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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 000-23043
PERVASIVE SOFTWARE INC.
(Exact name of registrant as specified in its charter)
Delaware 74-2693793
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
12365 Riata Trace Parkway, Bldg. II
Austin, Texas 78727
(Address of principal executive offices)
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(512) 231-6000
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 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
(1) Yes X No
--------- ---------
(2) Yes X No
--------- ---------
As of February 11, 1999 there were 13,517,404 shares of the Registrant's
common stock outstanding.
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PERVASIVE SOFTWARE INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements................................................. 3
Condensed Consolidated Balance Sheets at December 31, 1998 and
June 30, 1998........................................................ 3
Condensed Consolidated Statements of Operations for the three and
six months ended December 31, 1998 and 1997.......................... 4
Condensed Consolidated Statements of Cash Flows for the six months
ended December 31, 1998 and 1997..................................... 5
Notes to Condensed Consolidated Financial Statements................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........17
PART II. OTHER INFORMATION....................................................26
Item 6. Exhibits and Reports on Form 8-K.....................................26
SIGNATURES....................................................................28
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Pervasive Software Inc.
Condensed Consolidated Balance Sheets
(in thousands)
December 31, June 30,
1998 1998
----------------- -----------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 1,862 $15,587
Marketable securities 6,590 4,943
Trade accounts receivable, net 6,859 5,304
Prepaid expenses and other current assets 3,050 2,266
----------------- -----------------
Total current assets 18,361 28,100
Property and equipment, net 6,648 3,667
Purchased technology and excess of cost over fair value
of net assets acquired, net 11,387 383
Other assets 754 493
----------------- -----------------
Total assets $37,150 $32,643
================= =================
Liabilities and Stockholders' Equity
Current liabilities:
Trade accounts payable $ 1,868 $ 1,382
Accrued payroll and payroll related costs 1,398 966
Other accrued expenses 3,904 2,710
Deferred revenues 2,878 1,929
Income taxes payable 627 1,140
Deferred royalty payable--Novell - 158
----------------- -----------------
Total current liabilities 10,675 8,285
Deferred tax liability 600 -
----------------- -----------------
Total liabilities 11,275 8,285
Minority interest in subsidiary 450 379
Stockholders' equity :
Common stock 27,111 26,270
Retained deficit (1,686) (2,291)
----------------- -----------------
Total stockholders' equity 25,425 23,979
----------------- -----------------
Total liabilities and stockholders' equity $37,150 $32,643
================= =================
See accompanying notes.
3
Pervasive Software Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)
Three months ended Six months ended
December 31, December 31,
------------------------------------- ---------------------------------------
1998 1997 1998 1997
----------------- --------------- ----------------- -----------------
Revenues $14,087 $8,470 $25,863 $16,141
Costs and expenses:
Cost of revenues and technical support 2,186 1,230 3,806 2,394
Sales and marketing 5,535 3,520 10,514 6,632
Research and development 3,521 2,292 6,481 4,543
General and administrative 1,193 791 2,218 1,421
Amortization of excess of cost over fair value of
net assets acquired 139 - 155 -
Charge for purchased research and development 1,800 - 1,800 -
----------------- --------------- ----------------- -----------------
Total costs and expenses 14,374 7,833 24,974 14,990
----------------- --------------- ----------------- -----------------
Operating income (loss) (287) 637 889 1,151
Interest and other income, net 122 218 340 199
----------------- --------------- ----------------- -----------------
Income (loss) before income taxes and minority
interest (165) 855 1,229 1,350
Provision for income taxes (506) (258) (932) (404)
Minority interest in earnings of subsidiary, net
of tax (17) (22) (3) (41)
----------------- --------------- ----------------- -----------------
Net income (loss) $ (688) $ 575 $ 294 $ 905
================= =============== ================= =================
Basic earnings (loss) per share $ (0.05) $ 0.04 $ 0.02 $ 0.12
================= =============== ================= =================
Diluted earnings (loss) per share $ (0.05) $ 0.04 $ 0.02 $ 0.06
================= =============== ================= =================
See accompanying notes.
4
Pervasive Software Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Six months ended
December 31,
------------------------------------------
1998 1997
------------------ -----------------
Cash from operating activities
Net income $ 294 $ 905
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 1,177 631
Non cash compensation expense pursuant to employee stock purchase plan 339 196
Other non cash items 331 127
Charge for purchased research and development 1,800 -
Change in current assets and liabilities:
Increase in trade accounts receivable (1,145) (1,349)
Increase in prepaid expenses and other current assets (448) (365)
Increase in accounts payable and accrued liabilities 44 347
Increase in deferred revenue 764 48
Increase (decrease) in income taxes payable (669) 64
------------------ -----------------
Net cash provided by operating activities 2,487 604
Cash from investing activities
Purchase of property and equipment (3,127) (1,162)
Purchase of marketable securities (1,647) -
Purchase of businesses, net of cash acquired (11,449) -
Increase in other assets 26 (31)
------------------ -----------------
Net cash used in investing activities (16,197) (1,193)
Cash from financing activities
Payment of royalty to Novell (158) (224)
Proceeds from issuance of stock, net of issuance costs 130 17,545
------------------ -----------------
Net cash provided by (used in) financing activities (28) 17,321
Effect of exchange rate on cash and cash equivalents 13 (293)
------------------ -----------------
Increase (decrease) in cash and cash equivalents (13,725) 16,439
Cash and cash equivalents at beginning of period 15,587 4,058
Cash and cash equivalents at end of period $ 1,862 $20,497
================== =================
See accompanying notes.
5
PERVASIVE SOFTWARE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. General and Basis of Financial Statements
The unaudited interim condensed consolidated financial statements include
the accounts of Pervasive Software Inc. and its majority-owned subsidiaries
(collectively, the "Company" or "Pervasive"). All material intercompany accounts
and transactions have been eliminated in consolidation.
The financial statements included herein reflect all adjustments, consisting
only of normal recurring adjustments, which in the opinion of management are
necessary to fairly state the Company's financial position, results of
operations and cash flows for the periods presented. These financial statements
should be read in conjunction with the Company's consolidated financial
statements and notes thereto for the year ended June 30, 1998, which are
contained in the Company's Registration Statement filed on Form S-1 on February
8, 1999 (File No. 333-71955) and Annual Report filed or on Form 10-K filed with
the Securities and Exchange Commission on September 28, 1998 (File No. 000-
23043). The results of operations for the three and six month periods ended
December 31, 1998 and 1997 are not necessarily indicative of results that may be
expected for any other interim period or for the full fiscal year.
2. Business Combinations
On November 12, 1998, Pervasive acquired for cash approximately 93% of the
outstanding common shares of EveryWare Development Inc. ("EveryWare"), a Web
development tool and Web-application server provider based in Toronto Canada.
Pervasive acquired the remaining outstanding shares of EveryWare in December
1998. The total value of the acquisition, including assumption of outstanding
options and transaction costs, was approximately $11.8 million. In addition,
the Company made advances to EveryWare totalling $705,000 in October and
November 1998.
The acquisition has been accounted for as a purchase business combination by
the Company and, accordingly, the net assets acquired were recorded at their
estimated fair values at the effective date of the acquisition. The following
table presents the allocation of the purchase price (in thousands):
Software technology $ 1,200
Purchased research and development 1,800
Excess of cost over fair value of net assets acquired 9,761
Deferred tax adjustment related to intangible assets acquired (600)
Net fair value of tangible assets acquired and liabilities assumed (377)
-------
$11,784
=======
Valuation of the intangible assets acquired were determined by an
independent third party appraisal company and consisted of purchased research
and development, software technology, and excess of fair value of net assets
acquired. The amount related to purchased research and development, as
determined by the independent third party appraisal company, was $1.8 million
and was charged against income in the quarter ended December 31, 1998 because
the underlying research and development projects had not yet reached
technological feasibility and had no alternative future uses. The excess of
costs over fair value of net assets acquired is amortized over a ten year
period.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
On February 13, 1998, the Company acquired Smithware, Inc. ("Smithware"), a
developer of database development and reporting components for Pervasive
products, for cash and common stock of the Company, plus up to an additional
$80,000 of cash and 47,502 shares of common stock payable upon achievement of
certain milestones in the future. In July 1998, the Company paid $80,000 in
cash and issued 19,000 shares of the Company's common stock valued at $155,000
to the former Smithware shareholders upon achieving the first two milestones
specified in the acquisition agreement. Payment of the additional purchase price
was recorded as additional goodwill and is being amortized over a ten year
period.
