,000. There has not been an
answer to this claim, but the company believes it will be settled in 1999 for an
amount paid to TSI Software not to exceed $100,000.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed for trading on the Nasdaq National
Market (Symbol: TSFW). The Company's Common Stock began trading on the Nasdaq
National Market on July 2, 1997. Prior to that time, there was no public market
for the Company's Common Stock. The following table sets forth for the fiscal
periods indicated the high and low reported sale prices for the Company's Common
Stock as reported by the Nasdaq National Market.
Reported
Sale Price
--------------------------
High Low
-------- --------
1997
First Quarter .................... -- --
Second Quarter ................... -- --
Third Quarter* ................... 15.125 9.00
Fourth Quarter ................... 14.75 9.125
1998
First Quarter .................... 18.625 9.50
Second Quarter ................... 24.75 17.5
Third Quarter .................... 36.25 21.125
Fourth Quarter ................... 51.00 17.00
1999
First Quarter .................... 60.50 41.00
* From July 2, 1997
** From February 23, 1999
The closing price for the Common Stock on the Nasdaq National Market on
February 23, 1999 was $49.75.
There were approximately 3,400 holders of record of the Common Stock as of
February 23, 1999, although the Company believes that there is a larger number
of beneficial owners of its Common Stock.
The Company has never paid cash dividends on its Common Stock and does not
anticipate the payment of cash dividends in the foreseeable future. The Company
currently anticipates that any future earnings will be retained to finance the
Company's operations.
Recent Sales of Unregistered Securities
On November 13, 1998, the Company agreed to acquire substantially all of
the assets of and assume certain liabilities of Software Consulting Partners, a
Delaware Corporation ("SCP"). The 33,922 shares of the Company's common stock
issued to SCP under the Asset Transfer Agreement (the "Asset Agreement") dated
November 13, 1998 by and among the Company, SCP and a stockholder of SCP (50% of
such shares are being held in escrow pursuant to the terms of the Asset
Agreement) were issued in reliance on the exemptions for non-public offerings
provided by Rule 506 and section 4(2) of the Securities Act of 1933, as amended
("The Act") and thus have not been registered. These shares constitute
"restricted securities" under rule 144(d) regulated by the Securities and
Exchange Commission ("SEC") under the Securities Act. The provisions of rule 144
permits only limited resale of "restricted securities," including that such
securities must generally be held for at least one year from the date of their
acquisition and may then be sold only if certain other requirements are met.
Use of Initial Public Offering Proceeds
The Form S-1 Registration Statement (SEC File No. 333-27293) related to the
Company's initial public offering of Common Stock, $0.01 par value per share,
was declared effective by the SEC on July 1, 1997. A total of 4,600,000 shares
(including shares issuable upon exercise of the Underwriters' over-allotment
option) of the Company's Common Stock was registered with the SEC with an
aggregate registered offering price of $41,400,000, which consisted of 3,000,000
shares registered on behalf of the Company (with an aggregate
11
registered offering price of $27,000,000) and 1,000,000 shares registered on
behalf of certain stockholders of the Company (with an aggregate registered
offering price of $9,000,000). The offering commenced on July 2, 1997 and all of
the shares of Common Stock offered by the Company and certain stockholders of
the Company, respectively, were sold for the aggregate registered offering price
through a syndicate of underwriters managed by Robertson, Stephens & Company,
SoundView Financial Group, Inc. and Wessels, Arnold & Henderson. The offering
terminated on July 2, 1997, immediately after all of the Common Stock was sold.
The Company and the selling stockholders paid to the underwriters an
underwriting discount totaling $1,890,000 and $630,000, respectively, in
connection with the offering. In addition the Company incurred additional
expenses of approximately $800,000 in connection with the offering. Thus the net
offering proceeds to the Company and the selling stockholders were approximately
$24,272,300 and $8,370,000, respectively. The underwriting discount and the
other offering expenses were not made directly or indirectly to any directors,
officers of the Company (or their associates), or persons owning ten (10)
percent or more of any class of equity securities of the Company or to any other
affiliates of the Company.
On July 23, 1997, the underwriters exercised the over-allotment option to
purchase an additional 600,000 shares registered from certain selling
stockholders. Proceeds to the selling stockholders were an additional
$5,022,000, and an underwriting discount of $378,000 was paid to the
underwriters with respect to these shares.
Through December 31, 1998 the net offering proceeds to the Company have
been utilized as follows:
Direct or indirect payments to
directors, officers, general
partners of the Company or
their associates; to persons
owning ten percent or more of
any class of equity securities Direct or
of the Company; and to indirect payments
Use affiliates of the Company to others
--- ------------------------- -----------------
Construction of plant, building and facilities -- 0
Purchase and installation of machinery and equipment -- $ 2,190,100
Purchase of real estate -- 0
Acquisition of other business(es) -- 4,653,000
Repayment of indebtedness -- 2,790,100
Debt/Capital Leases -- 54,100
Working capital -- 0
Temporary investment-Purchase Marketable
Securities and Cash Equivalents -- 14,585,000
Other purposes (specify) -- --
-----------
TOTAL NET PROCEEDS $24,272,300
===========
Second Public Offering
On June 5, 1998, the company filed a Registration Statement with the
Securities and Exchange Commission for a public offering of 3,511,000 shares of
its Common Stock. Of the 3,511,000 shares being offered, 1,200,000 were offered
by the Company and 2,311,000 were offered by selling stockholders. Selling
Stockholders shares included 382,281 shares subject to warrant which were sold
to the underwriters who then exercised the warrant and resold the shares of
common stock.
On July 5, 1998, the underwriters exercised their 30-day option to purchase
an additional 526,650 shares of the company's stock of which were purchased from
the Company and 300,000 of which were purchased from certain selling
stockholders.
The Company intends to use the approximately $26.5 million of net proceeds
of this offering primarily for working capital and general corporate purposes.
The Company did not receive any proceeds from the sale of the shares by selling
stockholders, but did receive an additional $764,562 upon the exercise of the
warrant by the Underwriters.
12
ITEM 6. SELECTED FINANCIAL DATA
Statements of Operations Data:
(In thousands, except per share data)
Year Ended December 31,
----------------------------------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
Revenues:
Software licensing ............................. $ 6,275 $ 7,553 $ 9,310 $ 14,603 $ 29,105
Service, maintenance and other ................. 7,659 8,508 9,694 12,067 16,211
-------- -------- -------- -------- --------
Total revenues ............................ 13,934 16,061 19,004 26,670 45,316
-------- -------- -------- -------- --------
Cost of revenues:
Software licensing ............................. 1,035 725 495 778 1,482
Service, maintenance and other ................. 2,522 2,200 2,006 2,490 5,407
-------- -------- -------- -------- --------
Total cost of revenues .................... 3,557 2,925 2,501 3,268 6,889
-------- -------- -------- -------- --------
Gross profit ................................... 10,377 13,136 16,503 23,402 38,427
-------- -------- -------- -------- --------
Operating Expenses:
Product development ............................ 2,231 3,068 3,452 4,462 5,699
Selling and marketing .......................... 6,124 7,160 8,715 13,095 22,033
General and administrative ..................... 1,927 2,001 2,922 3,792 6,232
-------- -------- -------- -------- --------
Total operating expenses .................. 10,282 12,229 15,089 21,349 33,964
-------- -------- -------- -------- --------
Operating income ............................... 95 907 1,414 2,053 4,463
Other income (expense), net .................... (199) (49) (150) 503 2,015
-------- -------- -------- -------- --------
Income before taxes ............................ (104) 858 1,264 2,556 6,478
Income tax (expense) benefit ................... (9) (35) (36) (76) 679
-------- -------- -------- -------- --------
Net income (loss) .............................. $ (113) $ 823 $ 1,228 $ 2,480 $ 7,157
======== ======== ======== ======== ========
Net income (loss) per share
- --Basic ........................................ $ (.04) $ 0.29 $ 0.43 $ 0.42 $ 0.71
- --Diluted ...................................... $ (.02) $ 0.15 $ 0.21 $ 0.29 $ 0.60
Weighted average number of common
and common equivalent shares
outstanding
- --Basic ........................................ 2,815 2,846 2,887 5,917 10,150
- --Diluted ...................................... 5,425 5,455 5,811 8,567 11,908
December 31,
----------------------------------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- -------
(In thousands)
Balance Sheet Data:
Cash and marketable securities ................. $ 450 $ 143 $ 41 $21,403 $47,945
Working capital ................................ (2,630) (2,128) (1,220) 23,371 53,742
Total assets ................................... 6,387 6,237 7,521 32,942 78,187
Total stockholders' equity (deficit) ........... (4,393) (3,570) (2,294) 25,416 61,899
- ----------
(1) For an explanation of the determination of the number of shares used in
computing per share amounts, see note 7 of Notes to Financial Statements.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The Company was incorporated in Connecticut in 1985 and reincorporated in
Delaware in September 1993. Historically, the Company has derived a majority of
its revenues from products other than Mercator, primarily its Trading Partner
family of products and its KEY/MASTER product. However, revenue related to
Mercator has grown significantly in each of the last three years and has
increased as a percentage of total revenues. The Company believes that future
growth in revenues, if any, will be mainly attributable to its Mercator product
line. The Company believes it cannot accurately predict the amount of revenues
that will be attributable to this product line or the life of such products. To
the extent the Company's Mercator products do not maintain continued market
acceptance, the Company's business, will be adversely affected.
The Company's revenues are derived principally from two sources: (i)
license fees for the use of the Company's software products and (ii) service
fees for maintenance, consulting services and training related to the Company's
software products. The Company generally recognizes revenue from software
license fees upon shipment, unless the Company has significant post-delivery
obligations, in which case revenues are recognized when these obligations are
satisfied. The Company's KEY/MASTER product is licensed under term-use contracts
rather than for a one-time license fee, and the Company recognizes revenue from
these arrangements on a present-value basis at the inception of the contract.
The Company does not actively market new term-use contracts for KEY/MASTER but
continues to receive maintenance revenues. As a result, maintenance revenue
accounts for a larger proportion of KEY/MASTER revenue than license revenues and
increases the percentage of the Company's total revenues represented by
services, maintenance and other revenues. The Company intends to continue to
increase the scope of its service offerings insofar as it supports the sale of
license revenues from sales of its products. The Company believes that software
licensing will continue to account for a larger portion of its revenues than
service, maintenance and other revenues.
Mercator can be used by Information Technology (IT) professionals as well
as Value Added Resellers (VARs), Independent Software Vendors (ISVs), Software
Integrators (SIs) or other third parties who resell, embed or otherwise bundle
Mercator with their products. To date, license fee revenues have been derived
principally from direct sales of software products through the Company's direct
sales force. Although the Company believes that direct sales will continue to
account for a significant portion of software licensing revenues, the Company
intends to increase its use of distributors and resellers. Furthermore, the
Company's planned expansion of its sales organization is expected to cause sales
and marketing expenses to increase.
The Company markets its products in North America primarily through its
direct sales and telesales organizations. Throughout the rest of the world, the
Company markets its products through distributors, resellers and direct sales.
International revenue accounted for 9.4% and 11.8% of total revenues for 1997
and 1998, respectively. The Company maintains an international sales and support
office in the United Kingdom. The Company intends to increase its international
direct sales force by establishing an office in Germany and focusing on
additional international distributor and reseller relationships.
The size of the Company's orders can range from a few thousand dollars to
over $150,000 per order. The loss or delay of large individual orders,
therefore, can have a significant impact on the revenues and other quarterly
results of the Company. In addition, the Company has generally recognized a
substantial portion of its quarterly software licensing revenues in the last
month of each quarter, and as a result, revenue for any particular quarter may
be difficult to predict in advance. Because the Company's operating expenses are
relatively fixed, a delay in the recognition of revenue from a limited number of
license transactions could cause significant variations in operating results
from quarter to quarter and could result in significant losses. To the extent
such expenses precede, or are not subsequently followed by, increased revenue,
the Company's operating results would be materially and adversely affected. As a
result of these and other factors, operating results for any quarter are subject
to variation, and the Company believes that period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance.
