SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
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 ________
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(2) Yes [x] No ________
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As of November 12, 1999 there were 15,611,510 shares of the Registrant's
common stock outstanding.
PERVASIVE SOFTWARE INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements................................................................. 3
Condensed Consolidated Balance Sheets at September 30, 1999 and June 30, 1999 ....... 3
Condensed Consolidated Statements of Operations for the three months ended
September 30, 1999 and 1998.......................................................... 4
Condensed Consolidated Statements of Cash Flows for the three months ended
September 30, 1999 and 1998.......................................................... 5
Notes to Condensed Consolidated Financial Statements ................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations ....................................................................... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk........................... 15
PART II. OTHER INFORMATION.................................................................... 27
Item 1. Legal Proceedings.................................................................... 27
Item 6. Exhibits and Reports on Form 8-K..................................................... 27
SIGNATURES.................................................................................... 28
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Pervasive Software Inc.
Condensed Consolidated Balance Sheets
(in thousands)
September 30, June 30,
1999 1999
--------------- --------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $15,978 $18,126
Marketable securities 22,480 21,777
Trade accounts receivable, net 10,060 9,352
Prepaid expenses and other current assets 4,721 3,979
------------- --------------
Total current assets 53,239 53,234
Property and equipment, net 7,887 7,509
Purchased technology and excess of cost over fair value
of net assets acquired, net 10,850 11,135
Other assets 1,304 995
------------- --------------
Total assets $73,280 $72,873
============= ==============
Liabilities and Stockholders' Equity
Current liabilities:
Trade accounts payable $ 2,809 $ 2,517
Accrued payroll and payroll related costs 1,255 1,403
Other accrued expenses 3,087 4,144
Deferred revenues 1,527 2,252
Income taxes payable 1,694 2,457
------------- --------------
Total current liabilities 10,372 12,773
Deferred tax liability 565 565
------------- --------------
Total liabilities 10,937 13,338
Minority interest in subsidiary 545 449
Stockholders' equity:
Common stock 58,571 57,869
Retained earnings 3,227 1,217
------------- --------------
Total stockholders' equity 61,798 59,086
------------- --------------
Total liabilities and stockholders' equity $73,280 $72,873
============= ==============
See accompanying notes.
3
Pervasive Software Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)
Three months ended
September 30,
1999 1998
-------------- --------------
Revenues $16,702 $11,776
Costs and expenses:
Cost of revenues and technical support 2,578 1,620
Sales and marketing 6,471 4,979
Research and development 4,304 2,960
General and administrative 1,138 1,025
Amortization of excess of cost over fair value of net assets
acquired 286 16
-------------- --------------
Total costs and expenses 14,777 10,600
-------------- --------------
Operating income 1,925 1,176
Interest and other income, net 491 218
-------------- --------------
Income before income taxes and minority interest 2,416 1,394
Provision for income taxes (846) (426)
Minority interest in (earnings) loss of subsidiary, net of tax (23) 14
-------------- --------------
Net income $ 1,547 $ 982
============== ==============
Basic earnings per share $ 0.10 $ 0.07
============== ==============
Diluted earnings per share $ 0.09 $ 0.06
============== ==============
See accompanying notes.
4
Pervasive Software Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Three months ended
September 30,
------------------------------------
1999 1998
------------ ------------
Cash from operating activities
Net income $ 1,547 $ 982
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 1,077 470
Non cash compensation expense pursuant to employee stock purchase plan 182 168
Other non cash items (204) 150
Change in current assets and liabilities:
Increase in trade accounts receivable (429) (741)
Increase in prepaid expenses and other current assets (802) (516)
Increase (decrease) in accounts payable and accrued liabilities (985) 499
Increase (decrease) in deferred revenue (401) 320
Decrease in income taxes payable (678) (248)
------------- -------------
Net cash provided (used) by operating activities (693) 1,084
Cash from investing activities
Purchase of property and equipment (1,168) (1,087)
Purchase of marketable securities, net (703) (554)
Purchase of businesses, net of cash acquired (11) -
Increase in other assets (17) (78)
------------- -------------
Net cash used in investing activities (1,899) (1,719)
Cash from financing activities
Payment of royalty to Novell - (158)
Proceeds from issuance of stock, net of issuance costs 453 28
------------- -------------
Net cash provided (used) by financing activities 453 (130)
Effect of exchange rate on cash and cash equivalents (9) (116)
------------- -------------
Decrease in cash and cash equivalents (2,148) (881)
Cash and cash equivalents at beginning of period 18,126 15,587
------------- -------------
Cash and cash equivalents at end of period $ 15,978 $ 14,706
============= =============
See accompanying notes.