3. Pro Forma Results of Operations
Pro forma results of operations for the six months ended December 31, 1997
and 1998 are presented below for illustrative purposes, as if the acquisition of
EveryWare had occurred as of the beginning of the fiscal year for each of the
periods presented.
Six months ended
December 31,
--------------------------------
1998 1997
------------- -------------
Revenues............................................ $27,006 $19,560
Operating income.................................... 471 200
Net loss............................................ (271) (172)
Basic loss per share................................ $ (0.01) $ (0.02)
4. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share (in thousands, except per share data):
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ --------------------------
1998 1997 1998 1997
---------- --------- --------- ---------
Numerator:
Net income (loss) $ (688) $ 575 $ 294 $ 905
========== ========= ========= =========
Denominator:
Denominator for basic earnings per share -
weighted average shares 13,431 13,236 13,404 7,681
Effect of dilutive securities:
Convertible preferred shares - - - 4,593
Employee stock options - 1,947 1,851 2,039
---------- --------- --------- ---------
Potentially dilutive common shares - 1,947 1,851 6,632
---------- --------- --------- ---------
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed
conversions 13,431 15,183 15,255 14,313
========== ========= ========= =========
Basic earnings per share $ (0.05) $ 0.04 $ 0.02 $ 0.12
========== ========= ========= =========
Diluted earnings per share $ (0.05) $ 0.04 $ 0.02 $ 0.06
========== ========= ========= =========
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
5. Comprehensive Income
Effective July 1, 1998, the Company adopted Financial Accounting Standards
Board (FASB) Statement No. 130, Reporting Comprehensive Income (Statement 130).
Statement 130 establishes new rules for the reporting and display of
comprehensive income and its components. The components of comprehensive income
are as follows:
Three months ended Six months ended
December 31, December 31,
---------------------------- ---------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
Net income................................................ $(688) $ 575 $ 294 $ 905
Foreign currency translation adjustments.................. 259 (77) 444 (230)
----------- ----------- ----------- -----------
Comprehensive income...................................... $(429) $ 498 $ 738 $ 675
=========== =========== =========== ===========
6. Recent Accounting Pronouncements
Effective July 1, 1998, the Company adopted AICPA Statement of Position (SOP)
97-2, Software Revenue Recognition and SOP 98-4, Deferral of the Effective Date
of a Provision of SOP 97-2. The Company believes the effect of such adoption
will not have a material effect on its financial statements in fiscal 1999.
In December 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-9, Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions. SOP 98-9 amends SOP 98-4 to
extend the deferral of the application of certain passages of SOP 97-2 provided
by SOP 98-4 through fiscal years beginning on or before March 15, 1999. All
other provisions of SOP 98-9 are effective for transactions entered into in
fiscal years beginning March 15, 1999. We believe that the adoption of SOP 98-9
will not have a material effect on the Company's results of operations or
financial position.
In June 1997, FASB issued Statement of Financial Accounting Standard No. 131,
Disclosures about Segments of an Enterprise and Related Information (Statement
131), which establishes the standards for the manner in which public enterprises
are required to report financial and descriptive information about their
operating segments. In accordance with Statement 131, the Company will provide
the required disclosures for the first time in its annual report on Form 10-K
for the year ended June 30, 1999 and on Form 10-Q for the quarter ended
September 30, 1999. The Company believes that the adoption of Statement 131
will not affect its results of operations or financial position, and will not
significantly affect the disclosure of segment information in the future.
In February 1998, the FASB issued Statement No. 132, Employers' Disclosures
about Pensions and Other Postretirement Benefits. The Statement supersedes the
disclosure requirements in Statements No. 87, Employers' Accounting for
Pensions, No. 88, Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits, and No. 106, Employers' Accounting
for Postretirement Benefits Other Than Pensions. Statement 132 revises the
required disclosures about pensions and other postretirement benefits. The
Company believes that the adoption of Statement 132 will have no affect on our
results of operations, financial position or disclosures in the future.
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is required to be adopted in fiscal
2000. Because of the Company's minimal use of derivatives, management does not
anticipate that the adoption of Statement 133 will have a significant effect on
the Company's results of operations or the financial position of the Company.
8
PERVASIVE SOFTWARE INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The statements contained in this Report on Form 10-Q that are not purely
historical statements are forward looking statements within the meaning of
Section 21E of the Securities and Exchange Act of 1934, including statements
regarding the Company's expectations, beliefs, hopes, intentions or strategies
regarding the future. These forward-looking statements involve risks and
uncertainties. Actual results may differ materially from those indicated in
such forward-looking statements. We are under no duty to update any of the
forward-looking statements after the date of this filing on Form 10-Q to conform
these statements to actual results. See "Risk Factors that May Affect Future
Results," and the factors and risks discussed in the Company's) Registration
Statement filed on Form S-1 on February 8, 1999 (File No. 333-71955), Annual
Report on Form 10-K filed with the Securities and Exchange Commission on
September 28, 1998 (File No. 000-23043) and other reports filed from time to
time with the Securities and Exchange Commission.
Overview
Pervasive Software Inc. is a leading provider of information management
solutions that dramatically simplify the development, deployment and maintenance
of Web-based and client/server applications. Our comprehensive, integrated suite
of software products includes zero administration databases, Web application
servers, Web development and deployment solutions and data management and
reporting tools. Together, these products offer a unique solution that masks the
complexity of developing, deploying and maintaining Web-based applications and
lower the cost of ownership of Web-based distributed computing environments. Our
business model leverages a value-added distribution channel of software
developers, value-added resellers and system integrators around the world.
On November 12, 1998, we acquired 93% of the outstanding stock of EveryWare
Development Inc., and acquired the remaining outstanding shares in December
1998, for total consideration of $11.8 million, including cash paid to the
EveryWare shareholders, transaction costs and the value of employee stock
options assumed. The transaction was recorded using the purchase accounting
method. The following table presents the allocation of the purchase price (in
thousands):
Software technology....................................................... $ 1,200
Purchased research and development........................................ 1,800
Excess of cost over fair value of net assets acquired..................... 9,761
Deferred tax adjustment related to intangible assets acquired............. (600)
Net fair value of tangible assets acquired and liabilities assumed........ (377)
------------
$11,784
============
We derive our revenues primarily from shrink-wrap licenses through independent
software vendors, value-added resellers and distributors and through OEM license
agreements with independent software vendors. Shrink-wrap license fees are
variable and based generally on user count, or in the case of Tango, number of
applications served. Our OEM licensing program offers independent software
vendors volume discounts and specialized technical support, training and
consulting in exchange for embedding our products in packaged applications and
paying us a royalty based on sales of the applications. Additionally, we
generate revenues from user count upgrades as well as from upgrades to
client/server environments from single user workstation or workgroup
environments.
We generally recognize revenues from software licenses when persuasive
evidence of an arrangement exists, the software has been delivered, the fee is
fixed or determinable and collectibility is probable. We generally recognize
revenues related to agreements involving nonrefundable fixed minimum license
fees when we deliver the product master or first copy if no significant vendor
obligations remain. We recognize per copy royalties in excess of a fixed minimum
amount as revenues when such amounts are reported to us. We operate with
virtually no order backlog
9
because our software products are shipped shortly after orders are received.
This makes product revenues in any quarter substantially dependent on orders
booked and shipped throughout that quarter. We enter into agreements with
certain distributors that provide for certain stock rotation and price
protection rights. These rights allow the distributor to return products in a
non-cash exchange for other products or for credits against future purchases. We
reserve for estimated sales returns, stock rotation and price protection rights,
as well as for uncollectable accounts based on experience.
We derive substantially all of our revenues from the license of our
Pervasive.SQL and Btrieve products, and to date we have not derived significant
revenues from our Tango products. Although we expect to continue to derive a
significant portion of our revenues from Btrieve licenses in the near term, we
expect that our future operating results will become increasingly dependent upon
market acceptance of Pervasive.SQL released in February 1998, and anticipate
that revenues from the license of Btrieve will decrease accordingly.
Pervasive.SQL market acceptance is largely dependent upon factors such as the
product development cycles of independent software vendors and value-added
resellers who embed our products into packaged software applications. In
February 1999, we launched a marketing program in which we are offering the
Tango development environment for free for a limited time. This program is
intended to encourage developers to build applications on the Tango platform as
a "seeding" strategy for Tango Application Server licenses. We cannot be
certain that we will successfully generate license revenue from our Tango
products through this marketing program or otherwise.