On November 13, 1998, TSI Software agreed to acquire substantially all of
the assets and assume certain liabilities of Software Consulting Partners, or
SCP. SCP is a professional services organization which provides installation,
maintenance and user support consulting services to enterprises utilizing SAP
software. The
14
transaction was recorded for accounting purposes as a purchase and was
structured to be a "tax-free" reorganization for federal income tax purposes.
In connection with the transaction, TSI Software issued SCP 33,922 shares
of its Common Stock, with 50% of these shares subject to an escrow to secure
certain indemnification obligations of SCP and a stockholder of SCP. In
addition, the Company may issue a maximum of an additional 33,921 shares of its
Common Stock (Earnout Shares) within ten days following the date on which TSI
Software announces its balance sheet and results of operations for fiscal year
1999. The number of Earnout Shares to be issued will be based upon professional
fee revenues generated and the number of employees who are continuously employed
that are related to the SCP business.
In accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed," software development costs are expensed as incurred until
technological feasibility has been established, at which time such costs are
capitalized until the product is available for general release to customers. To
date, the establishment of technological feasibility of the Company's products
and general release of such software have substantially coincided. As a result,
software development costs qualifying for capitalization have been
insignificant, and therefore, the Company has not capitalized any software
development costs.
Results of Operations
The following table sets forth, for the periods indicated, the percentage
of total revenues represented by certain items from the Company's Statements of
Operations.
Years Ended December 31,
------------------------------
1996 1997 1998
------ ------ ------
Revenues:
Software licensing ..................... 49.0% 54.7% 64.2%
Service, maintenance and other ......... 51.0 45.3 35.8
------ ------ ------
Total revenues .................... 100.0 100.0 100.0
------ ------ ------
Cost of revenues:
Software licensing ..................... 2.6 2.9 3.3
Service, maintenance and other ......... 10.6 9.3 11.9
------ ------ ------
Total cost of revenues ............ 13.2 12.2 15.2
------ ------ ------
Gross profit ................................ 86.8 87.8 84.8
------ ------ ------
Operating expenses:
Product development .................... 18.2 16.7 12.6
Selling and marketing .................. 45.9 49.1 48.6
General and administrative ............. 15.3 14.2 13.8
------ ------ ------
Total operating expenses .......... 79.4 80.0 75.0
------ ------ ------
Operating income (loss) ................ 7.4 7.8 9.8
Other income (expense), net ............ (0.7) 1.8 4.5
------ ------ ------
Income (loss) before taxes ............. 6.7% 9.6% 14.3%
Income taxes (expense), benefit ........ (.2) (.3) 1.5
------ ------ ------
Net income ............................. 6.5 9.3 15.8
------ ------ ------
Gross profit:
Software licensing ..................... 94.7% 94.8% 94.9%
Service, maintenance and other ......... 79.3 81.3 66.6
15
Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
Revenues
Total Revenues. Total revenues increased 70% from $26.7 million in 1997 to
$45.3 million in 1998.
Software Licensing. Software licensing revenues increased 99% from $14.6
million in 1997 to $29.1 million in 1998. This increase was primarily due to a
154% increase in Mercator license revenues to $23.8 million in 1998, partially
offset by a decrease in licenses of the Company's mainframe-based Trading
Partner and KEY/MASTER products.
Service, Maintenance and Other. Service, maintenance and other revenues
increased 34% from $12.1 million in 1997 to $16.2 million in 1998. The increase
was primarily due to a 70% increase in professional services revenues to $6.4
million in 1998, particularly professional services associated with Mercator. To
a lesser extent, this increase was also due to an increase in Mercator
maintenance revenue, offset by a slight decrease in maintenance revenue related
to the Company's mainframe-based Trading Partner and KEY/MASTER products.
Maintenance revenues attributable to KEY/MASTER were $4.2 million and $3.8
million for 1997 and 1998, respectively.
Cost of Revenues
Cost of software licensing revenues consists primarily of media, manuals,
distribution costs and the cost of third-party software that the Company
resells. Cost of service, maintenance and other revenues consists primarily of
personnel-related costs in providing maintenance, technical support, consulting,
and training to customers.
Gross margin on software licensing revenues is higher than gross margin on
service, maintenance and other revenues, reflecting the low materials, packaging
and other costs of software products compared with the relatively high personnel
costs associated with providing maintenance, technical support, consulting and
training services. Cost of service, maintenance and other revenues also varies
based upon the mix of maintenance, technical support, consulting and training
services.
Cost of Software Licensing. Cost of software licensing revenues increased
90% from $778,000 in 1997 to $1,481,000 in 1998. This increase was due to an
increase in product sales of Mercator. Software licensing gross margin remained
constant at 95% in 1997 and 1998.
Cost of Service, Maintenance and Other. Cost of service, maintenance and
other revenues increased 116% from $2.5 million in 1997 to $5.4 million in 1998.
The increase was primarily due to an increase in the number of support personnel
related to the Company's Mercator product, and the purchase of Software
Consulting Partners. Service, maintenance and other gross margin decreased from
80% in 1997 to 67% in 1998 due to the larger amount of professional services
business which has lower margin due to high labor costs.
Operating Expenses
Product Development. Product development expenses include expenses
associated with the development of new products and enhancements to existing
products. These expenses consist primarily of salaries, recruiting and other
personnel-related expenses, depreciation of development equipment, supplies,
travel and allocated facilities and communications costs.
Product development expenses increased 27% from $4.5 million in 1997 to
$5.7 million in 1998. This increase was primarily due to increased headcount
associated with the development of new Mercator-based products. Product
development expenses represented 17% and 13% of total revenues for 1997 and
1998, respectively.
The Company believes that a significant level of research and development
expenditures is required to remain competitive. Accordingly, the Company
anticipates that it will continue to devote substantial resources to research
and development. The Company expects that the dollar amount of research and
development expenses will increase through at least the remainder of 1999. To
date, all research and development expenditures have been expensed as incurred.
Selling and Marketing. Selling and marketing expenses consist of sales and
marketing personnel costs, including sales commissions, recruiting, travel,
advertising, public relations, seminars, trade shows, product descriptive
literature, and allocated facilities and communications costs.
16
Selling and marketing expenses increased 68% from $13.1 million in 1997 to
$22.0 million in 1998. This increase was primarily due to the increased number
of sales and marketing personnel required to address Mercator marketing
opportunities and increased spending on Mercator-related marketing programs.
Selling and marketing expenses remained constant at 49% of total revenues for
1997 and 1998, respectively.
The Company expects to continue hiring additional sales and marketing
personnel and to increase promotional expenses through at least the remainder of
1999 to address Mercator marketing opportunities and anticipates that sales and
marketing expenses will increase in absolute dollar amount.
General and Administrative. General and administrative expenses consist
primarily of salaries, recruiting, and other personnel-related expenses for the
Company's administrative, executive, and finance personnel as well as outside
legal and audit costs.
General and administrative expenses increased from $3.8 million in 1997 to
$6.2 million in 1998. The increase was primarily due to increased personnel and
management information system support, increased depreciation expenses for
computer equipment and system upgrades, and the amortization of intangible
assets of $303,000 related to the purchase of SCP. General and administrative
expenses represented 14% of total revenues for both 1997 and 1998.
The Company believes that the dollar amount of its general and
administrative expenses will continue to increase as the Company expands its
administrative staff and incurs additional costs.
Other Income (Expense), Net
Interest income increased from $688,000 in 1997 to $2,025,000 in 1998 due
to investment income earned on proceeds from the Company's initial public
offering in July, 1997 and follow on public offering in June, 1998. Borrowing
expenses decreased from $185,800 in 1997 to $10,900 in 1998 due to the repayment
of the Company's bank debt with the proceeds of its initial public offering.
Taxes
At December 31, 1998, the Company had remaining federal net operating loss
carryforwards of $1.9 million. The Company has concluded that it is more likely
than not that all of its federal net operating loss carryforwards will be
utilized; accordingly, the company reversed its valuation allowance for deferred
income taxes which resulted in the recording of a net tax benefit for the year
ending December 31, 1998. Due to utilization of net operating loss
carryforwards, the provision for income taxes in 1997 was insignificant.
Year Ended December 31, 1997 Compared with Year Ended December 31, 1996
Revenues
Total Revenues. Total revenues increased 40% from $19.0 million in 1996 to
$26.7 million in 1997.
Software Licensing. Software licensing revenues increased 57% from $9.3
million in 1996 to $14.6 million in 1997, primarily due to a 97% increase in
Mercator license revenues partially offset by a decrease in licenses of the
Company's mainframe-based Trading Partner and KEY/MASTER products.
Service, Maintenance and Other. Service, maintenance and other revenues
increased 25% from $9.7 million in 1996 to $12.1 million in 1997, primarily due
to a 125% increase in professional services revenues, particularly professional
services associated with Mercator and, to a lesser extent, an increase in
Mercator maintenance revenue, offset by a slight decrease in maintenance revenue
related to the Company's mainframe-based Trading Partner and KEY/MASTER
products. Maintenance revenues attributable to KEY/MASTER were $4.6 million and
$4.2 million for 1996 and 1997, respectively.
Cost of Revenues
Cost of Software Licensing. Cost of software licensing revenues increased
57% from $495,000 in 1996 to $778,000 in 1997. This increase was due to an
increase in product sales of Mercator. Software licensing gross margin remained
constant at 95% in 1996 and 1997.
17
Cost of Service, Maintenance and Other. Cost of service, maintenance and
other revenues increased 25% from $2.0 million in 1996 to $2.5 million in 1997.
The increase was primarily due to an increase in the number of support personnel
related to the Company's Mercator product. Service, maintenance and other gross
margin remained constant at 79% in 1996 and 1997.
Operating Expenses
Product Development. Product development expenses increased 29% from $3.5
million in 1996 to $4.5 million in 1997, primarily due to increased headcount
associated with the development of new Mercator-based products. Product
development expenses represented 18% and 17% of total revenues for 1996 and
1997, respectively.
Selling and Marketing. Selling and marketing expenses increased 51% from
$8.7 million in 1996 to $13.1 million in 1997. This increase was primarily due
to the increased number of sales and marketing personnel required to address
Mercator marketing opportunities and increased spending on Mercator-related
marketing programs. Selling and marketing expenses represented 46% and 49% of
total revenues for 1996 and 1997, respectively.
General and Administrative. General and administrative expenses increased
31% from $2.9 million in 1996 to $3.8 million in 1997. The increase was
primarily due to increased management and management information system staff
and increased depreciation expenses for computer equipment and system upgrades.
General and administrative expenses represented 15% and 14% of total revenues
for 1996 and 1997, respectively.
Other Income (Expense), Net
Interest income increased from $135,000 in 1996 to $688,000 in 1997 due to
investment income earned on proceeds from the Company's initial public offering.
Borrowing expenses decreased from $286,000 in 1996 to $185,800 in 1997 due to
the repayment of the Company's bank debt with the proceeds from its initial
public offering.
Taxes
Due to the utilization of net operating loss carryforwards, the provisions
for income taxes for 1997 and 1996 were not significant. At December 31, 1997,
the Company had federal net operating loss carryforwards of $6.8 million, all of
which expire through 2009. Due to the "change in ownership" provisions of the
Internal Revenue Code of 1986, the availability of net operating loss
carryforwards and research tax credits to offset federal taxable income in
future periods could be subject to an annual limitation if a change in ownership
for income tax purposes should occur.