5
PERVASIVE SOFTWARE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
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, 1999, which are
contained in the Company's Annual Report filed on Form 10-K on September 28,
1999 (File No. 333-71955). The results of operations for the three month periods
ended September 30, 1999 and 1998 are not necessarily indicative of results that
may be expected for any other interim period or for the full fiscal year.
2. 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
September 30,
------------------------
1999 1998
-------- --------
Numerator:
Net income.................................................................. $ 1,547 $ 982
======== =======
Denominator:
Denominator for basic earnings per share - weighted average
shares...................................................................... 15,544 13,378
Effect of dilutive securities:
Employee stock options....................................................... 2,463 1,850
======== =======
Potentially dilutive common shares 2,463 1,850
======== =======
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed conversions.................... 18,007 15,228
======== =======
Basic earnings per share....................................................... $ 0.10 $ 0.07
======== =======
Diluted earnings per share..................................................... $ 0.09 $ 0.06
======== =======
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. Comprehensive Income
The components of comprehensive income are as follows:
Three months ended
September 30,
1999 1998
--------- ---------
Net income................................................... $ 1,547 $ 982
Foreign currency translation adjustments..................... 471 184
--------- ---------
Comprehensive income......................................... $ 2,018 $ 1,166
========= =========
4. Recent Accounting Pronouncements
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 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 adopted
SOP 98-9 in fiscal year 2000. The effect of such adoption was not significant.
In June 1998, the FASB issued Statement 133, Accounting for Derivative
Instruments and Hedging Activities. In June 1999, the FASB issued Statement of
Financial Accounting Standards No. 137, Accounting for Derivative Instruments
and Hedging Activities - Deferral of the Effective Date of FASB Statement No.
133, which defers for one year the effective date of Statement 133. Statement
133 is now effective for all fiscal quarters of all fiscal years beginning after
our fiscal year 2001. We do not anticipate that the adoption of Statement 133
will have a significant effect on our results of operations or financial
position because of our minimal use of derivatives.
5. Contingencies
A class action complaint was filed on November 4, 1999 in the U.S. District
Court for the Western District of Texas against the Company and certain of its
officers and directors. The complaint alleges that the Company and certain of
its officers and directors violated certain provisions of the federal securities
laws, including Rule 10b-5 under the Securities Exchange Act of 1934, by making
false statements, failing to disclose material information and taking other
actions intending to artificially inflate and maintain the market price of the
Company's common stock during the Class Period of July 15, 1999 and October 21,
1999. While the proceeding is at a very early stage, the Company believes the
suit is without merit and intends to defend itself vigorously.
6. Subsequent Event
On October 29, 1999, the Company acquired an additional 19.5% ownership
interest in Pervasive Software Japan by purchasing stock held by a minority
shareholder for $750,000 in cash. The acquisition was accounted for under the
purchase method and, accordingly the excess of purchase price over the fair
market value of net assets acquired ($160,000) was recorded as goodwill and will
be amortized over a ten year period. After the acquisition, the Company holds
100% of the outstanding stock of Pervasive Japan.
7
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 forward
looking statements after the date of this filing on Form 10-Q to conform these
statements with actual results. See "Risk Factors that May Affect Future
Results," and the factors and risks discussed in the Company's Annual Report on
Form 10-K filed on September 28, 1999 (File No. 333-71955) and other reports
filed from time to time with the Securities and Exchange Commission.
Overview
Pervasive Software Inc. is a leading provider of application development and
deployment software that dramatically simplifies the development, deployment and
maintenance of Web-based and client/server applications. Our comprehensive,
integrated suite of software products includes development and deployment
products and high performance zero administration databases. Combined, these
products offer a unique solution that simplifies the development, deployment and
maintenance of Web-based and client/server applications and lowers the cost of
ownership of Web-based and client/server distributed computing environments. Our
business model leverages a channel of software developers, application service
providers, Web and systems integrators, and value-added resellers around the
world.