In December 1998, we granted Novell, Inc., a non-exclusive, perpetual,
irrevocable license to reproduce and distribute a two-user version of
Pervasive.SQL for distribution only in combination with other products
distributed by Novell. We do not receive any royalties directly from Novell
related to the agreement. We do believe, however, that we will receive fees in
the future by licensing multi-user upgrades for some of the two-user versions
distributed by Novell. Novell has not yet begun to distribute our two-user
version, but we believe Novell will do so in 1999.
Results of Operations
The following table sets forth for the periods indicated the percentage of
revenues represented by certain lines in our consolidated statements of
operation. The results of EveryWare subsequent to November 12, 1998 are included
in, but are not significant to, our consolidated statement of operations for the
six months ended December 31, 1998, except for the effect of purchase accounting
adjustments for purchased research and development and amortization of cost in
excess of net assets acquired.
Three Months Ended Six Months Ended
December 31, December 31,
----------------------------- -----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
Revenues........................................................ 100% 100% 100% 100%
Costs and expenses:
Cost of revenues and technical support....................... 16 15 15 15
Sales and marketing.......................................... 39 42 41 41
Research and development..................................... 25 27 25 28
General and administrative................................... 8 9 8 9
Amortization of excess of cost over fair value
of net assets acquired.................................... 1 - 1 -
Charge for purchased research and development................ 13 - 7 -
----------- ----------- ----------- -----------
Total costs and expenses........................................ 102 93 97 93
----------- ----------- ----------- -----------
Operating income................................................ (2) 7 3 7
Interest and other income, net............................... 1 3 1 1
----------- ----------- ----------- -----------
Income before income taxes and minority interest................ (1) 10 4 8
Provision for income taxes................................... (4) (3) (3) (2)
Minority interest in earnings of subsidiary.................. - - - -
----------- ----------- ----------- -----------
Net income...................................................... (5)% 7% 1% 6%
=========== =========== =========== ===========
10
Revenues
The Company's revenues increased to $14.1 million for the three months ended
December 31,1998, an increase of 66% over the $8.5 million reported for the
comparable period in the prior fiscal year. Our revenues for the six months
ended December 31, 1998 were $25.9 million, representing a 60% increase from the
$16.1 million reported for the comparable period in the prior fiscal year. We
attributed the revenue increase in each period to increased market acceptance of
our products operating on Windows NT, introduction of Pervasive.SQL and
expansion of our worldwide sales organization. Although our revenues have
increased in recent periods, we cannot be certain that revenues will grow in
future periods, that they will grow at past rates or that we will remain
profitable on a quarterly or annual basis in the future.
Licenses of our software operating on Windows NT or other Microsoft operating
systems increased to approximately 50% of our revenues in the three months ended
December 31, 1998 from approximately 46% in the comparable period in the prior
year. These same licenses represented 50% of our revenues in the six months
ended December 31, 1998 compared to 43% in the comparable period in 1997.
Licenses of our software operating on NetWare represented approximately 37% of
revenues in the three months ended December 31, 1998, as compared to 49% in the
comparable period in the prior year. In the six months ended December 31, 1998,
NetWare licenses represented 40% of our revenues compared to 52% in the
comparable period in the prior year. We believe that the increase in the
percentage of revenues attributable to licenses of our products operating on
Windows NT and other Microsoft operating systems is due to two factors: (1) the
increased market acceptance of our products operating on Microsoft platforms and
(2) the increased market penetration of Microsoft platforms relative to other
operating systems. We expect that the percentages of our revenues attributable
to licenses of our software operating on particular platforms will continue to
change from time to time. We cannot be certain that our revenues attributable to
licenses of our software operating on Windows NT, or any other operating system
platform, will grow in the future, or at all.
International revenues, consisting of all revenues from customers located
outside of North America, were $3.3 million and $5.9 million in the three months
ended December 31, 1997 and 1998, representing 38% and 42% of total revenues,
respectively. We recognized international revenues of $6.5 million and $10.2
million for the six months ended December 31, 1997 and 1998, representing 40%
and 39% of total revenues, respectively. We attribute the increase in dollar
amount in each period primarily to expansion of our international sales
organization, particularly in Europe and Japan. We believe that revenues from
international markets represent a significant opportunity. Therefore, we expect
that international revenues may account for an increasing portion of our
revenues in the future as we expand internationally, primarily in Europe and
Japan, but also in other areas of the world.
Costs and Expenses
Cost of Revenues and Technical Support. Cost of revenues and technical support
consists primarily of the cost to manufacture and fulfill orders for the
Company's shrink wrap software products and the cost to provide technical
support, primarily telephone support, which is typically provided within 30 days
of purchase. Cost of revenues and technical support was $1.2 million and $2.2
million in the three months ended December 31, 1997 and 1998, representing 15%
and 16% of total revenues, respectively. Cost of revenues and technical support
was $2.4 million and $3.8 million in the six months ended December 31, 1997 and
1998, representing 15% of revenues in both periods. Cost of revenues and
technical support increased in each period due to increased sales volume and
increased technical support personnel in the U.S., Europe and Japan. We
anticipate that cost of revenues and technical support will continue to increase
in dollar amount as we expand our international operations, particularly in
Japan, and provide technical support for additional products. Cost of revenues
and technical support may vary as a percentage of revenues in the future.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and bonuses earned by sales and marketing personnel,
foreign sales office expenses, travel and entertainment and promotional
expenses. Sales and marketing expenses were $3.5 million and $5.5 million in
the three months ended December 31, 1997 and 1998, representing 42% and 39% of
revenues, respectively. Sales and marketing expenses were $6.6 million and
$10.5 million in the six months ended December 31, 1997 and 1998, representing
41% in both periods. Sales and marketing expenses increased in dollar amounts in
both the three and six month periods ended December 31,
11
1998 over the comparable periods in the prior year primarily due to increased
costs associated with hiring additional sales and marketing personnel, the
promotion of Pervasive.SQL and increased infrastructure costs associated with
foreign sales office expansion. We expect that sales and marketing expenses will
continue to increase in dollar amount as we continue to promote Pervasive.SQL
and Tango, hire additional sales and marketing personnel and expand our
international operations. Sales and marketing expenses are likely to continue to
fluctuate as a percentage of revenues due to the timing of costs associated with
new product releases, marketing promotions and international expansion.
Research and Development. Research and development expenses consist primarily
of personnel and related costs. Research and development expenses were $2.3
million and $3.5 million in the three months ended December 31, 1997 and 1998,
representing 27% and 25% of revenues, respectively. Research and development
expenses were $4.5 million and $6.5 million in the six months ended December 31,
1997 and 1998, representing 28% and 25% of revenues, respectively. Research and
development expenses increased in dollar amount each period primarily due to the
increased hiring of, and contracting with, additional research and development
personnel. Research and development expenses decreased as a percentage of
revenues primarily because of significant revenue growth that outpaced research
and development expenditures. We anticipate that we will continue to devote
substantial resources to research and development and that such expenses will
continue to increase in dollar amount.
Software development costs that were eligible for capitalization in accordance
with Statement of Financial Accounting Standards No. 86 were insignificant
during these periods. Accordingly, we charged all software development costs to
research and development expenses.
In March 1998, we announced a joint development initiative with Oracle
Corporation to enable application developers to create and deploy a single
application for both small businesses and large corporations without substantial
code changes. The joint development effort should also allow existing packaged
application providers to migrate their solutions to Pervasive and Oracle
databases. We have performed, and will perform, all of the development effort
required to create the technology and will own the technology in its final form.
Oracle has allowed us access to certain of their proprietary information to
enable us to design and develop the resulting application programming interface.
We have no financial arrangement with Oracle related to the initiative. Research
and development expenses related to the joint development initiative with Oracle
were not material for the year ended June 30, 1998, or for the six months ended
December 31, 1998, and we do not expect these expenses to be material in the
future.
General and Administrative. General and administrative expenses consist
primarily of the personnel and other costs of our finance, human resources,
information systems and administrative departments. General and administrative
expenses were $790,000 and $1.2 million in the three months ended December 31,
1997 and 1998, representing 9% and 8% of revenues, respectively. General and
administrative expenses were $1.4 million and $2.2 million in the six months
ended December 31, 1997 and 1998, representing 9% and 8% of revenues,
respectively. We attribute the increase in dollar amount in each period
primarily to the increased staffing and associated expenses necessary to manage
and support our increased scale of operations, both domestically and
internationally. General and administrative expenses decreased as a percentage
of revenue in fiscal 1997 and 1998 primarily because of significant revenue
growth that outpaced general and administrative expenditures. We believe that
our general and administrative expenses will increase in dollar amount in the
future as our administrative staff expands to support our growing worldwide
operations.