Liquidity and Capital Resources
At December 31, 1998 the Company had net working capital of $53.7 million,
which includes cash and marketable securities of $47.9 million. Working capital
at December 31, 1997 was $23.4 million, including cash and marketable securities
of $21.4 million. In 1998, cash provided by operations was $5.7 million compared
to cash used of ($195,500) in 1997.
Net accounts receivable were $18.0 million at December 31, 1998 compared to
$7.9 million at December 31, 1997. The number of days of average revenues in
accounts receivables was 88 at December 31, 1997 compared to 109 at December 31,
1998. The increase in accounts receivable is due to the increase in sales billed
during the last month of the quarter as compared to 1997, the increase in
deferred revenue and the granting of extended terms for certain customers.
Capital expenditures have been, and future capital expenditures are anticipated
to be, primarily for facilities, equipment and computer software to support
expansion of the Company's operations. Additions to property, plant and
equipment accounted for $1,802,200 and $876,200 for 1998 and 1997, respectively.
As of December 31, 1998, the Company had no material commitments for capital
expenditures.
The Company believes that its current cash and cash equivalent balances,
and net cash generated by operations, will be sufficient to meet its anticipated
cash needs for working capital, capital expenditures and business expansion for
at least the next 12 months. Thereafter, if cash generated by operations is
insufficient to
18
satisfy the Company's operating requirements, the Company may seek additional
debt or equity financing. The sale of additional equity or debt securities could
result in dilution to the Company's stockholders. In an effort to best utilize
its working capital, the Company intends to pursue the development and
acquisition of additional products or businesses which support the current
business needs. Although the Company is continually considering and evaluating
opportunities for future growth, the Company has no agreements or understandings
with respect to any material acquisitions.
Year 2000 Readiness Disclosure
Awareness; The company is aware of the issues associated with the
programming code in existing computer systems as the millennium ("Year 2000")
approaches. Many currently installed computer systems and software products are
unable to distinguish between twentieth century dates and twenty-first century
dates because such systems may have been developed using two digits rather than
four to determine the applicable year. For example, computer programs that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This error could result in system failures, generation of
erroneous data or miscalculations causing disruption of operations, including
among other things, a temporary inability to process transactions, send invoices
or engage in similar normal business activities. As a result, many companies'
software and computer systems may need to be upgraded or replaced to comply with
such Year 2000 requirements. The Year 2000 problem is pervasive and complex.
Significant uncertainty exists in the software industry concerning the potential
impact of Year 2000 problems. The Company is assessing the potential overall
impact of the impending century change on the Company's business, financial
condition and results of operations.
State of Readiness; based on the Company's assessment to date, the Company
believes the current versions of its software products and services are "Year
2000 compliant" -- that is, they are capable of adequately distinguishing
twenty-first century dates from twentieth century dates. New products are being
designed to be Year 2000 compliant. Although the Company's products have
undergone, or will undergo, the Company's normal quality testing procedures,
there can, however, be no assurance that the Company's products will contain all
necessary date code changes. Furthermore, use of the Company's products in
connection with other products which are not Year 2000 compliant, including
non-compliant hardware, software and firmware may result in the inaccurate
exchange of dates and result in performance problems or system failure. In
addition, OEM derivative versions of older products may not be Year 2000
compliant. Any failure of the Company's products to perform, including system
malfunctions associated with the onset of year 2000, could result in claims
against the Company. However, success of the Company's Year 2000 compliance
efforts may depend on the success of its customers in dealing with the Year 2000
issue. We have issued disclosure statements to all our existing customers and
have posted these statements on our website.
Although the Company has not been a party to any litigation or arbitration
proceeding to date that involves Year 2000 compliance issues with its products
or services, it could be required to defend its products or services in such
proceedings, or to negotiate resolutions of claims based on Year 2000 issues.
The costs of defending and resolving Year 2000-related disputes, regardless of
the merits of such disputes, and any liability of the Company for Year
2000-related damages, excluding consequential damages, could have a material
adverse effect on the Company's business.
In addition, the Company believes that purchasing patterns of customers and
potential customers of the Company may be affected by Year 2000 compliance
issues as organizations expend significant resources to correct their current
software systems for Year 2000 compliance. These expenditures may result in
reduced funding available to such entities for other information technology
purchases, such as those products and services offered by the Company.
Furthermore, customers and potential customers may defer information technology
purchases generally until early in the next millennium to avoid Year 2000
compliance problems. Any such deferral of purchases by the Company's customers
or potential customers could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company's business depends on numerous systems that could potentially
be impacted by Year 2000 related problems. Those systems include, among others:
hardware and software systems used by the Company to deliver products and
services to its customers (including software supplied by third parties);
communications networks such as the wide area network and local area networks
upon which the Company depends to communicate product orders to its
manufacturing and distribution operations and to develop products; the internal
systems of the Company's customers and suppliers; software products sold to
customers; the hardware and
19
software systems used internally by the Company in the management of its
business; and non-information technology systems and services used by the
Company in the management of its business, such as power, telephone systems and
building systems.
The Company is currently in the process of evaluating its information
technology infrastructure in order to identify and modify any products, services
or systems that are not Year 2000 compliant. Based on its initial analysis of
the systems potentially impacted by conduct business in the twenty-first
century, the Company is applying a phased approach to making such systems, and
accordingly, the Company's operations, ready for the year 2000. Beyond awareness
of the issues and scope of systems involved, the phases of activities in process
include: an assessment of specific underlying computer systems, programs and
hardware; renovation or replacement of Year 2000 non-compliant technology;
validation and testing of critical systems certified by third-party suppliers to
be Year 2000 compliant; and implementation of Year 2000 compliant systems. The
table below describes the status and timing of such phased activities:
Impacted Systems Targeted
Assessment Status Completion
---------- ------ ----------
Software products sold to customers
-- Existing Products Software products Q3 1998
tested and available (completed)
for distribution
-- New Products ongoing
Hardware and software Assessment in process Q1 1999
systems used to deliver
products and services
Communication networks used Assessment in progress Q1 1999
to carry products and
provide services
Hardware and software Assessment in progress Q1 1999
systems used to manage
the Company's business
Hardware and software Validation, testing Q2 1999
systems used to deliver and remediation
products and services
Communication networks used Validation, testing Q2 1999
To carry products and and remediation
provide services
Hardware and software Validation, testing Q3 1999
systems used to manage and remediation
the Company's business
Non-information technology Systems upgraded or Q3 1999
systems and services replaced as appropriate,
testing and implementation
Extensive Year 2000 Testing will be conducted on all systems considered
critical to the Company. To date, the Company has not encountered any material
problems in this regard with its computer systems or any other equipment that
might be subject to such problems. In the event that any of the Company's
significant suppliers or customers does not successfully and timely achieve Year
2000 compliance, the Company's business or operations could be adversely
affected. This could result in system failures or generation of erroneous
information and could cause significant disruption to business activities. The
Company is reviewing what further actions are required to make all software
systems used internally Year 2000 compliant as well as actions needed to
mitigate vulnerability to problems with suppliers and other third parties'
systems. Such actions include a review of vendor contracts and formal
communication with suppliers to request certification that products are Year
2000 compliant.
20
Cost to Address Year 2000 Issues;The total cost of these Year 2000 compliance
activities has not been, and is not anticipated to be, material to the Company's
business, results of operations and financial condition. These costs and the
timing in which the Company plans to complete its Year 2000 modification and
testing processes are based on management's estimates. However, there can be no
assurance that the Company will timely identify and remedy all significant Year
2000 problems, that remediation efforts will not involve significant time and
expense, or that such problems will not have a material adverse effect on the
Company's business, results of operations and financial condition.
Contingency Plan;The Company does not presently have a formal contingency
plan for handling Year 2000 problems that are not detected and corrected prior
to their occurrence, although the company has identified specific individuals to
address and resolve any Year 2000 related issues.
CONVERSION TO A SINGLE EUROPEAN CURRENCY
The company has sales in a number of foreign countries. However, as the
majority of foreign sales are in the UK, conversion to a single European
currency would not have a material impact on the Company's financial results.
FACTORS THAT MAY AFFECT FUTURE RESULTS
TSI Software depends on it's Mercator Product Line. The Company introduced
its Mercator products in 1993. In recent years, a significant and increasing
portion of the Company's revenue has been attributable to licenses of its
Mercator products and related services, and the Company expects that revenues
attributable to Mercator will represent an increasing portion of the Company's
total revenue for the foreseeable future. The development and marketing of its
Mercator product line has required the Company to, among other things, focus its
attention and resources away from some of its traditional products, market its
products to a different customer base and shift a large portion of its
development efforts to the Mercator product line. Accordingly, the Company's
future operating results are highly dependent on the market acceptance and
growth of its Mercator product line and enhancements to this line.
Market acceptance of the Mercator product line may not increase or remain
at current levels. The Company may not be able to successfully market the
Mercator product line and develop extensions and enhancements to this product
line on a long-term basis. In the event the Company's current or future
competitors release new products that provide, or are perceived as providing,
more advanced features, greater functionality, better performance, better
compatibility with other systems or lower prices than the Mercator product line,
demand for the Company's products and services would likely decline. See "Risks
Associated with Technological Change, Product Enhancements and New Product
Development" and "Competition." A decline in demand for, or market acceptance
of, the Mercator product line as a result of competition, technological change
or other factors would have a material adverse effect on the Company's business.
TSI Software depends on SAP R/3 System Implementations. A substantial
portion of the Company's sales of its Mercator products and related services has
been attributable to sales of Mercator for R/3 and related services. The Company
believes that its future revenue growth, if any, will also depend in significant
part upon continued sales of Mercator for R/3 and related services. The Company
has devoted and must continue to devote substantial resources to identifying
potential customers in the R/3 market, building strategic relationships and
attracting and retaining skilled technical, sales and professional services
personnel with expertise in R/3 systems. Personnel with expertise in the R/3
system are in high demand and as such are typically difficult to hire and
retain. Regardless of the investments the Company makes in pursuing this new
market, there can be no assurance that the Company will be successful in
implementing a sales and marketing strategy appropriate for this market or in
attracting and retaining the necessary skilled personnel.
Demand for and market acceptance of Mercator for R/3 and related services
will be dependent on the continued market acceptance of the SAP R/3 system. As a
result, any factor adversely affecting demand for or use of SAP's R/3 system
could have a material adverse effect on the Company's business, operating
results and financial condition. Implementation of the SAP R/3 system is a
costly and time-consuming process and there can be no assurance that businesses
will choose to purchase such systems. Furthermore, there can be no assurance
that businesses which may implement such systems will wish to commit the
additional resources required to implement Mercator for R/3. In addition, SAP
could in the future introduce business application integration solutions
competitive with Mercator for R/3 and related services. Moreover, any changes in
or new versions of SAP's R/3
21
system could materially and adversely affect the Company's business, operating
results and financial condition if the Company were not able to successfully
develop or implement any related changes to Mercator for R/3 in a timely
fashion. The Company will also be required to maintain ALE, EDI and DMI
certifications for Mercator for R/3. In order to maintain such certification,
the Company's product must adhere to SAP's technical specifications which are
updated by SAP from time to time, and the Company has no control over whether
and when such specifications will be changed. Any material change by SAP in such
specifications could require the Company to devote significant development
resources to updating this product to comply with such specifications. In such
event, there can be no assurance that the Company would be able to successfully
modify Mercator for R/3 on a timely basis, if at all, and any failure to do so
could materially and adversely affect the Company's business, operating results
and financial condition.
The Company may, in the future, seek to develop and market enhancements to
existing products or new products which are targeted for applications, systems
or platforms which the Company believes will achieve commercial acceptance.