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,
the customer's volume requirements and the number of application servers. Our
OEM licensing program offers independent software vendors volume discounts and
specialized technical support, training and consulting in exchange for
integrating our products in packaged applications and paying us a royalty based
on sales of the applications. Additionally, we generate revenues from version
upgrades, user count upgrades, and 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 generally operate
with virtually no order backlog 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.
Historically, we have derived substantially all of our revenues from our
Pervasive.SQL and Btrieve data management products. On June 30, 1999, we
discontinued general availability of our Btrieve products to consolidate our
development, marketing and technical support resources behind our current Tango
and Pervasive.SQL products. Accordingly, we expect that our revenue from the
license of Tango and Pervasive.SQL
8
will account for substantially all of our revenues for the foreseeable future as
revenue from the license of Btrieve will decline substantially over time. Our
future operating results will depend upon continued market acceptance of
Pervasive.SQL, our ability to develop and market our Tango products, and the
expenses associated with these efforts. 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 product, and the
failure of Tango to achieve market acceptance, would have a damaging effect on
our business, operating results and financial condition.
In October 1999, we announced a major initiative to significantly increase
sales and marketing and development expenses over the next four quarters to
capitalize on the anticipated growth in the market for e-business and mobile
computing applications. The sales and marketing initiatives include significant
incremental spending on programs and activities intended to attract and recruit
Web application developers and Web integrators who design and deploy e-business
applications and to increase brand awareness. The increased development expenses
are intended to accelerate delivery of new features to our Tango 2000 and
Pervasive.SQL 2000 products to support deployment of e-business applications
across popular client and server environments, including the emerging market for
mobile and wireless handheld devices. We anticipate that we may incur operating
losses as a result of the increased expenses related to these initiatives. We
cannot be certain that these initiatives or future initiatives will successfully
generate license revenue from our Tango and Pervasive.SQL products.
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 in combination with other products distributed by
Novell. Novell is currently distributing our two-user version in a service
release. We believe Novell may begin general distribution in December 1999,
although we cannot be certain whether or when Novell will begin general
distribution. We will not receive any royalties directly from Novell related to
the agreement. We do believe, however, that we may receive fees in the future by
licensing multi-user upgrades to end users of some of the two-user versions
distributed by Novell.
9
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
operations.
Three months ended
September 30,
---------------------
1999 1998
------ -------
Revenues.......................................................... 100% 100%
Costs and expenses:
Cost of revenues and technical support....................... 15 14
Sales and marketing.......................................... 39 42
Research and development..................................... 26 25
General and administrative................................... 7 9
Amortization of excess of cost over fair value
of net assets acquired....................................... 2 --
------ -------
Total costs and expenses.......................................... 89 90
------ -------
Operating income.................................................. 11 10
Interest and other income.................................... 3 2
------ -------
Income before income taxes and minority interest.................. 14 12
Provision for income taxes................................... (5) (4)
Minority interest in earnings of subsidiary.................. -- --
------ -------
Net income........................................................ 9% 8%
====== =======
Supplemental disclosures:
Operating income, excluding certain charges*........................ 13% 10%
------ -------
Net income, excluding certain charges*.............................. 11% 8%
====== =======
* Amounts for the quarters ended September 30, 1999 and 1998 exclude
amortization of excess of cost over fair value of net assets acquired of
$286,000 and $16,000, or 2% and 0% of revenues, respectively.
Revenues
Our revenues increased to $16.7 million in the three months ended September
30, 1999, an increase of 42% over the $11.8 million reported for the comparable
period in the prior fiscal year. We attributed this revenue increase to
increased market acceptance of Pervasive.SQL operating on Windows NT and ongoing
expansion of our worldwide sales organization. Our revenues for the three months
ended September 30, 1999 declined from the $17.5 million reported for the three
months ended June 30, 1999, primarily due to seasonality associated with summer
purchasing patterns, delays in shipping approximately $700 thousand worth of
orders due to limitations on fulfillment capacity at the end of the quarter, and
our decisions in the prior two quarters related to the allocation of sales and
marketing resources to our Tango products for which revenues have not yet been
realized and which may have negatively impacted revenue growth of
our Pervasive.SQL shrink-wrap products. We believe that the latter of the three
factors could continue to affect our results in the near term and, accordingly,
we cannot be certain that revenues will grow in future periods, that they will
grow at past rates or, as a result of our announced initiatives in sales and
marketing and development, 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 60% of our revenues in the three
months ended September 30, 1999 from approximately 50% in the comparable period
in the prior fiscal year. Licenses of our software operating on NetWare
represented approximately 35% of revenues in the three months ended September
30, 1999, as compared to 44% in the comparable period in the prior fiscal 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, increased from $4.3 million to $7.7 million in the
three months ended September 30, 1998 and 1999, representing 37% and
10
46% of total revenues, respectively. We attribute the increase primarily to
expansion of our international sales organization, first in Europe and then in
Japan. Therefore, we expect that international revenues will continue to account
for a significant portion of our revenues in the future as we continue to 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 our
shrink wrap software products, the cost to provide technical support, primarily
telephone support, which is typically provided within 30 days of purchase,
payment of license fees for third-parties technologies embedded in our products
and the costs to deliver professional services and training services to others.