Charge for Purchased Research and Development. We acquired 93% of the capital
stock of EveryWare Development Inc. in November 1998, and acquired the remaining
outstanding shares in December 1998, for total consideration of $11.8 million,
including cash paid to the EveryWare shareholders, transaction costs and the
value of employee stock options assumed. We accounted for the acquisition using
the purchase method of accounting. We hired an independent third-party appraisal
company to determine the valuation of the intangible assets acquired. The
valuation allocated the purchase price as follows: $1.8 million attributed to
purchased research and development; $1.2 million attributed to current
technology; and $200,000 attributed to the assembled workforce. We charged to
operations $1.8 million in purchased research and development in the quarter
ended December 31, 1998, because the underlying research and development
projects had not yet reached technological feasibility and had no alternative
future uses.
12
We are using the purchased research and development to complete new products
that will become part of our product lines in fiscal 1999 and fiscal 2000. We
believe these new products will include new technology which furthers the
extensibility, ease-of-use, productivity and performance of our Web application
server and Web development and deployment solutions, as well as new integrated
tools and utilities for administration and analysis. We expect that
substantially all the purchased research and development will reach
technological feasibility, but there can be no assurance that the commercial
viability of these products will actually be achieved. If commercial viability
is not achieved, we would look to other alternatives to provide these solutions.
We do not believe that a delay in providing such alternative solutions would
have a significant adverse effect on our results of operations. At the time of
the acquisition, we estimated the time to be incurred to transform the purchased
research and development into commercially viable products as approximately 79
man months or approximately $400,000.
The nature of the efforts required to complete development of the purchased
research and development into commercially viable products principally relates
to the completion of all designing, prototyping, verification and testing
activities necessary to establish that the products can be produced to meet
design specifications, including functions, features, and technical performance
requirements.
An independent third-party appraiser determined the value assigned to
purchased research and development. This third-party appraiser projected cash
flows related to future products expected to be derived once technological
feasibility is achieved, including costs to complete the development of
technology and the future revenues and costs which are expected to result from
commercialization of the products. Cash flows recognized the contribution of
core technology and other supporting assets and were discounted back to their
present value at a rate of 25% for one project and 30% for another project. The
resulting net cash flows from such projects are based on our estimates of
revenues, cost of revenues and technical support, research and development
expenses, selling, general and administrative expenses and income taxes
resulting from such projects. Our estimates were based on expected trends in
technology and the nature and expected timing of completion of purchased
research and development. Nothing has come to our attention that would lead us
to believe substantial changes need to be made to the underlying assumptions.
Provision for Income Taxes. The Company's income tax provisions for interim
periods are based on estimated annual effective income tax rates. The projected
income tax provision for fiscal 1999 reflects the Company's anticipated mix of
foreign and domestic income and the expected benefit from release of the
Company's valuation allowance recorded against its deferred tax assets.
The estimated effective tax rate, before considering the impact of the non-
deductible charge for purchased research and development, for both the three
and six month periods ended December 31, 1998, was 31% compared with 30% for the
comparable period in the prior year. The increase in the Company's effective
tax rate for fiscal year 1999 is primarily due to increased foreign taxes
associated with the Company's increased operations overseas and a decrease in
the expected benefit from partial release of the valuation allowance recorded
against the Company's deferred tax assets. The Company expects its effective
tax rate will increase in the future once the Company's deferred tax asset is
fully realized.
We believe that, based on a number of factors, it is more likely than not that
a substantial amount of our deferred tax assets may not be realized. These
factors include:
. A limited history of profitability;
. Recent increases in expense levels to support our growth;
. The lack of carryback capacity to realize the deferred tax assets;
. The potential impact of anticipated deductions due to exercise of employee
stock options on deferred tax assets with limited carryforward periods; and
. The intensely competitive market in which we operate and which is subject to
rapid change.
13
Accordingly, we have recorded a valuation allowance to the extent deferred tax
assets exceed the potential benefit from carryback of deferred items to offset
current or prior year taxable income. We expect our effective tax rate will
increase in the future once our deferred tax asset is fully realized.
Liquidity and Capital Resources
Cash provided by operations was $600,000 and $2.5 million for the six months
ended December 31, 1997 and 1998, respectively. The increase in cash generated
by operations resulted primarily from increased earnings, excluding a non-cash
charge for purchased research and development and amortization of acquisition
related intangibles.
During the first six months of fiscal 1999, we invested $1.6 million in
marketable securities, consisting of various taxable and tax advantaged
securities. In addition, we purchased property and equipment totaling
approximately $1.2 million for the six months ended December 31, 1997 and $3.1
million for the six months ended December 31, 1998 including approximately $1.3
million for furniture and fixtures and improvements related to our new facility.
We expect that our capital expenditures will increase as our employee base
grows.
In November 1998, we acquired 93% of the outstanding stock of EveryWare
Development Inc., and acquired the remaining outstanding shares in December
1998. We financed the acquisition by using available funds of approximately $11
million during the quarter ended December 31, 1998 and, therefore, substantially
reduced our liquidity position.
In February 1998, we acquired Smithware, Inc. ("Smithware"), a developer of
database development and reporting components for Pervasive products. We
acquired Smithware for approximately $390,000 consisting of $170,000 in cash,
23,752 shares of our common stock valued at $160,000 and acquisition costs of
$60,000, plus up to an additional $80,000 of cash and 47,502 shares of common
stock payable upon achievement of certain milestones in the future. In
conjunction with the acquisition, we repaid Smithware's outstanding debts of
approximately $110,000. In the six months ended December 31, 1998, we paid
$80,000 in cash and issued 19,000 shares of our common stock valued at $155,000
to the former Smithware shareholders upon achieving the first two milestones
specified in the acquisition agreement.
In September 1997, we completed an initial public offering in which we sold
2,000,000 shares of common stock for net proceeds of $17.4 million, after
deducting the underwriter's discount and expenses of the offering.
On December 31, 1998, we had $7.7 million in working capital including $1.9
million in cash and cash equivalents and $6.6 million in marketable securities.
We have a $10.0 million revolving line of credit with a bank, but have at no
time borrowed under such line. Our line of credit contains certain financial
covenants and restrictions as to various matters including our ability to pay
cash dividends and effect mergers or acquisitions without the bank's prior
approval. We are currently in compliance with such financial covenants and
restrictions. We have granted a first priority security interest in
substantially all of our tangible assets as security for our obligations under
our credit lines.
The Company filed a Registration Statement on Form S-1 with the Securities and
Exchange Commission on February 8, 1999 (File No. 333-71955) in which the
Company will offer 1,500,000 shares of common stock. In addition, the Company
has granted the underwriters of the offering a 30-day option to purchase up to
an additional 450,000 shares of common stock to cover over-allotments.
Recently Issued Accounting Standards
In October 1997, the American Institute of Certified Public Accountants, or
AICPA, issued Statement of Position 97-2, Software Revenue Recognition, which
changes the requirements for revenue recognition. In March 1998, the AICPA
issued SOP 98-4, Deferral of the Effective Date of a Provision of SOP 97-2,
"Software Revenue Recognition." We adopted SOP 97-2 and SOP 98-4 in fiscal
1999. The effect of such adoption was not significant.
In December 1998, the AICPA issued Statement of Position 98-9, Modification of
SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.
SOP 98-9 amends SOP 98-4 to extend the deferral of the
14
application of certain passages of SOP 97-2 provided by SOP 98-4 through fiscal
years beginning on or before March 15, 1999. All other provisions of SOP 98-9
are effective for transactions entered into in fiscal years beginning March 15,
1999. We believe that the adoption of SOP 98-9 will not have a material effect
on our results of operations or financial position.
In June 1997, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income, or Statement 130. This statement establishes standards for reporting and
display of comprehensive income. We adopted Statement 130 in fiscal 1999.
In June 1997, the FASB also issued Statement 131, Disclosures about Segments
of an Enterprise and Related Information. Statement 131 establishes the
standards for the manner in which public enterprises are required to report
financial and descriptive information about their operating segments. We are
required to adopt Statement 131 for the year ended June 30, 1999. We believe
that the adoption of Statement 131 will not affect our results of operations or
financial position, and will not significantly affect the disclosure of segment
information in the future.
In February 1998, the FASB issued Statement 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits. The Statement supersedes the
disclosure requirements in Statements No. 87, Employers' Accounting for
Pensions, No. 88, Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits, and No. 106, Employers' Accounting
for Postretirement Benefits Other Than Pensions. Statement 132 revises the
required disclosures about pensions and other postretirement benefits. We
believe that the adoption of Statement 132 will have no affect on our results of
operations, financial position or disclosures in the future.