These efforts could require the Company to devote significant development and
sales and marketing personnel as well as other resources to such efforts which
would otherwise be available for other purposes. The Company may not be able to
successfully identify such applications, systems or platforms. Also these
applications, systems or platforms will achieve commercial acceptance or Company
may not realize a sufficient return on its investment.
In addition, the introduction or announcement by the Company, or by one or
more of its current or future competitors, of products embodying new
technologies or features could render the Company's existing products obsolete
or unmarketable
Dependence upon Development of Distribution Channels. An integral part of
the Company's strategy is to expand both its direct sales force and its indirect
sales channels such as Value-Added Resellers (or VARs), Independent Software
Vendors (or ISVs), Systems Integrators (or SIs) and distributors. Although VARs,
ISVs, SIs and distributors have not accounted for a substantial percentage of
the Company's total revenues historically, the Company is increasing resources
dedicated to developing and expanding its indirect distribution channels. TSI
Software may not be successful in expanding the number of indirect distribution
channels for its products. Furthermore, any new VARs, ISVs, SIs or distributors
may offer competing products, or have no minimum purchase requirements of the
Company's products. These third parties may also not provide adequate levels of
services and technical support. The inability of the Company to enter into
additional indirect distribution arrangements, the failure of these third
parties to perform under agreements with the Company and to penetrate their
markets, or the inability of the Company to retain and manage VARs, ISVs, SIs
and distributors with the technical and industry expertise required to market
the Company's products successfully could have a material adverse effect on the
Company's business. The Company's planned efforts to expand its use of VARs,
ISVs, SIs and distributors may not be successful. To the extent that the Company
is successful in increasing its sales through indirect sales channels, it
expects that those sales will be at lower per-unit prices than sales through
direct channels. Therefore revenue to the Company for each such sale will be
less than if the Company had licensed the same product to the customer directly.
Selling through indirect channels may limit the Company's contacts with its
customers. As a result, the Company's ability to accurately forecast sales,
evaluate customer satisfaction and recognize emerging customer requirements may
be hindered.
The Company's strategy of marketing its products directly to end-users and
indirectly through VARs, ISVs, SIs and distributors may also result in
distribution channel conflicts. The Company's direct sales efforts may compete
with those of its indirect channels and, to the extent different resellers
target the same customers, resellers may also come into conflict with each
other. Although the Company has attempted to manage its distribution channels to
avoid potential conflicts, channel conflicts could materially and adversely
affect its relationships with existing VARs, ISVs, SIs or distributors or
adversely affect its ability to attract new VARs, ISVs, SIs and distributors.
Management of Growth. The growth of the Company's business has placed, and
is expected to continue to place, a strain on the Company's administrative,
financial, sales and operational resources and increased demands on its systems
and controls. In particular, the Company noted an increase in days sales
outstanding from December 31, 1997 to December 31, 1998 from approximately 88
days to approximately 109 days, and an increase in total accounts receivable
from $7.9 million to $18.0 million. Accounts Receivable DSOs were higher at
December 31, 1998 versus December 31, 1997 due to an increase of maintenance
billings, an increase in deferred revenue where
22
amounts have been billed and revenue will be recognized in future periods, and a
higher proportion of new sales billed during the last month of the Company's
fourth quarter of 1998 as compared to the fourth quarter of 1997.
The Company has implemented or is in the process of implementing and will
be required to implement in the future a variety of new and upgraded operational
and financial systems, procedures and controls and to hire additional
administrative personnel. TSI Software may not be able to complete the
implementation of these systems, procedures and controls or hire such personnel
in a timely manner. The failure of the Company or its management to respond to,
and manage, its growth and changing business conditions, or to adapt its
operational, management and financial control systems to accommodate its growth
could have a material adverse effect on the Company's business. To promote
growth in the Company's sales and operations, the Company will also continue to
expand its sales and marketing organizations, expand and develop its
distribution channels, fund increasing levels of product development and
increase the size of its training, professional services and customer support
organization to accommodate expanded operations. The Company may not be
successful in these endeavors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
TSI is exposed to market risk primarily through its investments in
marketable securities. TSI's investment policy calls for investment in short
term, low risk instruments. As of December 31, 1998, investments in marketable
securities was $32.8 million. Due to the nature of these investments, any
decrease in rates would not have material impact on the Company's financial
statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements of the Company meeting the requirements of Regulation
S-X are filed on pages F1 to F17 of this Annual Report on Form 10-K. See Part
IV, Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
23
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Information regarding the Company's directors as required by this item will
be included in the Company's proxy statement, to be delivered to stockholders in
connection with the Company's annual meeting of stockholders to be held in March
1999. Such information is incorporated herein by reference.
The following sets forth certain information with respect to the Company's
executive officers:
Executive Officers
Name Age Position with the Company
---- --- -------------------------
Constance F. Galley ................. 57 President and Chief Executive Officer and Director
Eric A. Amster ...................... 44 Vice President, Sales
Patricia T. Boggs ................... 47 Vice President, Professional Services
Robert Bouton ....................... 58 Vice President, Marketing
Albert Denz ......................... 48 Vice President, Managing Director EUMA and AP
Ira A. Gerard ....................... 51 Vice President, Finance and Administration,
Chief Financial Officer and Secretary
James Monks ......................... 43 Vice President, International Operations
Ulrich K. Neubert ................... 47 Vice President, Consulting
R. Anthony Percy .................... 52 Vice President, Strategic Planning
David Raye .......................... 37 Vice President, Operations
Edward J. Watson .................... 61 Executive Vice President, Business Development
Saydean Zeldin ...................... 58 Vice President, Research and Development
Constance F. Galley has been President, Chief Executive Officer and a
director of the Company since 1985, when the Company commenced operating as an
independent entity. Prior to 1985, Ms. Galley directed the Company's Marketing
and Development Operations when the Company was part of the Dun & Bradstreet
Corporation. Ms. Galley is a member of the Board of Directors of the software
division of ITAA and IVANS, and is the former chairperson of SACIA, the Business
Council of Southwestern Connecticut. Ms. Galley holds a Bachelor of Arts degree
in Chemistry from Duke University.
Eric A. Amster has been Vice President, Sales since joining the Company in
December 1995. From February 1992 until December 1995, Mr. Amster was employed
by General DataComm Industries, Inc., a data communications company, where he
served most recently as Vice President of U.S. Federal and Commercial Sales. Mr.
Amster holds a Bachelor of Science degree in Computer Science from the
University of Maryland.
Patricia T. Boggs has been Vice President, Professional Services since
joining the Company in June 1997. From February 1991 to 1997, Ms. Boggs was
employed by Datalogix International Inc., where she served most recently as Vice
President Client Services. Prior to 1991 Ms. Boggs was an Assistant Professor at
both John Carroll University, University Heights, Ohio and Wright State
University in Dayton, Ohio. Ms. Boggs holds a Masters Degree in Economics and a
Doctorate in Operations Research/Statistics from Kent State University.
Robert Bouton has been Vice President, Marketing since joining the Company
in March 1992. Prior to March 1992, Mr. Bouton served in various sales and
marketing capacities in the software industry, including Vice President,
Marketing for CGI Systems. Mr. Bouton holds a Bachelor of Science degree in
Electrical Engineering from Cornell University.
Albert Denz, Managing Director and Vice President International Operations
joined TSI Software in January, 1999 from SAP AG where he served as vice
president, corporate marketing beginning in 1996. Prior to SAP, Denz had a
19-year career at IBM where he served in various executive sales positions and
as IBM's international director of SAP operations. Denz graduated from the
University of Teubingen in Saarbruecken, Germany, with a degree in economics.
24
Ira A. Gerard has been Vice President, Finance and Administration, Chief
Financial Officer, Treasurer and Secretary since joining the Company in October
1995. From March 1994 to October 1995, Mr. Gerard served as Vice President and
Chief Financial Officer of Adage Systems International, Inc., an ERP software
company. From July 1993 to March 1994, Mr. Gerard was an independent consultant.
From December 1989 until July 1993, Mr. Gerard was employed by Gestetner PLC, a
photocopier and photographic equipment company, where he served most recently as
Vice President, Finance and Operations. Mr. Gerard holds a Bachelor of Arts
degree in Economics from Union College and a Master of Business Administration
from Harvard University.
James Monks has been Vice President, International Operations of the
Company since May 1997 and was Director, International Operations of the Company
from May 1992 until May 1997. From May 1989 until May 1992, Mr. Monks served as
the Company's Director of European Operations and from April 1985 until May
1989, Mr. Monks served as the Company's U.K. Manager. Prior to April 1985, Mr.
Monks held various technical support and management positions with the Company
when the Company was a part of the Dun & Bradstreet Corporation. Mr. Monks holds
an Honours Degree in Sports Science and Geography from the University of
Loughborough, U.K.
Ulrich K. Neubert, Vice President, Consulting, joined TSI Software with
TSI's acquisition of Software Consulting Partners in November, 1998. Prior to
joining TSI, Neubert was president of Software Consulting Partners, an SAP
implementation firm he founded in 1994. Prior thereto, Neubert spent 8 years at
SAP AG, where he last served as a consulting manager. Neubert graduated from the
University of Saarbruecken in Germany, with a degree in informatics.
R. Anthony Percy, Vice President, Strategic Planning, joined TSI Software
in January, 1999 after more than ten years with Gartner Group, where he was Vice
President, Director of Research and a research fellow. Percy is a graduate of
Christ Church, Oxford.
David Raye has been the Vice President, Operations of the Company since
June 1994. From August 1992 until May 1994, Mr. Raye served as Vice President,
KEY/MASTER Operations. From August 1991 until July 1992, Mr. Raye served as the
Company's Director of Operations. Prior to August 1991, Mr. Raye served in
various management capacities in the software industry including Director of
Marketing for Information Sciences and Senior Product Marketing Manager for
On-Line Software, International. Mr. Raye holds a Bachelor of Science degree in
Marketing from Rutgers University and a Master of Business Administration from
St. John's University, New York.
Edward J. Watson has been Executive Vice President, Business Development of
the Company since June 1994. From January 1994 until June 1994, Mr. Watson
managed the Company's PC Division. From November 1990 until January 1994, Mr.
Watson was a consultant to the Company and a General Partner of DownEast
Partners, a consulting company. Prior to 1990, Mr. Watson served in various
management capacities in the software industry, including President of TSI
International (the predecessor of the Company) and Higher Order Software. Mr.
Watson is married to Ms. Saydean Zeldin, the Vice President, Research and
Development of the Company. Mr. Watson attended Oxford University.
Saydean Zeldin has been Vice President, Research and Development of the
Company since October 1994. From November 1990 to October 1994, Ms. Zeldin was a
consultant to the Company and a general partner at DownEast Partners, a
consulting company. Prior to 1990, Ms. Zeldin served in several senior
engineering positions in the software industry, including serving as Founder and
President of Touchstone Engineering, a software company that developed a
management planning system using artificial intelligence technology, and Founder
and Executive Vice President of Higher Order Software. Ms. Zeldin was also
responsible for the re-entry guidance development of the Apollo flight software
at the Instrumentation Laboratory, a laboratory of MIT. Ms. Zeldin is married to
Mr. Watson, the Executive Vice President, Business Development of the Company.
Ms. Zeldin holds a Bachelor of Arts degree in Physics from Temple University.
Appointment to Board of Directors. On August 27, 1998 James P. Schadt,
Chairman, Dailey & Partners and retired chairman and CEO, Readers Digest
Association, Inc. was appointed to TSI Software's Board of Directors.
25
ITEM 11. EXECUTIVE COMPENSATION
Compensation Agreements
Information required by this item will be included in the Company's proxy
statement, to be delivered to stockholders in connection with the Company's
annual meeting of stockholders to be held in March, 1999. Such information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT
Information required by this item will be included in the Company's proxy
statement, to be delivered to stockholders in connection with the Company's
annual meeting of stockholders to be held in March 26, 1999. Such information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item will be included in the Company's proxy
statement, to be delivered to stockholders in connection with the Company's
annual meeting of stockholders to be held in March, 1999. Such information is
incorporated herein by reference.