Cost of revenues and technical support was $1.6 million and $2.6 million in the
three months ended September 30, 1998 and 1999, representing 14% and 15% of
revenues, respectively. Cost of revenues and technical support increased due to
increased sales volume and increased technical support and service personnel in
the U.S., Europe and Japan. We anticipate that cost of revenues and technical
support will continue to increase in dollar amount and may increase as a
percentage of revenues in the future as we expand our international operations,
incur increased license fees for third-party technologies embedded in or bundled
with our products, provide technical support for additional products and invest
in personnel to deliver professional services and training services to others.
In October 1999, Hayden Stewart resigned his position as Vice President,
Customer Engineering. Mr. Stewart joined Pervasive in September 1997 as Director
of Information Systems and has served as Vice President, Customer Engineering
since July 1999.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and bonuses earned by sales and marketing personnel,
foreign sales office expenses, marketing programs and promotional expenses, and
travel and entertainment. Sales and marketing expenses were $5.0 million and
$6.5 million in the three months ended September 30, 1998 and 1999, representing
42% and 39% of revenues, respectively. Sales and marketing expenses decreased as
a percentage of revenues primarily because of revenue growth that outpaced sales
and marketing expenditures. Sales and marketing expenses increased in dollar
amount primarily due to increased costs associated with hiring additional sales
and marketing personnel, the promotion of Pervasive.SQL, market development
activities for Tango and increased infrastructure costs associated with foreign
sales office expansion. In October 1999, we announced plans to increase sales
and marketing expenses over the next four quarters in anticipation of growth of
the e-business and wireless Web computing markets. As a result, we expect sales
and marketing expenses will increase significantly in dollar amount and are
likely to increase as a percentage of revenues due to the timing and extent of
Tango and other product market development activities and costs associated with
new product releases, marketing promotions, brand awareness campaigns, lead
generation programs, hiring additional sales and marketing personnel and
international expansion.
David Dunnigan joined the company as Vice President, World Wide Sales in
November 1999, succeeding Casey Leaman. Prior to joining Pervasive Mr. Dunnigan
served as Vice President, Sales and Marketing for Novient, Inc., a world wide
provider of professional services automation software for the consulting and
systems integration industry. Prior to Novient, Inc. Mr. Dunnigan served as
General Manager-Front Office VAR Division for Aurum Software, a Baan Company.
In November 1999, Scott Bleakley left the Company. Mr. Bleakley served as
Senior Vice President, Corporate Strategy and Development, a position he has
held since July 1999. Mr. Bleakley also served as Vice President, Marketing from
December 1998 to June 1999 and served as Vice President, Corporate Development
from April 1998 to December 1998.
Research and Development. Research and development expenses consist
primarily of personnel and related costs. Research and development expenses were
$3.0 million and $4.3 million in the three months ended September 30, 1998 and
1999, representing 25% and 26% of revenues, respectively. Research and
development expenses increased in dollar amount primarily due to the increased
hiring of and/or contracting with additional research and development personnel.
In October 1999, we announced plans to increase research and development
expenditures
11
over the next four quarters. The increased expenditures are intended to
accelerate the delivery of new features in our Tango and Pervasive.SQL products
to support deployment of e-business applications across several popular client
and server platforms. We anticipate that research and development expenses will
increase in dollar amount and as a percent of revenue during the next four
quarters.
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.
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 $1.0 million and $1.1 million in the three months ended September
30, 1998 and 1999, representing 9% and 7% of revenues, respectively. We
attribute the increase in dollar amount 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 primarily because of revenue
growth that outpaced general and administrative expenditures. We believe that
our general and administrative expenses will continue to increase in dollar
amount in the future as our administrative staff expands to support our growing
worldwide operations.