In June 1998, the FASB issued Statement 133, Accounting for Derivative
Instruments and Hedging Activities, which is required to be adopted in fiscal
2000. Because of the Company's minimal use of derivatives, management does not
anticipate that the adoption of Statement 133 will have a significant effect on
the Company's results of operations or the financial position of the Company.
Year 2000 Compliance
The "Year 2000" issue results from an industry-wide practice of representing
years with only two digits instead of four. Beginning in the year 2000, date
code fields will need to accept four digit entries to distinguish twenty-first
century dates from twentieth century dates (2000 or 1900). As a result, in less
than one year, computer systems and/or software used by many companies may need
to be upgraded to comply with such Year 2000 requirements. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance.
Our Year 2000 readiness plan for our current versions of Pervasive.SQL 7,
Btrieve v6.15, ODBC Interface v2 and Tango v3.5 includes the following:
. Assessment-Take an inventory of products to be tested, survey third-party
programs utilized, generate compliance plan, and define what compliance will
mean;
. Implementation-Devise upgrades to correct any Year 2000 issues;
. Validation-Test and debug current versions of products; and
. Contingency Planning-Plan to implement in the event that we do not achieve
Year 2000 compliance by January 1, 2000.
We have completed all phases of our plan, except for contingency planning,
with respect to the current versions of all of our products. Based on our
review, each of the current versions of our products was found to have no known
Year 2000 limitations, when configured and used in accordance with the related
documentation, and provided that the underlying operating system of the host
machine and any other software used with or in the host machine are also Year
2000 compliant. An earlier release of Scalable SQL and certain other
discontinued products were not designed to be Year 2000 compliant. However, the
product documentation for these earlier products did describe how to utilize the
products in a manner which would support four digit entries. Earlier versions of
our products have not been tested for
15
Year 2000 compliance as these earlier versions of our products are no longer
supported by us. We recommend upgrading to the current version of our products
if customers have any concerns.
We have defined "Year 2000 Compliant" as the ability to:
. Correctly handle date information needed for the transition from December
31, 1999 to January 1, 2000;
. Function according to the product documentation provided for this date
change, without changes in operation resulting from the approaching new
century, assuming correct configuration;
. Where appropriate, respond to two-digit date input in a way that resolves
the ambiguity as to century in a disclosed, defined, and predetermined
manner;
. If the date elements in interfaces and data storage specify the century,
store and provide output of date information in ways that are unambiguous
as to century; and
. Recognize Year 2000 as a leap year.
We do not currently have any information concerning the Year 2000 compliance
status of our customers or third-party vendors who embed or resell our products.
Third-party applications that utilize our products may still be written in a
manner that does not take advantage of the Year 2000 capabilities of our
products. If our current or future customers fail to achieve Year 2000
compliance or if they divert technology expenditures away from software products
such as those offered by us to address Year 2000 issues, our business, operating
results, or financial condition could be materially adversely affected.
We have not specifically tested software licensed from third parties that is
marketed through our channel, but we have received warranties and
representations from our vendors that the licensed software is Year 2000
Compliant. Despite testing by us and by our current and potential customers, and
assurances from developers of products incorporated into our products, our
products may contain undetected errors or defects associated with Year 2000 date
functions. Unknown errors or defects in our products could result in loss of
revenues or delay in market acceptance, which could have a material adverse
effect on our business, operating results and financial condition. Some
commentators have predicted significant litigation regarding Year 2000
compliance issues. Because of the nature of such litigation, it is uncertain
whether or to what extent we may be affected by it.
Our internal systems include both our information technology and non-IT
systems (such as our security system, building equipment, and embedded
microcontrollers). We have initiated an informal Year 2000 compliance project to
assess our material internal IT systems and our non-IT systems. The project
encompasses two major areas of our internal IT structure: the technical services
area, including all hardware, operating system, and standard application issues;
and the applications area, including all corporate database, accounting and
custom applications. To the extent that we are not able to test the technology
provided by third-party vendors, we are seeking assurances from such vendors
that their systems are Year 2000 Compliant. Although we are not currently aware
of any material operational issues or costs associated with preparing our
internal IT and non-IT systems for the Year 2000, we may experience material
unanticipated problems and costs caused by undetected errors or defects in the
technology used in such systems. We plan to formalize our internal IT and non-IT
Year 2000 readiness plan beginning March 1999. We anticipate that a majority of
the existing Year 2000 issues will be eliminated by this time, and we believe
that this time frame will provide adequate time to resolve any remaining
material issues. Nonetheless, undetected errors or defects in the technology
used in our internal IT and non-IT systems could have a material adverse affect
on our business, operating results, or financial condition.
We have funded our Year 2000 plan from operating cash flows and have not
separately accounted for these costs in the past, nor do we have specific
dollars budgeted for the project as the costs are not considered to be material.
We have not yet fully developed a comprehensive contingency plan to address
situations that may result if we are unable to achieve Year 2000 compliance of
our critical operations. The cost of developing and implementing such a plan may
itself be material.
Finally, we are also subject to external forces that might generally affect
industry and commerce, such as utility or transportation company Year 2000
compliance failures and related service interruptions. The costs associated with
any such external forces could be material.
16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The majority of the Company's operations are based in the U.S. and,
accordingly, the majority of its transactions are denominated in U.S. Dollars.
However, the Company does have foreign-based operations where transactions are
denominated in foreign currencies and are subject to market risk with respect to
fluctuations in the relative value of currencies. Currently, the Company has
operations in Canada, Japan, Germany, France, Ireland, England, Belgium, and
Hong Kong and conducts transactions in the local currency of each location. The
Company monitors its foreign currency exposure and, from time to time will
attempt to reduce its exposure through hedging. The impact of fluctuations in
the relative value of other currencies was not material for the quarter ended
December 31, 1998. Quantitative and qualitative information about market risk
was addressed in Item 7A of the Company's Form 10-K for the fiscal year ended
June 30, 1998.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones we face. If any of the following risks actually occur, our business,
financial condition or results of operations could be materially adversely
affected. In such case, the trading price of our common stock could decline, and
you may lose all or part of your investment.
We Expect Our Financial Results May Vary Significantly from Quarter to Quarter
Our operating results have varied significantly from quarter to quarter in the
past and will continue to vary significantly from quarter to quarter in the
future due to a variety of factors. Many of these factors are outside of our
control. These factors include:
. Demand for our products;
. Seasonality and the timing of product sales;
. Unexpected delays in introducing new products and services;
. New product releases or pricing policies by our competitors;
. Lack of order backlog;
. Loss of a significant distributor;
. Increased expenses, whether related to sales and marketing, product
development or administration; and
. The mix of domestic and international sales.
In addition, we may experience fluctuations based on our past and future
acquisitions of businesses and product lines. For example, we incurred a loss in
the quarter ended December 31, 1998 as a result of a charge for purchased
research and development associated with our acquisition of EveryWare
Development Inc.
We will continue to determine our investment and expense levels based on our
expected future revenues, which may not grow at historical rates in future
periods, if at all. A significant portion of our expenses are not variable in
the short term and cannot be quickly reduced to respond to decreases in
revenues. Therefore, if our revenues are below our expectations, our operating
results and net income are likely to be adversely and disproportionately
affected. In addition, we may reduce our prices or accelerate our investment in
research and development efforts in response to
17
competitive pressures or to pursue new market opportunities. Any one of these
activities may further limit our ability to adjust spending in response to
revenue fluctuations.
Seasonality May Contribute to Fluctuations in Our Quarterly Operating Results
Our business has experienced, and is expected to continue to experience,
seasonal customer buying patterns. In recent years, we have had relatively
stronger demand for our products during the quarters ending December 31 and June
30, and relatively weaker demand in the quarters ending March 31 and September
30. We believe that this pattern may continue. In addition, to the extent
international operations constitute a greater percentage of our revenues in
future periods, we anticipate that demand for our products in Europe and Japan
will decline because of reduced corporate buying patterns during the vacation
season in the summer months.
We Currently Operate Without a Backlog
We currently operate with virtually no order backlog because our software
products are shipped and revenue is recognized shortly after orders are
received. This lack of backlog makes product revenues in any quarter
substantially dependent on orders booked and shipped throughout that quarter. As
a result, if orders in the first month or two of a quarter fall short of
expectations, it is likely we will not meet our revenue targets for that
quarter. As a result, our quarterly operating results would be materially and
adversely affected.