26
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements, Financial Statement Schedules and Exhibits
1. Financial Statements
The consolidated financial statements of the Company filed as part of the
Annual Report on Form 10-K are listed in Item 8 of this Annual Report on Form
10-K.
2. Financial Statement Schedules
The financial statement schedules required by Regulation S-X are listed in
Item 14(d) of this Annual Report on Form 10-K.
3. Exhibits.
The Exhibits filed as a part of this Annual Report are listed in Item 14(c)
of this Annual Report on Form 10-K.
(b) Reports on Form 8-K.
The Company filed a report on Form 8-K on November 30, 1998 with respect to
the Company's acquisition of substantially all of the assets of and assumption
of certain liabilities of Software Consulting Partners.
(c) Exhibits.
The Exhibits required by Regulation S-K are set forth in the following list
and filed either by incorporation by reference from previous filings with the
Securities and Exchange Commission or by attachment to this Annual Report on
Form 10-K as so indicated in such list.
Exhibit
Number Exhibit Title
------ -------------
2.01 Asset Transfer Agreement dated as of November 13, 1998 by and
among the Company, Software Consulting Partners ("SCP") and a
stockholder of SCP/(1)/
3.01 Amended and Restated Certificate of Incorporation/(2)/
3.02 Registrant's Amended and Restated Bylaws/(3)/
3.03 Certificate of Designations specifying the terms of the Series
A Junior Participating Preferred Stock of the Company/(4)/
4.01 Form of Specimen Certificate for Registrant's Common
Stock/(2)/
4.02 Stockholders Agreement dated as of June 1, 1989, as
amended/(2)/
4.03 1989 Stock Purchase Agreement dated as of June 1, 1989, as
amended/(2)/
10.01 *Registrant's 1993 Stock Option Plan and related
documents/(2)/
10.02 *Registrant's 1997 Equity Incentive Plan/(2)/
10.03 *Registrant's 1997 Directors Stock Option Plan/(2)/
10.04 *Registrant's 1997 Employee Stock Purchase Plan/(2)/
10.05 *Registrant's Profit Participation Plan/(2)/
10.06 Form of Indemnification Agreement to be entered into by
Registrant with each of its directors and executive
officers/(2)/
10.07 Lease Agreement dated as of January 2, 1990 between Registrant
and Robert D. Scinto, as amended/(2)/
10.08 Office Building Lease dated as of February 4, 1994 between
Registrant and American National Bank and Trust Company of
Chicago, not individually but solely as Trustee under Trust
No. 42978, as amended/(2)/
10.09 Lease Agreement dated as of July 1, 1996 between Registrant
and Boca Corners, L.P., Ltd., as amended/(2)/
10.10 Credit Agreement dated as of July 31, 1994 between Registrant
and The Bank of New York, as amended/(2)/
27
Exhibit
Number Exhibit Title
------ -------------
10.11 Security Agreement dated as of July 31, 1994 between
Registrant and The Bank of New York/(2)/
10.12 Guarantee Agreement dated as of August 22, 1994 by and between
the Connecticut Development Authority and The Bank of New
York, as amended/(2)/
10.13 *Letter Agreement, between Registrant and Constance
Galley/(2)/
10.14 *Letter Agreement dated as of December 5, 1995 between
Registrant and Eric Amster/(2)/
10.15 *Letter Agreement dated as of October 5, 1995, between
Registrant and Ira Gerard/(2)/
10.16 *Letter Agreement dated as of January 1, 1994 between
Registrant and Edward Watson/(2)/
10.17 *Letter Agreement dated as of October 1, 1994, between
Registrant and Saydean Zeldin/(2)/
10.18 Series E Preferred Stock Purchase Agreement dated as of May
15, 1997 between the Company and the Purchasers named
therein/(2)/
11.01 Statement of Earnings Per Share
23.01 Independent Auditors' Report on Schedules
24.01 Power of Attorney (see signature page)
27.01 Financial Data Schedule
- ----------
* Indicates a management contract or compensatory plan or arrangement.
(1) Previously filed as an exhibit to the Company's current Report on Form 8-K
filed on November 30, 1998 and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Registration Statement on
Form S-1 (File No. 333-27293) and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's Registration Statement on
Form 8-A (File No. 000-22667) filed on September 4, 1998 and incorporated
herein by reference.
(4) Previously filed as an exhibit to the Company's Report on Form 8-K filed on
September 4, 1998 and incorporated herein by reference.
(d) Financial Statement Schedules.
28
Schedule II Valuation and Qualifying Accounts
TSI International Software Ltd.
Financial Statement Schedule
Valuation and Qualifying Accounts
Charged
Balance at Costs Charged to Balance at
Beginning and Other End of
Description of Period Expenses Accounts/(1)/ Deductions/(2)/ Period
----------- --------- -------- ------------- --------------- ------
Allowance for Doubtful
Accounts Receivable
Year ended December 31, 1996 ...... 158,100 431,700 1,400 (271,300) 319,900
Year ended December 31, 1997 ...... 319,900 431,600 100,000 (380,200) 471,300
Year ended December 31, 1998 ...... 471,300 837,800 800,000 (211,200) 1,897,900
- ----------
(1) Recoveries of balances previously written off and initial reserve recorded
upon acquisition of SCP accounts receivable.
(2) Write-offs of receivables and reversals of unneeded balances.
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission have been
omitted because they are not required under the related instructions or are
inapplicable, or because the information has been provided in the Consolidated
Financial Statements or the Notes thereto.
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act,
the Registrant caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized.
March __, 1998
TSI INTERNATIONAL SOFTWARE, LTD.
By:
------------------------------------------
Constance F. Galley
President and Chief Executive Officer
By:
------------------------------------------
Ira A. Gerard
Vice President, Finance and Administration,
Chief Financial Officer, Treasurer and Secretary
30
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
The Board of Directors
TSI International Software Ltd.
The audits referred to in our report dated February 2, 1998 included the
related financial statement schedule for the years ended December 31, 1996,
1997, and 1998, included in the registration statement. This financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion of this financial statement schedule based on our
audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly in
all material respects, the information set forth therein.
KPMG PEAT MARWICK LLP
New York, New York
February 2, 1999
31
TSI INTERNATIONAL SOFTWARE LTD.
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report ............................................. F-2
Balance Sheets as of December 31, 1996 and 1997 .......................... F-3
Statements of Income for the years ended
December 31, 1995, 1996 and 1997 .................................... F-4
Statements of Stockholders' Equity (Deficit) as of
December 31, 1995, 1996 and 1997 .................................... F-5
Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997 .................................... F-6
Notes to Financial Statements ............................................ F-7
F-1
Independent Auditors' Report
The Board of Directors
TSI International Software Ltd.:
We have audited the accompanying balance sheets of TSI International
Software Ltd. (the "Company") as of December 31, 1997 and 1998, and the related
statements of income, stockholders' equity (deficit) and cash flows for each of
the years in the three year period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of TSI International Software
Ltd. as of December 31, 1997 and 1998, and the results of its operations and its
cash flows for each of the years in the three year period ended December 31,
1998 in conformity with generally accepted accounting principles.
New York, New York
February 3, 1999
F-2
TSI International Software, Ltd.
Balance Sheets
December 31,
----------------------------
1997 1998
------------ ------------
Assets
Current Assets
Cash .................................................................. $ 10,912,500 $ 15,132,700
Investments in marketable securities .................................. 10,490,500 32,812,100
Accounts receivable, less allowances of $471,300 and $1,897,900 ....... 7,864,100 17,965,500
Current portion of investment in licensing contracts receivable,
net of unearned finance income of $60,000 and $68,100 ............... 678,100 522,000
Prepaid expenses and other current assets ............................. 745,000 729,400
Deferred tax assets ................................................... -- 2,695,100
------------ ------------
Total current assets .................................................. 30,690,200 69,856,800
Furniture, fixtures and equipment, net ..................................... 1,587,300 2,699,400
Intangible assets, net ..................................................... -- 5,155,400
Investment in licensing contracts receivable, net of unearned finance
income of $38,700 and $51,100 ......................................... 421,800 271,300
Other assets ............................................................... 242,400 204,400
------------ ------------
$ 32,941,700 $ 78,187,300
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ...................................................... $ 600,200 $ 1,546,700
Accrued expenses ...................................................... 2,207,900 6,479,900
Current portion of deferred revenue ................................... 4,511,000 8,088,000
------------ ------------
Total current liabilities ........................................ 7,319,100 16,114,600
Other long-term liabilities ................................................ 17,800 17,500
Deferred revenue, less current portion ..................................... 188,400 156,400
------------ ------------
Total liabilities ................................................ 7,525,300 16,288,500
------------ ------------
Stockholders' equity:
Convertible Preferred Stock (authorized 5,000,000 shares; no par value) -- --
Common stock ($.01 par value; authorized 20,000,000 shares;
issued 9,056,542 shares and 11,141,569 shares); ..................... 90,600 111,600
Additional paid-in capital ............................................ 33,359,300 63,956,200
Deferred Compensation ................................................. (225,100) (1,430,500)
Accumulated deficit ................................................... (7,557,000) (400,200)
Other comprehensive income ............................................ (199,300) (338,300)
Treasury stock, at cost (102,478 and 0 shares) ........................ (52,100) --
------------ ------------
Total stockholders' equity ....................................... 25,416,400 61,898,800
------------ ------------
Total liabilities and stockholders' equity ....................... $ 32,941,700 $ 78,187,300
============ ============
F-3
TSI International Software, Ltd.
Statements of Income
Years ended December 31,
--------------------------------------------
1996 1997 1998
------------ ------------ ------------
Revenues:
Software licensing ................. $ 9,309,500 $ 14,602,400 $ 29,104,700
Service, maintenance and other ..... 9,694,400 12,067,300 16,211,400
------------ ------------ ------------
Total revenues ................ 19,003,900 26,669,700 45,316,100
------------ ------------ ------------
Cost of revenues:
Software licensing ................. 494,800 778,100 1,481,900
Service, maintenance and other ..... 2,005,700 2,490,000 5,407,200
------------ ------------ ------------
Total cost of revenues ........ 2,500,500 3,268,100 6,889,100
------------ ------------ ------------
Gross profit .................. 16,503,400 23,401,600 38,427,000
------------ ------------ ------------
Operating expenses:
Product development ................ 3,452,300 4,461,800 5,699,000
Selling and marketing .............. 8,715,200 13,095,100 22,032,500
General and administrative ......... 2,921,500 3,791,600 6,232,100
------------ ------------ ------------
Total operating expenses ...... 15,089,000 21,348,500 33,963,600
------------ ------------ ------------
Operating income .............. 1,414,400 2,053,100 4,463,400
Borrowing expenses ...................... (285,500) (185,800) (10,900)
Investment income ....................... 135,200 688,300 2,025,400
------------ ------------ ------------
Income before income taxes .... 1,264,100 2,555,600 6,477,900
Provision for (benefit from) income taxes 36,200 76,000 (678,900)
------------ ------------ ------------
Net income .................... $ 1,227,900 2,479,600 7,156,800
============ ============ ============
Net income per share:
Basic .............................. $ 0.43 $ 0.42 $ 0.71
============ ============ ============
Diluted ............................ $ 0.21 $ 0.29 $ 0.60
============ ============ ============
Average shares outstanding:
Basic .............................. 2,886,822 5,916,993 10,149,503
============ ============ ============
Diluted ............................ 5,811,210 8,566,761 11,907,804
============ ============ ============
See accompanying notes to financial statements.
F-4
TSI International Software Ltd.
Statements of Cash Flows
Years ended December 31,
--------------------------------------------
1996 1997 1998
------------ ------------ ------------
Cash flows from operating activities:
Net income ........................................... $ 1,227,900 $ 2,479,600 $ 7,156,800
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization ................... 436,100 623,300 1,129,500
Amortization of deferred compensation ........... -- 35,900 65,200
Tax benefit of options exercised ................ -- -- 937,700
Provision for losses on accounts receivable ..... 431,700 281,400 837,800
Deferred taxes .................................. -- -- (2,405,100)
Changes in operating assets and liabilities:
Accounts receivable ........................ (1,930,500) (3,848,600) (10,734,000)
Investment in licensing contracts receivable 585,300 193,700 306,600
Prepaid expenses and other current assets .. (87,200) (357,000) 15,600
Other assets ............................... (43,500) (129,300) 48,100
Accounts payable ........................... 255,700 (94,600) 946,500
Accrued expenses ........................... 220,000 736,900 3,887,500
Deferred maintenance revenue ............... (365,600) (116,800) 3,545,000
------------ ------------ ------------
Net cash provided (used) by
operating activities ................ 729,900 (195,500) 5,737,200
------------ ------------ ------------
Cash used by investing activities:
Purchase of furniture, fixtures and equipment ........ (827,500) (876,200) (1,802,200)
Net cash paid to satisfy liabilities of SCP .......... -- -- (4,653,300)
Purchases of marketable securities ................... -- (10,490,500) (22,316,200)
------------ ------------ ------------
Net cash used by investing activities . (827,500) (11,366,700) (28,771,700)
------------ ------------ ------------
Cash flows from financing activities:
Net proceeds from public offerings ................... -- 24,272,300 25,378,200
Issuance of Preferred Stock .......................... -- 993,400 --
Net borrowings (repayments) under
revolving line of credit ........................... (50,000 (2,790,100) --
Exercise of warrants ................................. -- -- 764,600
Payments under capital leases ........................ (51,900) (55,100) (10,500)
Stock options exercised .............................. -- 8,700 130,300
Proceeds from employee stock plan .................... -- -- 988,600
------------ ------------ ------------
Net cash (used) provided by financing activities (101,900) 22,429,200 27,251,200
------------ ------------ ------------
Effect of exchange rate changes on cash ................... 98,300 4,200 3,500
------------ ------------ ------------
Net change in cash ................................... (101,200) 10,871,200 4,220,200
Cash at beginning of period ............................... 142,500 41,300 10,912,500
------------ ------------ ------------
Cash at end of period ..................................... $ 41,300 $ 10,912,500 $ 15,132,700
============ ============ ============
Supplemental information:
Cash paid for:
Interest ........................................ $ 278,900 $ 171,500 $ --
Income taxes .................................... 27,100 42,200 615,517
Non-cash investing and financing activities:
Acquisition of equipment under capital leases ........ $ -- $ 30,000 $ --
Conversion of preferred stock to common stock ........ -- 9,100 --
Net exercise of warrants ............................. -- 3,000 500
Common Stock issued for acquisition of SCP ........... -- -- 1,200,000
See accompanying notes to financial statements.
F-5
TSI INTERNATIONAL SOFTWARE, LTD.
STATEMENT OF STOCKHOLDERS EQUITY/(DEFICIT)
Convertible
Preferred Stock Common Stock Additional
----------------------------- ---------------------------- Paid in Deferred
Shares Par Value Shares Par Value Capital Compensation
----------- ----------- ----------- ----------- ----------- ------------
Balance at
December 31, 1995 ..... 860,969 8,600 3,000,000 30,000 7,888,800 --
Net income ............... -- -- -- -- --
Currency translation
adjustment ............ -- -- -- -- -- --
Total comprehensive
income ................ -- -- -- -- -- --
----------------------------------------------------------------------------------------------------
Balance at
December 31, 1996 ..... 860,969 8,600 3,000,000 30,000 7,888,800 --
Issuance of Series E
Preferred Stock, net .. 50,000 500 -- -- 992,900 --
Net proceeds from
initial public offering -- -- 3,000,000 30,000 24,242,300 --
Conversion of
Preferred Stock ....... (910,969) (9,100) 2,759,715 27,600 (18,500) --
Exercise of warrants on
a net exercise basis .. -- -- 296,827 3,000 (3,000) --
Stock options exercised .. -- -- -- -- (4,200) --
Options issued
under incentive plans.. -- -- -- -- 261,000 (261,000)
Amortization of deferred
compensation .......... -- -- -- -- -- 35,900
Net income ............... -- -- -- -- -- --
Currency translation
adjustment ............ -- -- -- -- -- --
Total comprehensive
income ................ -- -- -- -- -- --
----------------------------------------------------------------------------------------------------
Balance at
December 31, 1997 ..... -- -- 9,056,542 90,600 33,359,300 (225,100)
Stock option exercises ... -- -- 91,730 1,100 91,900 --
Purchases under
employee stock plan ... -- -- 99,344 1,000 972,800 --
Net proceeds from
secondary offering .... -- -- 1,426,650 14,300 25,363,900 --
Exercise of warrants ..... -- -- 382,281 3,800 760,800 --
Exercise of warrants on a
net basis ............. -- -- 51,100 500 (500) --
Shares issued in
connection with the
acquisition of SCP .... -- -- 33,922 300 1,199,700 --
Options issued
under incentive plans.. -- -- -- -- 1,270,600 (1,270,600)
Amortization of
deferred comp ......... -- -- -- -- -- 65,200
Tax benefit of options
exercised ............. -- -- -- -- 937,700 --
Net income ............... -- -- -- -- --
Currency translation
adjustment ............ -- -- -- -- -- --
Total comprehensive
income ................ -- -- -- -- -- --
----------------------------------------------------------------------------------------------------
Balance at
December 31, 1998 ..... -- -- 11,141,569 111,600 63,956,200 (1,430,500)
=========== =========== =========== =========== =========== =============
Other Treasury Stock
Retained Comprehensive Comprehensive -----------------------------
Earnings Income Income Shares Value Total
----------- ----------- ----------- ----------- ----------- -----------
Balance at
December 31, 1995 ..... (11,264,500) (167,500) (113,478) (65,000) (3,569,600)
Net income ............... 1,227,900 -- 1,227,900 -- -- 1,227,900
Currency translation
adjustment ............ -- 48,000 48,000 -- -- 48,000
-----------
Total comprehensive
income ................ -- -- 1,275,900 -- -- --
===========
-------------------------------------------------------------------------------------------------
Balance at
December 31, 1996 ..... (10,036,600) (119,500) (113,478) (65,000) (2,293,700)
Issuance of Series E
Preferred Stock, net .. -- -- -- -- 993,400
Net proceeds from
initial public offering -- -- -- -- 24,272,300
Conversion of
Preferred Stock ....... -- -- -- -- --
Exercise of warrants on
a net exercise basis .. -- -- -- -- --
Stock options exercised .. -- -- 11,000 12,900 8,700
Options issued
under incentive plans..
Amortization of deferred
compensation .......... -- -- -- -- 35,900
Net income ............... 2,479,600 -- 2,479,600 -- -- 2,479,600
Currency translation
adjustment ............ -- (79,800) (79,800) -- -- (79,800)
-----------
Total comprehensive
income ................ -- -- 2,399,800 -- -- --
===========
------------------------------------------------------------------------------------------------
Balance at
December 31, 1997 ..... (7,557,000) (199,300) (102,478) (52,100) 25,416,400
Stock option exercises ... -- -- 73,476 37,300 130,300
Purchases under
employee stock plan ... -- -- 29,002 14,800 988,600
Net proceeds from
secondary offering .... -- -- -- -- 25,378,200
Exercise of warrants ..... -- -- -- -- 764,600
Exercise of warrants on a
net basis ............. -- -- -- -- --
Shares issued in
connection with the
acquisition of SCP .... -- -- -- -- 1,200,000
Options issued
under incentive plans..
Amortization of
deferred comp ......... -- -- -- -- 65,200
Tax benefit of options
exercised ............. -- -- -- -- 937,700
Net income ............... 7,156,800 -- 7,156,800 -- -- 7,156,800
Currency translation
adjustment ............ -- (139,000) (139,000) -- -- (139,000)
-----------
Total comprehensive
income ................ -- -- 7,017,800 -- -- --
===========
------------------------------------------------------------------------------------------------
Balance at
December 31, 1998 ..... (400,200) (338,300) -- -- -- 61,898,800
=========== =========== =========== =========== =========== ===========
F-6
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
The Company
TSI International Software Ltd. (the "Company") develops, markets,
licenses, and supports computer software and related services which allow
organizations to integrate their business applications within the enterprise and
with outside business partners. The Company's customers are located primarily
throughout the United States and Western Europe and represent a broad range of
industries.
(a) Revenue Recognition
The Company adopted Statement of Position (SOP) 97-2 for software
transactions entered into beginning January 1, 1998. SOP 97-2 generally requires
revenue earned on software arrangements involving multiple elements, such as
additional software products, upgrades or enhancements, rights to exchange or
return software, post contract customer support, or services, including elements
deliverable only on a when-and-if-available basis, to be allocated to the
various elements of such sale based on "vendor-specific objective evidence of
fair values" allocable to each such element. If sufficient vendor-specific
objective evidence of fair market values does not exist, revenue from the sale
could be deferred until such sufficient evidence exists, or until all elements
have satisfied the requirements for revenue recognition. The adoption of SOP
97-2 did not have a material impact on the Company's results of operations or
financial positionl.
Software licensing revenues are recognized based upon the following four
criteria: persuasive evidence of an agreement exists, delivery has occurred, the
fee is fixed and determinable, and the fee is collectible. Maintenance contract
revenue is recognized ratably over the term of the contracts, which is generally
for one year. The unrecognized portion of maintenance revenue is classified as
deferred maintenance revenue in the accompanying balance sheets. Consulting and
training revenues are recognized as services are performed.
The Company licenses its KEY/MASTER product on a term-use basis for 15 to
60 month periods. The contracts provide for maintenance and generally do not
have renewal or purchase options. At contract inception, the present value of
the payments to be received under the contract is apportioned between software
licensing revenue and maintenance revenue and recognized as described above. The
present value of the payments to be received is recorded as the investment in
licensing contracts receivable. License interest revenue is recognized over the
term of the contract at a constant rate of return.
(b) Product Development Costs
Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for
the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,"
requires that software development costs: (i) be expensed as incurred until
technological feasibility (as defined therein) is achieved; and (ii) capitalized
subsequent to achieving technological feasibility and prior to the product being
available to customers. The establishment of technological feasibility of the
Company's products has essentially coincided with the products' general release
to customers. Accordingly, the Company has expensed all software development
costs as incurred.
(c) Furniture, Fixtures, and Equipment
Furniture, fixtures, and equipment are carried at cost less accumulated
depreciation computed using the straight-line method over their estimated useful
lives. Furniture, fixtures, and equipment held under capital leases and
leasehold improvements are amortized on a straight-line basis over the lease
term.
(d) Intangible Assets
Intangible assets are comprised of the excess of the purchase price and
related costs over the value assigned to the net tangible assets of the business
acquired. Intangible Assets are being amortized over 3 years on a straight line
basis. Amortization expense was $303,300 in 1998.
(e) Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the
F-7
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Valuation allowances are provided for any portion of the deferred tax assets
which are not more likely than not to be realized.
(f) Earnings per Share
In December 1997, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 128, "Earnings Per Share." SFAS No. 128 replaced the
calculation of primary and fully diluted net income per share with basic and
diluted net income per share. Basic earnings per share is computed based upon
the weighted average number of common shares outstanding. Diluted earnings per
share is computed based upon the weighted average number of common shares
outstanding increased for any dilutive effects of options, warrants, and
convertible securities. All net income per share data for prior years has been
restated to conform with the provisions of SFAS No. 128.