Our Success Depends on Our Management of Significant Growth and Change Within
Our Business
We have expanded our operations rapidly since inception, resulting in new and
increased responsibilities for management and placing a strain upon our
financial and other resources. During this period, we have experienced revenue
growth, an increase in the number of our employees, an expansion in the scope of
our operating and financial systems and an expansion in the geographic area of
our operations. In particular, we had a total of 305 employees at December 31,
1998, as compared to 189 at December 31, 1997. In order to manage growth
effectively, we must implement and improve our operational systems, procedures
and controls on a timely basis. If we fail to implement and improve these
systems, our business, operating results and financial condition will be
materially adversely affected.
Our Performance Depends on Our Successful Transition To and Market Acceptance of
Pervasive.SQL
Prior to the release of our Pervasive.SQL products, we derived substantially
all of our revenues from the license of our Btrieve products. Although we expect
to continue to derive a significant portion of our revenues from Btrieve
licenses in the near term, our future operating results will become increasingly
dependent on market acceptance of Pervasive.SQL. We cannot be certain that
future sales of Pervasive.SQL will continue at initial rates. The pace and
timing of market acceptance of Pervasive.SQL has depended largely on factors
such as the product development cycles of developers and resellers who embed our
products into packaged software applications. We cannot be certain whether or
when Pervasive.SQL will become integrated into our customers' development,
marketing and support infrastructure to the same extent as Btrieve. Although we
recognized increased revenue from Pervasive.SQL in the first and second quarters
of fiscal 1999, one-time upgrades from earlier versions of our products, our
favorable upgrade pricing, or other factors may have contributed to such sales.
Our Future Success Will Depend on Our Ability to Successfully Market and Support
Tango
We acquired the technology for our Tango products in November 1998 and we
recently began to market the Tango Application Server and Tango Development
Studio both as stand-alone products and integrated with Pervasive.SQL. To date,
we have not derived significant revenues from the Tango products. Our
performance depends on our ability to generate demand for, gain market
acceptance of and effectively support our Tango products in the near future.
Because of our limited experience marketing the Tango products, we cannot be
certain that we will achieve market acceptance for or generate significant
revenue from the Tango products.
18
Our ability to rapidly gain market acceptance and to effectively support our
Tango products is subject to a number of factors, including:
. Our ability to successfully integrate Pervasive.SQL with the Tango products;
. Our ability to recruit and train new and existing value-added resellers;
. The success of our seeding promotion involving free downloads of our Tango
development environment and our ability to ultimately receive Tango
Application Server revenue from this promotion;
. The time lag between adoption and deployment of the Tango product line;
. Our ability to successfully market Tango products to our installed base of
customers, independent software vendors and value-added resellers;
. The extent of competitive pricing pressure from companies in our markets
that are willing to accept losses in an attempt to gain market share; and
. Continued growth in the market for Web-based development products.
We Must Successfully Integrate Our Recent Acquisition of EveryWare Development
Inc.
Our failure to successfully address the risks associated with our acquisition
of EveryWare Development Inc. of Toronto, Canada could have a material adverse
affect on our business, operating results and financial condition. We acquired
EveryWare in November 1998. The success of this acquisition will depend on our
ability to:
. Successfully integrate and manage EveryWare's operations, which are based in
Canada;
. Retain EveryWare's software developers; and
. Implement our business strategy.
We Have Significant Product Concentration
We currently derive substantially all of our revenues from our Pervasive.SQL
and Btrieve data management products. Data management-related revenue will
continue to account for substantially all of our revenues for the foreseeable
future. As a result, our future operating results will depend upon continued
market acceptance of Pervasive.SQL and our ability to develop and market our
Tango products. Pervasive.SQL may not achieve continued market acceptance, and
Tango may not achieve market acceptance at all. Any decrease in demand or market
acceptance for our Pervasive.SQL and Btrieve product would have a damaging
effect on our business, operating results and financial condition.
Our Efforts to Develop Brand Awareness of Our Products May Not be Successful
We believe that developing and maintaining awareness of the "Tango" and
"Pervasive" brand names is critical to achieving widespread acceptance of our
products. The importance of brand recognition will increase as competition in
the market for Web-based development and deployment products increases. A key
element of our business strategy is to commit significant resources to promote
our brands. We have not obtained a United States registration of the trademark
for these names, and we are aware of other companies that use these marks, in
particular "Tango," in their marks alone or in combination with other words.
We expect that it may be difficult or impossible to prevent third-party uses for
competing goods and services. Competitors or others that use marks that are
similar to our brand names may cause confusion among actual and potential
customers, which could prevent us from achieving significant brand
19
recognition. If we fail to promote and maintain our brands or incur significant
related expenses, our business, operating results and financial condition could
be materially adversely affected.
A Small Number of Distributors Account For a Significant Percentage of Our
Revenues
The loss of a major distributor or any reduction in orders by such
distributor, including reductions due to market or competitive conditions,
combined with the inability to replace the distributor on a timely basis, could
materially adversely affect our business, operating results and financial
condition. Many of our independent software vendors, value-added resellers and
end users place their orders through distributors. A relatively small number of
distributors have accounted for a significant percentage of our revenues. In the
six months ended December 31, 1998, two distributors accounted for a combined
24% of revenues, and two distributors accounted for a combined 22% of revenues
for the comparable period in the 1997 fiscal year. We expect that we will
continue to be dependent upon a limited number of distributors for a significant
portion of our revenues in future periods. Moreover, we expect that such
distributors will vary from period to period. Our distributors have not agreed
to any minimum order requirements. Although we forecast demand and plan
accordingly, if a distributor purchases excess product, we may be obligated to
accept the return of some products.
We Depend on Our Indirect Sales Channel
Our failure to continue to grow our indirect sales channel or the loss of a
significant number of members of our indirect channel partners would have a
material adverse effect on our business, financial condition and operating
results. We do not have a substantial direct sales force and derive
substantially all of our revenues from indirect sales through a channel
consisting of independent software vendors, value-added resellers, system
integrators, consultants and distributors. Our sales channel could be adversely
affected by a number of factors including:
. The emergence of a new platform resulting in the failure of independent
software vendors to develop and the failure of value-added resellers to
sell our products based on our supported platforms;
. Pressures placed on the sales channel to sell competing products;
. Our failure to adequately support the sales channel; and
. Competing product lines offered by certain of our indirect channel
partners.
We cannot be certain that we will be able to continue to attract additional
indirect channel partners or retain our current partners. In addition, we cannot
be certain that our competitors will not attempt to recruit certain of our
current or future partners.
We May Face Problems in Connection With Future Acquisitions or Joint Ventures
In the future, we may acquire additional businesses, products and
technologies, or enter into joint venture arrangements, that could complement or
expand our business. Our negotiations of potential acquisitions or joint
ventures and our integration of acquired businesses, products or technologies
could divert time and resources. Any future acquisitions could require us to
issue dilutive equity securities, incur debt or contingent liabilities, amortize
goodwill and other intangibles, or write-off purchased research and development
and other acquisition-related expenses. If we are unable to fully integrate
acquired businesses, products or technologies with our existing operations, we
may not receive the intended benefits of acquisitions.
We May Not Be Able to Develop Strategic Relationships
Our current collaborative relationships may not prove to be beneficial to us,
and they may not be sustained. Further we may not be able to enter into
successful new strategic relationships in the future, which could have a
material adverse effect on our business, operating results and financial
condition. From time to time, we have collaborated with other companies,
including Oracle, Novell and Macromedia, in areas such as product development,
20
marketing, distribution and implementation. Maintaining these and other
relationships is a meaningful part of our business strategy. However, many of
our current and potential strategic partners are either actual or potential
competitors with us. In addition, many of these relationships are informal or,
if written, terminable with little or no notice.
We Depend on Third-Party Technology in Our Products
We rely upon certain software that we license from third parties, including
software that is integrated with our internally developed software and used in
our products to perform key functions. These third-party software licenses may
not continue to be available to us on commercially reasonable terms. The loss
of, or inability to maintain or obtain any of these software licenses, could
result in shipment delays or reductions until we develop, identify, license and
integrate equivalent software. Any delay in product development or shipment
could damage our business, operating results and financial condition.
We May be Unable to Protect Our Intellectual Property and Proprietary Rights
Our success depends to a significant degree upon our ability to protect our
software and other proprietary technology. We rely primarily on a combination of
copyright, trademark and trade secret laws, confidentiality procedures and
contractual provisions to protect our proprietary rights. However, these
measures afford us only limited protection. In addition, we rely in part on
"shrink wrap" and "click wrap" licenses that are not signed by the end user
and, therefore, may be unenforceable under the laws of certain jurisdictions.
Unauthorized parties may attempt to copy aspects of our products or to obtain
and use information that we regard as proprietary. Although we believe software
piracy may be a problem, we are unable to determine the extent to which piracy
of our software products exists. In addition, portions of our source code are
developed in foreign countries with laws that do not protect our proprietary
rights to the same extent as the laws of the United States.