(g) Cash Equivalents
The Company considers securities with maturities of three months or less,
when purchased, to be cash equivalents.
(h) Marketable Securities
All marketable securities are classified as trading securities under the
provision of Statement of Financial Accounting Standard ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" and
unrealized gains and losses are reflected in earnings.
(i) Long-Lived Assets
During 1996, the Company adopted Statement of Financial Accounting Standard
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." SFAS No. 121 requires companies to review
assets for possible impairment and provides guidelines for recognition of
impairment losses related to long-lived assets, certain intangibles, and assets
to be disposed of. The impact of the adoption of SFAS No. 121 was not material.
(j) Stock Options
The Company accounts for stock-based transactions in accordance with
Statement of Financial Accounting Standard ("SFAS") No. 123, "Accounting for
Stock-Based Compensation." In accordance with SFAS No. 123, the Company has
elected to measure stock-based employee compensation arrangements in accordance
with the provisions of APB No. 25, "Accounting for Stock Issued to Employees,"
and comply with the disclosure provisions of SFAS No. 123. Accordingly, the
Company recorded compensation expense for stock options granted to employees in
accordance with the provisions of APB 25 and will disclose in the notes to its
financial statements the impact on net income and net income per share (see note
6).
(k) Use of Estimates
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
(l) Business Segments
The Company adopted the provisions of SFAS No. 131, "Disclosure and
Segments of an Enterprise and Related Information" in the fourth quarter of
1998. SFAS 131 establishes standards for the way that public business
enterprises report information about operating segments. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Company has determined that it does not have any
separately reportable business segments and therefore the adoption of SFAS 131
did not impact the Company's reporting disclosures.
F-8
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
(m) Comprehensive Income
The Company adopted the provisions of SFAS No. 130, "Reporting
Comprehensive Income" during 1998. SFAS 130 requires the company to report in
its financial statements, in addition to its net income, comprehensive income,
which includes all changes in equity during a period from non-owner sources. The
Company's comprehensive income consists of net income and foreign currency
translation adjustments and is presented in the Statement of Stockholders'
Equity/(Deficit). The adoption of SFAS No. 130 had no impact on total
shareholders' equity (deficit). Prior year financial statements have been
reclassified to conform to the SFAS 130 requirements.
(n) Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for Costs of Computer Software
Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1 provides guidance
or determining whether computer software originally developed or obtained for
internal use and then subsequently sold to the public. It also provides guidance
on capitalization of the costs incurred for computer software developed or
obtained for internal use. The Company does not believe that the adoption of SOP
98-1 will have a material impact on its results of operations or financial
position.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," (SFAS 133) which establishes accounting and
reporting standards for derivative instruments, including derivative instruments
embedded in other contracts, and for hedging activities. SFAS No. 133 is
effective for all fiscal quarters of fiscal years beginning after June 15,
19999. This statement is not expected to affect the Company as the Company
currently does not have any significant derivative instruments or hedging
activities.
(2) Foreign Operations
The Company's balance sheets include foreign branch assets of $3,867,200
and $4,278,800 and liabilities of $406,600 and $978,600 at December 31, 1997 and
1998, respectively. Revenue from foreign operations totaled $968,400,
$2,505,200, and $5,361,100, respectively in 1996, 1997, and 1998. The foreign
net income for the years ended December 31, 1996, 1997 and 1998, after
allocation of corporate charges, was $345,400, $45,300 and $1,565,900,
respectively.
With the exception of direct sales activities in the United Kingdom, France
and Canada, the Company utilizes distributors and agents to market its products
outside the United States. Revenues generated through these third parties
amounted to $288,700, $125,400 and $25,000 for the years ended December 31,
1996, 1997 and 1998, respectively.
(3) Investment in Licensing Contracts
The net investment in licensing contracts at December 31, 1997, is
comprised of future minimum contract payments receivable, net of unearned
interest income. The interest rate implicit in term-use licensing contracts was
9.5% for contracts entered into during the years 1997 and 1998. Total minimum
contract payments receivable at December 31, 1998 are as follows:
1999 ................................... $ 522,000
2000 ................................... 261,900
2001 ................................... 104,500
2002 ................................... 24,100
---------
912,500
Less unearned interest income .......... (119,200)
---------
793,300
Less current portion ................... (522,000)
---------
Non current portion .................... $ 271,300
=========
F-9
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
(4) Furniture, Fixtures, and Equipment
Furniture, fixtures and equipment consist of the following:
December 31,
--------------------------- Useful Life
1997 1998 Range
---------- ---------- ---------
Computer systems ................. $3,175,900 $4,552,500 3-7 years
Furniture and fixtures ........... 607,200 728,900 3-7 years
Office equipment ................. 335,900 757,100 3-7 years
Leasehold improvements ........... 443,700 476,400 3-10 years
Automobiles ...................... 64,900 51,000 5 years
---------- ----------
4,627,600 6,565,900
Less accumulated depreciation
and amortization ............... (3,040,300) (3,866,500)
---------- ----------
$1,587,300 $2,699,400
========== ==========
Depreciation expense was $436,100, $623,300 and $826,200 for the years
ended December 31, 1996, 1997, and 1998 respectively. Computer systems and
equipment under capital leases included in the above totals, net of accumulated
depreciation, was $30,800 and $22,800 as of December 31, 1997 and 1998,
respectively.
(5) Long-Term Debt
The Company had a line of credit facility with The Bank of New York which
provided for Company borrowings equal to the lesser of $4,000,000 or the sum of
80% of eligible accounts receivable, and a lesser percentage of certain other
receivables. Borrowings could take the form of prime rate loans (which bear
interest on borrowings at either the bank's prime rate plus 1.0%) or LIBOR rate
loans (which bear interest at the LIBOR rate plus 3.0%). The Company's
obligations under this credit line were secured by substantially all of the
Company's assets. This line of credit expired in November, 1998, and has not
been replaced. All amounts outstanding under this line of credit were paid off
in July 1997 with proceeds from the Company's initial public offering. The
Company had no borrowings outstanding at December 31, 1998. Borrowing costs and
effective interest rates under this agreement were as follows:
Years ended December 31,
--------------------------------------
1996 1997 1998
-------- -------- --------
Interest expense ......... $250,200 $171,500 $ 0
Guarantee fees ........... 23,600 1,400 0
Commitment fees .......... 11,700 12,900 10,900
-------- -------- --------
$285,500 $185,800 $ 10,900
======== ======== ========
Effective interest rate .. 9.51% 13.26% --
======== ======== ========
(6) Stockholders' Equity
(a) Preferred Stock
The Company has authorized 5,000,000 shares of Preferred Stock which may be
issued by the Board of Directors on such terms and with such rights,
preferences, and designations as the Board may determine without any vote of the
stockholders. There were no shares outstanding at December 31, 1997 or 1998.
(b) Common Stock
On July 1, 1997, the Company sold 3,000,000 shares of common stock in an
initial public offering (IPO) which resulted in proceeds of approximately
$24,272,300, net of offering expenses of $837,700. In connection with the
completion of the IPO, the following transactions were completed: (i) The
Company increased the number of authorized shares of common stock and preferred
stock to 20,000,000 shares and 5,000,000 shares, respectively; (ii) the Company
completed a three-for-one common stock split; (iii) all outstanding preferred
shares were
F-10
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
converted into 2,759,715 shares of common stock; and, (iv) certain shareholders
of the Company registered and sold 1,600,000 of common stock with net proceeds
to these shareholders of $13,392,000. The accompanying financial statements have
been retroactively adjusted to reflect the common stock split.
In addition, on May 15, 1997, three new investors acquired a total of
50,000 shares of Series E convertible preferred stock at $20 a share, which at
closing of the IPO converted into 150,000 shares of common stock.
On June 5, 1998, the company sold 1,200,000 shares of common stock in a
second public offering which resulted in proceeds of approximately $21,287,200
net of offering expenses of $392,800. Existing shareholders sold 2,311,000
shares of stock in connection with this offering.
On July 5, 1998, the underwriters exercised their option to purchase
526,650 additional shares of the Company's stock of which 226,650 were purchased
from the Company for additional proceeds of approximately $4,091,000.
(c) Stock Purchase Warrants
At December 31, 1996, certain owners of preferred and common stock held an
aggregate of nine warrants to purchase common stock at $2.00 a share. During
1997 and 1998, warrants were exercised into an aggregate of 296,827 and 51,100
shares, respectively. As these three warrants were exercised on a net exercise
basis, no proceeds were received by the Company. Also, in connection with the
secondary public offering in 1998, one of the remaining warrants was sold to the
underwriters and subsequently exercised into 382,281 shares with total proceeds
of $764,562. At December 31, 1998, there are five warrants remaining which are
exercisable into 269,490 shares.
(d) Stock Option Plans
The Company established the Equity Incentive Stock Option Plan ("Equity
Plan") in May 1997 which replaced the 1993 Stock Option Plan. The Equity Plan
provides that the Company may grant options to employees to purchase up to
2,641,671 shares of the Company's common stock. The Company granted 250,600 and
606,000 options under the Plan in 1997 and 1998 respectively at exercise prices
from $1.66 to $14.38 and $11.91 to $44.58 per share, respectively. No options
may be granted for a term greater than 10 years.
In addition, the Company established a Directors Stock Option Plan
("Directors Plan") in May 1997 which authorizes the issuance of options to
directors to purchase 225,000 shares of the Company's stock. During 1997, 60,000
options were granted at $6.67 per share. During 1998, 15,000 and 15,000 shares
were granted at $22.76 and $26.75 per share, respectively.
In 1997 and 1998 the Company recorded deferred compensation expense in
connection with the grant of certain options to employees representing the
difference between the quoted market price of the stock at the grant date and
the exercise price of the options. This amount is presented as a reduction of
stockholders equity and is amortized over the vesting period of the applicable
options.
Transactions under the Equity Plan and the Directors Plan are summarized
below:
Weighted
Number average
of shares exercise price
--------- --------------
Shares under option at December 31, 1995 919,857 $ 0.33
Exercised ........................... --
Granted ............................. 150,000 $ 1.40
Cancelled ........................... (6,000) $ 0.33
---------
Shares under option at December 31, 1996 1,063,857 $ 0.48
Exercised ........................... (10,700) $ 0.82
Granted ............................. 310,600 $ 6.41
Cancelled ........................... -- $ 0.00
---------
Shares under option at December 31, 1997 1,363,757 $ 1.83
Exercised ........................... (165,206) $ 0.82
Granted ............................. 636,000 $21.93
Cancelled ........................... (9,500) $11.93
---------
Shares under option at December 31, 1998 1,825,051 $ 8.85
=========
Options exercisable were as follows:
December 31, 1996 ................... 576,357 $ 0.33
December 31, 1997 ................... 771,907 $ 0.42
December 31, 1998 ................... 807,601 $ 0.93
F-11
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
Options outstanding at December 31, 1998 have a weighted average remaining
contractual life of 7.3 years.
Options were granted in 1995 and prior years at an exercise price of $0.33
a share; options were granted during 1996 at exercise prices of $0.67 and $1.67
a share; options were granted during 1997 at exercise prices between $1.66 to
$14.34; and options were granted during 1998 at exercise prices between 11.91
and 44.58. Substantially all options vest ratably over a four year period from
the date of grant. There were 909,174 shares available for grant under the
option plans at December 31, 1998.
As discussed in note 1, the Company adopted SFAS No. 123 during 1996 and
elected not to recognize compensation expense relating to employee stock options
where the exercise price of the option equaled the fair value (as estimated by
the Company prior to July 1, 1997) of the stock on the date of grant. In 1996,
the Company utilized the minimum value method to determine compensation based on
the fair value of the options on the date of grant as the Company was a
non-public entity prior to July 1, 1997. The compensation expense has been
calculated utilizing the Black-Scholes method in 1997 and 1998. Following are
the resultant pro forma amounts of net income and net income per share:
1996 1997 1998
------------- ------------- -------------
Net income -- as reported .......... $1,227,900 $2,479,600 $7,156,800
Net income -- pro forma ............ 1,216,600 2,023,600 5,012,900
Earnings per share -- as reported:
Basic .......................... $.43 $.42 $.71
Diluted ........................ $.21 $.29 $.60
Earnings per share -- pro forma:
Basic .......................... $.42 $.34 $.49
Diluted ........................ $.21 $.24 $.42
The weighted average fair value of each option granted in 1996, 1997 and
1998 was $0.92, $4.24 and $21.92, respectively. These values are based on
estimates on the date of grant using the modified Black-Scholes option pricing
model using the following weighted average assumptions:
1996 1997 1998
------------ ------------ ------------
Risk-free interest rate ..... 6.27% 5.37 to 7.07 4.49 to 5.77
Expected life in years ...... 6 6 6
Expected volatility ......... 0% 59.8% 65%
Expected dividend yield ..... 0% 0% 0%
(e) Stockholders Rights Plan
On September 2, 1998, the Company adopted the Stockholder Rights Plan
("Rights Plan") designed to protect the long-term value of the company for its
stockholders during any future unsolicited acquisition attempt. In connection
with the plan, the Board declared a dividend of one preferred share purchase
right for each share of the Company's common stock. Each right will entitle the
holder to purchase one-hundredth of a share of Series A Junior Participating
Preferred Stock at an exercise price of $140.00.
Initially, the rights are neither exercisable nor traded separately from
the common stock. If a person or a group (an "Acquiring Person") acquires or
announces an intention to make a tender offer to acquire 15 percent (20 percent
if a 5 percent or more shareholder at August 27, 1998) or more of the Company's
common stock, the rights will become exercisable and thereafter trade separately
from the common stock. The Company's Board of Directors may exchange the
outstanding rights for common stock of the Company at an exchange ratio of one
share of common stock per right. The Board may also redeem outstanding rights at
any time prior to a person becoming an Acquiring Person at a price of $0.001 per
right. Prior to such time, the terms of the rights may be amended by the Board.
The rights will expire on September 2, 2008.
F-12
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
(f) Employee Stock Purchase Plan
The Company established an Employee Stock Purchase Plan which reserves a
total of 750,000 shares of the Company's common stock for issuance thereunder.
The plan permits eligible employees to acquire shares of the Company's common
stock through payroll deductions subject to certain limitations. The shares are
acquired at 85% of the fair market value. As of December 31, 1998, 128,346
shares had been purchased under the plan and 621,654 were remaining and
available for grant.
(7) Earnings per Share
In February 1997, Statement of Financial Accounting Standard ("SFAS") No.
128, "Earnings per Share" was issued. The statement sets forth guidance on the
presentation of earnings per share and requires dual presentation of Basic and
Diluted earnings per share on the face of the income statement. The computation
of basic earnings per share is based on income available to common stockholders
and the weighted average number of common shares outstanding during each period.
Diluted earnings per share reflect the potential dilution that could occur if
dilutive stock options were exercised resulting in the issuance of common stock
that then shared in the earnings of the Company. In connection with the IPO, all
outstanding preferred stock was converted into common stock on the basis
described in note 6 and, accordingly, are shown as outstanding for the diluted
earnings per share calculation for all periods presented. Following are the
components of common stock used to calculate Basic and Diluted earnings per
share:
Years ended December 31,
------------------------------------------
1996 1997 1998
---------- ---------- ----------
Weighted average common shares
outstanding (basic shares) ............... 2,886,822 5,916,993 10,149,503
Common shares issuable upon conversion
of preferred stock ....................... 2,609,415 1,304,632 --
Dilutive effect of stock options and warrants 314,973 1,345,136 1,758,301
---------- ---------- ----------
Total diluted shares ........................ 5,811,210 8,566,761 11,907,804
========== ========== ==========
(8) Employee Bonus and Savings Plans
The Company maintains a bonus plan for all non-executive officer employees.
The bonus plan is reviewed annually by the Board of Directors and provides for
payments based upon a percentage of pretax income, as defined. Bonus payments
were $200,000, $200,000 and $251,000 in 1996, 1997 and 1998, respectively.
On July 1, 1990, the Company established a defined contribution plan under
Section 401(k) of the Internal Revenue Code which provides for voluntary
employee salary deferrals but does not require Company matching funds. The
defined contribution plan covers substantially all employees. Employees are
eligible to contribute to the defined contribution plan upon completion of three
months of service with the Company. Contributions are subject to established
limitations as determined by the Internal Revenue Service. As of January 1, 1998
the Company amended the plan to include an employer match of 50% of
participants' contributions up to 4%. The Company has made contributions to the
plan of $210,000 for the year ended December 31, 1998.
(9) Income Taxes
The provision for (benefit from) income taxes is comprised of the following
for the years ended December31, 1996, 1997 and 1998:
1996 1997 1998
--------- --------- ---------
Federal ................................... $36,200 $46,000 $(943,300)
State ..................................... -- 30,000 84,500
Foreign ................................... -- -- 179,900
--------- --------- ---------
Provision for (benefit from) income taxes . $36,200 $76,000 $(678,900)
========= ========= =========
F-13
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
At December 31, 1998, the Company had federal tax net operating loss
carryforwards of $1,900,000 expiring between the years 2000 and 2009 and
research and experimentation credits of $1,055,000 expiring between 2003 and
2008. At December 31, 1997 and 1998, the components of net deferred taxes
(utilizing a 41.4% and 38.8% combined tax rate, respectively) were:
1997 1998
----------- -----------
Deferred tax assets:
Other Federal credits ...................... $655,700 $1,372,400
Deferred revenues .......................... 1,495,400 934,300
Net operating loss carryforwards ........... 2,835,400 1,011,900
Allowance for doubtful accounts ............ 195,200 736,400
Other ...................................... 188,000 51,800
----------- -----------
Total gross deferred tax assets ............ 5,369,700 4,106,800
Less valuation allowance ................... 4,441,500 1,054,500
----------- -----------
Total deferred tax assets .................. 928,200 3,052,300
=========== ===========
Deferred tax liabilities:
Licensing contracts receivable ............. (455,400) (307,800)
Difference between book and tax depreciation (472,800) (49,400)
----------- -----------
Total deferred tax liability ............... (928,200) (357,200)
----------- -----------
Net deferred tax assets .................... $ -- $2,695,100
=========== ===========
The decrease in the valuation allowance of $3,387,000 in 1998 is the result
of the utilization of net operating loss carryforwards and the reversal of the
remaining net operating loss carryforward valuation allowance.
The following table summarizes the significant differences between the U.S.
Federal statutory tax rate and the Company's effective tax rate for financial
statement purposes:
1997 1998
------ ------
U.S. Federal Statutory Rate ....................... 34.0% 34.0%
Non-deductible expenses ........................... 1.6% 3.7%
State income taxes, net of U.S. federal tax benefit 0.8% 4.8%
Tax credits ....................................... -- (7.2%)
Other ............................................. -- 2.2%
Change in valuation allowance ..................... (33.4%) (48.0%)
------ ------
Effective tax rate ................................ 3.0% (10.5%)
====== ======
(10) Accrued Expenses
Included in accrued expenses as of December 31, 1997 and 1998, are
compensation costs (regular payroll, commissions, bonus, profit sharing, and
other withholdings) of $1,473,500 and $3,718,871, respectively.
F-14
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
(11) Commitments and Contingencies
The Company rents premises and furniture, fixtures, and equipment under
operating leases which expire at various dates through 2011.
Future minimum payments, by year and in the aggregate, under operating and
capital leases at December 31, 1998 are:
Year Capital Operating
- ---- ------- ----------
1999 ................................................ $10,500 $1,379,800
2000 ................................................ 10,500 1,318,000
2001 ................................................ 10,500 740,000
2002 ................................................ 1,800 266,100
2003 ................................................ -- 270,400
------- ----------
Total ........................................... $33,300 $3,974,300
==========
Less amount representing interest ................... 10,500
-------
Present value of minimum capital lease payments ... $22,800
=======
Certain of the aforementioned leases provide for additional payments
relating to taxes and other operating expenses. Rental expense for the years
ended December 31, 1996, 1997, and 1998, under all operating leases aggregated
approximately $717,300, $840,400 and $1,385,000 respectively.
(12) Acquisition of Software Consulting Partners
On November 13, 1998, the Company acquired certain assets of Software
Consulting Partners (SCP) for 33,922 shares of the Company's stock with a total
fair value of $1.2 million and the assumption of certain liabilities totaling
$4.7 million. The purchase price was allocated to the assets based on their fair
values. The excess of the purchase price over the fair value o the net assets
acquired was approximately $5.5 million and is being amortized on a straight
line basis over 3 years.
The Company issued 33,922 shares of common stock based upon the total value
of $1.2 million as prescribed by the agreement and the market price of the stock
on the acquisition date with 50% of such shares subject to an escrow to secure
certain indemnification obligations of SCP and the SCP stockholder. In addition,
the company may issue a maximum of an additional 33,921 shares of its common
stock in February 2000, based on the achievement of certain revenue and employee
retention goals relating to the SCP business.
The acquisition was accounted for by the purchase method of accounting for
business combinations. Accordingly, the accompanying statements of operations do
not include any revenues or expenses related to this acquisition prior to the
closing date. The amounts used to satisfy the acquired liabilities were financed
through available cash. Following are the Company's unaudited proforma results
for the year ended December 31, 1998, assuming the acquisition took place on
January 1, 1998:
Revenues .......................................... $52,633
Net Income ........................................ $3,832
Net Income per share:
Basic ......................................... $0.38
Diluted ....................................... $0.32
Weighted average shares outstanding:
Basic ......................................... 10,165,358
Diluted ....................................... 11,923,659
These unaudited proforma results have been prepared for comparative
purposes only and include certain adjustments, such as additional amortization
expense as a result of goodwill and a decrease in interest income due to the use
of cash to satisfy liabilities. They do not purport to be indicative of the
results of operations which actually would have resulted had the combination
been in effect on January 1, 1998, or of future results of operations.
F-15
TSI INTERNATIONAL SOFTWARE, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
(13) Condensed Quarterly Information (Unaudited)
The following condensed quarterly information has been prepared by
management on a basis consistent with the Company's audited financial
statements. Such quarterly information may not be indicative of future results.
Amounts are in thousands, except per share data.
1997
-------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Total revenues .......................... $5,508 $6,155 $7,000 $8,007
Gross profit ............................ 4,786 5,491 6,032 7,093
Net income .............................. 313 267 785 1,115
Net income per share:
Basic ............................... .11 .09 .09 .12
Diluted ............................. .05 .04 .07 .10
Weighted average number of common and
common equivalent shares outstanding:
Basic ............................... 2,887 2,887 8,944 8,950
Diluted ............................. 6,369 6,493 10,724 10,682
1998
-------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Total revenues .......................... $8,187 $10,133 $12,124 $14,872
Gross profit ............................ 7,193 8,676 10,840 11,718
Net income .............................. 871 1,226 1,871 3,189
Net income per share:
Basic ............................... .10 .13 .17 .29
Diluted ............................. .08 .11 .15 .25
Weighted average number of common and
common equivalent shares outstanding:
Basic ............................... 9,044 9,541 10,962 11,049
Diluted ............................. 10,827 11,434 12,627 12,743
The sum of the quarterly per share amounts does not agree to the respective
annual amounts due to rounding.
F-16