We may increasingly be subject to claims of intellectual property infringement
as the number of products and competitors in our industry segment continues to
grow and the functionality of products in different industry segments
increasingly overlaps. Although we are not aware that any of our products
infringe upon the proprietary rights of third parties, third parties may claim
infringement by us with respect to current or future products. Any infringement
claims, with or without merit, could be time-consuming, result in costly
litigation, cause product shipment delays or the loss or deferral of sales or
require us to enter into royalty or licensing agreements. If we are required to
enter into royalty or licensing agreements, they may not be on terms acceptable
to us. Unfavorable royalty and licensing agreements could seriously damage our
business, operating results and financial condition.
We Must Adapt to Rapid Technological Change
Our future success will depend upon our ability to continue to enhance our
current products and to develop and introduce new products on a timely basis
that keep pace with technological developments and satisfy increasingly
sophisticated customer requirements. Rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer demands and evolving industry standards characterize the market for
our products. The introduction of products embodying new technologies and the
emergence of new industry standards can render existing products obsolete and
unmarketable. As a result of the complexities inherent in client/server
computing environments and the performance demanded by customers for embedded
databases and Web-based products, new products and product enhancements can
require long development and testing periods. As a result, significant delays in
the general availability of such new releases or significant problems in the
installation or implementation of such new releases could have a material
adverse effect on our business, operating results and financial condition. We
have experienced delays in the past in the release of new products and new
product enhancements. We may not be successful in:
. Developing and marketing, on a timely and cost-effective basis, new products
or new product enhancements that respond to technological change, evolving
industry standards or customer requirements;
21
. Avoiding difficulties that could delay or prevent the successful
development, introduction or marketing of these products; or
. Achieving market acceptance for our new products and product enhancements.
We May be Affected by Unexpected Year 2000 Problems
We are subject to potential "Year 2000" problems affecting our products, our
internal systems and the systems of our vendors and distributors, any of which
could have a material adverse effect on our business, operating results and
financial condition. Many existing computer systems and software products do not
properly recognize dates after December 31, 1999. This "Year 2000" problem
could result in miscalculations, data corruption, system failures or disruptions
of operations.
The latest versions of Btrieve and Pervasive.SQL are designed to be Year 2000
compliant. An earlier release of the predecessor to Pervasive.SQL, Scalable SQL,
and certain other discontinued products were not designed to be Year 2000
compliant; however, the product documentation described how to utilize the
products in a manner that would support four digit date entries. We cannot be
certain that our software products that are designed to be Year 2000 compliant
contain all necessary date code changes. In addition, third party applications
in which our products are embedded, or for which our products are separately
licensed, may not comply with Year 2000 requirements, which may have an adverse
impact on demand for our products. As a result, we may incur increased expenses
and lose customers to competing products.
Tango, when installed alone, does not involve data storage. Thus, the ability
of a Web-based application built with Tango to comply with Year 2000
requirements is largely dependent on whether the database underlying the
application is Year 2000 compliant. Therefore, we cannot ensure that Web-based
applications developed using our products will comply with Year 2000
requirements. For example, if Tango, when installed alone, is connected to a
database that is not Year 2000 compliant, the information received by a Tango
application may be incorrect.
Changing purchasing patterns of customers impacted by Year 2000 issues may
result in reduced funds available for our products.
In addition, there can be no assurance that Year 2000 errors or defects will
not be discovered in our internal software systems and, if such errors or
defects are discovered, there can be no assurance that the costs of making such
systems Year 2000 compliant will not be material.
Year 2000 errors or defects in the internal systems maintained by our vendors
or distributors could require us to incur significant unanticipated expenses to
remedy any problems or replace affected vendors and could reduce our revenue
from our distribution channel.
Our Software May Contain Undetected Errors
Errors or defects in our products may result in loss of revenues or delay in
market acceptance, and could materially adversely affect our business, operating
results and financial condition. Software products such as ours may contain
errors or defects, sometimes called "bugs," particularly when first introduced
or when new versions or enhancements are released. In the past, we have
discovered software errors in certain of our new products after their
introduction. Despite our testing, current versions, new versions or
enhancements of our products may still have defects and errors after
commencement of commercial shipments.
22
We May Become Subject to Product Liability Claims
A product liability claim, whether or not successful, could damage our
reputation and our business, operating results and financial condition. Our
license agreements with our customers typically contain provisions designed to
limit our exposure to potential product liability claims. However, these
contract provisions may not preclude all potential claims. Product liability
claims could require us to spend significant time and money in litigation or to
pay significant damages.
We Compete with Microsoft while Simultaneously Supporting Microsoft Technologies
We currently compete with Microsoft in the market for data management and Web
development and deployment products while simultaneously maintaining a working
relationship with Microsoft. Microsoft has a longer operating history, a larger
installed base of customers and substantially greater financial, distribution,
marketing and technical resources than the Company. As a result, we may not be
able to compete effectively with Microsoft now or in the future, and our
business, operating results and financial condition may be materially adversely
affected.
We expect that Microsoft's commitment to and presence in both the database and
Web development and deployment products markets will substantially increase
competitive pressures. We believe that Microsoft will continue to incorporate
Web application server or SQL Server database technology into its operating
system software and certain of its server software offerings, possibly at no
additional cost to its users. We believe that Microsoft will also continue to
enhance its SQL Server database technology.
We believe that we must maintain a working relationship with Microsoft to
achieve success. Many of our customers use Microsoft-based operating platforms.
Thus it is critical to our success that our products be closely integrated with
Microsoft technologies. Notwithstanding our historical and current support of
Microsoft platforms, Microsoft may in the future promote technologies and
standards more directly competitive with or not compatible with our technology.
We Face Significant Competition From Other Companies
We encounter competition for our database products primarily from large,
public companies, including Microsoft, Oracle, Informix, Sybase and IBM. In
particular, Sybase offers a small memory footprint database software product,
Adaptive Server Anywhere, which directly competes with our products. In
addition, because there are relatively low barriers to entry in the software
market, we may encounter additional competition from other established and
emerging companies.
The Web development and deployment market is an emerging, intensely
competitive environment, subject to rapidly changing products and new market
participants. The market is also undergoing tremendous consolidation, which
could result in the creation of a relatively few dominant players. In the last
year, Netscape acquired Kiva Software, Sun Microsystems acquired NetDynamics and
BEA Systems acquired WebLogic. Both Oracle and IBM entered the Web development
and deployment market with internally developed solutions. The primary
competitor for Tango is Allaire's Cold Fusion product. Additional competitors
include Silverstream, HAHT Software, Bluestone and Microsoft. Another set of
competitors could arise as traditional online transaction processing and
database vendors expand their application server solutions to include Web-based
application development software. We believe that, given the projected size of
the market and strong trend towards distributed computing, it is likely that
additional competitors may enter the market. This could lead to intense pricing
pressure, particularly on front-end development tools, and result in higher
research and development costs to compete on a feature-for-feature basis.
Most of our competitors have longer operating histories, significantly greater
financial, technical, marketing and other resources, significantly greater name
recognition and a larger installed base of customers. As a result, our
competitors may be able to respond more quickly to new or emerging technologies
and changes in customer requirements, or to devote greater resources to the
development, promotion and sale of competitive products, than we can. There is
also a substantial risk that announcements of competing products by large
competitors such as Microsoft
23
or Oracle could result in the cancellation of customer orders in anticipation of
the introduction of such new products. In addition, current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties to increase the ability of their products to
address customer needs and which may limit our ability to sell our products
through particular distribution partners. Accordingly, new competitors or
alliances among current and new competitors may emerge and rapidly gain
significant market share in our current or anticipated markets. We also expect
that competition will increase as a result of software industry consolidation.
Increased competition is likely to result in price reductions, fewer customer
orders, reduced margins and loss of market share, any of which could materially
adversely affect our business. We cannot be certain that we will be able to
compete successfully against current and future competitors or that the
competitive pressures that we face will not materially adversely affect our
business, operating results and financial condition.
We Are Susceptible to a Shift in the Market for Client/Server Applications
Toward Web-Based Applications
We derive substantially all of our revenues from the use of our products in
client/server applications. We expect to rely on continued market demand for
client/server applications indefinitely. Although the market for client/server
applications has been growing in recent years, other application platforms are
emerging. In particular, we may see market demand shift from client/server
applications to Web-based applications. This shift may occur before our Web-
based product line achieves market acceptance. In addition, we cannot be certain
that should such a platform shift occur, developers of Web-based applications
would select our Web-based products. A decrease in client/server application
sales coupled with an inability to derive revenues from the Web-based
application market could have a material adverse effect on our business,
operating results and financial condition.
We Increasingly Depend on the Growth of International Sales and Operations
We anticipate that for the foreseeable future we will derive a significant
portion of our revenues from sources outside North America. In fiscal 1998, we
derived 39% of our revenues outside North America. Our international operations
are generally subject to a number of risks. These risks include:
. Costs of translating products for foreign languages;
. Foreign laws and business practices favoring local competition;
. Dependence on local channel partners;
. Compliance with multiple, conflicting and changing government laws and
regulations;
. Longer sales cycles;
. Greater difficulty or delay in collecting payments from customers;
. Difficulties in staffing and managing foreign operations;
. Foreign currency exchange rate fluctuations and the associated effects on
product demand;
. Increased tax rates in certain foreign countries;
. Difficulties with financial reporting in foreign countries;
. Quality control of certain development activities; and
. Political and economic instability.
24
We intend to continue expanding our sales and support operations
internationally. Despite our efforts, we may not be able to expand our sales and
support operations internationally in a timely and cost-effective manner. Such
an outcome would limit or eliminate any sales growth internationally, which in
turn would materially adversely affect our business, operating results and
financial condition. Even if we successfully expand our international
operations, we may be unable to maintain or increase international market demand
for our products.
We expect that planned expansion of international operations will lead to
increased financial and administrative demands on us and our management,
including increased operational complexity associated with expanded facilities,
administrative burdens associated with managing an increasing number of
relationships with foreign partners and expanded treasury functions to manage
foreign currency risks.
Fluctuations in the Relative Value of Foreign Currencies Can Affect Our Business
To date, the majority of our transactions have been denominated in U.S.
dollars. The majority of our international operation expenses, substantially all
of our sales in Japan and certain other international sales have been
denominated in currencies other than the U.S. dollar. Therefore, our operating
results may be adversely affected by changes in the value of the U.S. dollar. As
our international operations expand, our exposure to exchange rate fluctuations
will increase as we use an increasing number of foreign currencies. We have
entered into limited hedging transactions to mitigate our exposure to currency
fluctuations. Despite these hedging transactions, exchange rate fluctuations
have caused, and will continue to cause, currency transaction gains and losses.
Although these transactions have not resulted in material gains and losses to
date, similar transactions could have a damaging effect on our business, results
of operations or financial condition in future periods.
We Must Continue to Hire and Retain Skilled Personnel in a Tight Labor Market
Qualified personnel are in great demand and short supply throughout the
software industry. Our success depends in large part on our ability to attract,
motivate and retain highly skilled employees on a timely basis, particularly
executive management, sales and marketing personnel, software engineers and
other senior personnel. Our failure to attract and retain the highly trained
technical personnel that are essential to our product development, marketing,
service and support teams may limit the rate at which we can generate revenue
and develop new products or product enhancements. This could have a material
adverse effect on our business, operating results and financial condition.
The Price of Our Stock Has Been Volatile and Could Continue to Fluctuate
Substantially
Our common stock is traded on the Nasdaq National Market. The market price of
our common stock has been volatile and could fluctuate substantially based on a
variety of factors outside of our control, in addition to our financial
performance. Furthermore, stock prices for many companies, including our own,
fluctuate widely for reasons that may be unrelated to operating results.
25
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS UNDER ITEM 601 OF REGULATION S-K
3.1* Restated Certificate of Incorporation
3.2* Bylaws of the Company
4.1* Reference is made to Exhibits 3.1, 3.2 and 4.3
4.2* Specimen Common Stock certificate
4.3* Investors' Rights Agreement dated April 19, 1995, between
the Company and the investors named therein
10.1* Form of Indemnification Agreement
10.2* 1997 Stock Incentive Plan
10.3* Employee Stock Purchase Plan
10.4* First Amended and Restated 1994 Incentive Plan
10.5* Amendment and Restatement of Credit Agreement dated March
31, 1997 between the Company and Texas Commerce Bank
National Association
10.6* Lease Agreement dated October 5, 1994 between the Company
and Colina West Limited
10.7* First Amendment to Lease Agreement dated September 8, 1995
between the Company and Colina West Limited
10.8* Sublease Agreement dated December 10, 1996 between the
Company and Reynolds, Loeffler & Dowling, P.C.
10.9* Joint Venture Agreement dated March 26, 1995 between the
Company and Novell Japan, Ltd., AG Tech Corporation and
Empower Ltd.
10.10** Lease agreement dated April 2, 1998 between the Company and
CarrAmerica Realty, L.P. T/A Riata Corporate Park
10.11** Amendment and Restatement of Credit Agreement and Promissory
Note dated February 28, 1998 between the Company and Chase
Bank of Texas, National Association
10.12*** First Amendment to Credit Agreement and Promissory Note
dated October 22, 1998 between the Company and Chase Bank of
Texas, National Association
27.1 Financial Data Schedule
*Incorporated by reference to the Company's Registration Statement on
Form S-1 (File No. 333-32199).
**Incorporated by reference to the Company's Annual Report on Form
10-K (File No. 000-23043).
***Incorporated by reference to the Company's quarterly report filed
on Form 10-Q for the period ended September 30, 1998 (File No. 000-
23043).
(b) Reports on Form 8-K
(i) Report on Form 8-K filed October 6, containing Pervasive Software
Inc.'s news release dated September 30, 1998 announcing
commencement of the Company's offer to purchase for cash all of
the outstanding Common Shares of EveryWare Development Inc. an
Internet application development and Web-application server
provider based in Toronto Canada.
26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
(b) REPORTS ON FORM 8-K (CONTINUED)
(ii) Report on Form 8-K filed on November 30, 1998 containing the
Company's news release dated November 12, 1998 announcing that the
Company has taken up and paid for 93% of the common shares of
EveryWare Development Inc. under its previously announced offer
and it has commenced compulsory procedures to acquire the
remaining shares of EveryWare Development Inc.
(iii) Report on Form 8-K/A (amendment no. 1) filed on February 1, 1999
amending the Form 8-K filed on November 30, 1998 to include
financial statements and pro forma financial information provided
in accordance with the instructions for Item 7.
(iv) Report of Form 8-K/A (amendment no. 2) filed on February 3, 1999
amending the Form 8-K/A filed on February 1, 1999 to include
unaudited interim financial information of EveryWare Development
Inc.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: February 16, 1999 PERVASIVE SOFTWARE INC.
(Registrant)
By: /s/ James R. Offerdahl
--------------------------------------
James R. Offerdahl
Chief Operating
Officer and Chief Financial
Officer (Duly Authorized Officer and
Principal Financial Officer)
28
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
3.1* Restated Certificate of Incorporation
3.2* Bylaws of the Company
4.1* Reference is made to Exhibits 3.1, 3.2 and 4.3
4.2* Specimen Common Stock certificate
4.3* Investors' Rights Agreement dated April 19, 1995, between the
Company and the investors named therein
10.1* Form of Indemnification Agreement
10.2* 1997 Stock Incentive Plan
10.3* Employee Stock Purchase Plan
10.4* First Amended and Restated 1994 Incentive Plan
10.5* Amendment and Restatement of Credit Agreement dated March 31,
1997 between the Company and Texas Commerce Bank National
Association
10.6* Lease Agreement dated October 5, 1994 between the Company and
Colina West Limited
10.7* First Amendment to Lease Agreement dated September 8, 1995
between the Company and Colina West Limited
10.8* Sublease Agreement dated December 10, 1996 between the Company
and Reynolds, Loeffler & Dowling, P.C.
10.9* Joint Venture Agreement dated March 26, 1995 between the
Company and Novell Japan, Ltd., AG Tech Corporation and
Empower Ltd.
10.10** Lease agreement dated April 2, 1998 between the Company and
CarrAmerica Realty, L.P. T/A Riata Corporate Park
10.11** Amendment and Restatement of Credit Agreement and Promissory
Note dated February 28, 1998 between the Company and Chase
Bank of Texas, National Association
10.12*** First Amendment to Credit Agreement and Promissory Note
dated October 22, 1998 between the Company and Chase Bank of
Texas, National Association
27.1 Financial Data Schedule
*Incorporated by reference to the Company's Registration Statement on
Form S-1 (File No. 333-32199).
**Incorporated by reference to the Company's Annual Report on Form
10-K (File No. 000-23043).
***Incorporated by reference to the Company's quarterly report filed
on Form 10-Q for the period ended September 30, 1998 (File No. 000-
23043).
29