Amortization of Excess of Cost Over Fair Value of Net Assets Acquired. 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. The remaining excess cost over the fair
market value of the net assets acquired is being amortized over a ten year
period. During the three month periods ended September 30, 1998 and 1999, the
Company recorded $16,000 and $286,000, respectively, related to amortization of
intangible assets related to the EveryWare and Smithware acquisitions.
Provision for Income Taxes. Provision for income taxes was approximately
$426,000 and $846,000 in the three months ended September 30, 1998 and 1999,
respectively. Our effective tax rates were 31% and 35% for the three months
ended September 30, 1998 and 1999, respectively, before considering the impact
of the charge for purchased research and development. Our effective tax rate for
fiscal year 2000 increased primarily due to foreign taxes associated with our
increased operations overseas and non-deductible amortization of intangibles
related to the acquisition of EveryWare.
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:
. Limited history of operating profits in the Company's Canadian
subsidiary;
. Anticipated operating losses in future periods due to increased
marketing and development costs;
. Recent increase in expense levels to support our growth and;
. 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.
12
Accordingly, we have recorded a valuation allowance against the deferred
tax assets related to the Canadian subsidiary and to the extent domestic
deferred tax assets exceed the potential benefit from carryback or carryover of
deferred items to offset taxable income in the current year, prior years or the
next succeeding year.
The provision for the remaining quarters of fiscal 2000 will be based on
our expected tax rate for the year. Although we may incur an overall loss for
the year, we will continue to record a provision for income taxes on profits
reported by our foreign operations. In addition, anticipated operating losses
reported by our domestic operations may require us to reserve certain deferred
tax assets that have limited carryforward periods. As a result, we anticipate
our effective tax rate to increase in future periods.
Liquidity and Capital Resources
Cash used by operations was $693,000 for the three months ended September
30, 1999 as compared with cash provided by operations of $1.1 million for the
comparable period in the prior fiscal year. The decrease in cash generated by
operations resulted primarily from decreases in accounts payable and accrued
expenses and increases in prepaid expenses and other current assets during the
period.
During the first three months of fiscal 1999 and 2000, we invested $554,000
and $703,000, respectively, in marketable securities, consisting of various
taxable and tax advantaged securities. In addition, we purchased property and
equipment totaling approximately $1.1 million and $1.2 million in the three
months ended September 30, 1998 and 1999, respectively. This property consisted
primarily of computer hardware and software for our growing employee base. We
expect that our capital expenditures will increase as our employee base grows.
On October 29, 1999, we acquired an additional 19.5% ownership interest in
Pervasive Software Japan by purchasing stock held by a minority shareholder for
$750,000 in cash. The acquisition was accounted for under the purchase method
and, accordingly the excess of purchase price over the fair market value of net
assets acquired ($160,000) was recorded as goodwill and will be amortized over a
ten year period. After the acquisition, we hold 100% of the outstanding stock of
Pervasive Software Japan.
We have entered into licensing agreements with three vendors related to
technology included, or to be included, with our internally developed products
which require fixed minimum license payments totaling $2.2 million for the year
ended June 30, 2000 and $700,000 for each of the years ended June 30, 2001 and
2002. For the three months ended September 30, 1999 we made payments relating to
licensing agreements totaling $125,000. License payments are capitalized as
prepaid expenses and amortized over the estimated useful life of the licensed
technology (two to four years), or on a per unit basis based on the terms of the
license agreement. These license agreements provide for use of the technologies
on a perpetual basis or for fixed periods of time.
On September 30, 1999, we had $42.9 million in working capital, including
$16.0 million in cash and cash equivalents and $22.5 million in marketable
securities. As of September 30, 1999 we had 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 agreement expired October 31, 1999
and we are currently negotiating an extension until October 2000.
Recently Issued Accounting Standards
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 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 adopted
SOP 98-9 in fiscal year 2000. The effect of such adoption was not significant.
13
In June 1998, the FASB issued Statement 133, Accounting for Derivative
Instruments and Hedging Activities. In June 1999, the FASB issued Statement of
Financial Accounting Standards No. 137, Accounting for Derivative Instruments
and Hedging Activities - Deferral of the Effective Date of FASB Statement No.
133, which defers for one year the effective date of Statement 133. Statement
133 is now effective for all fiscal quarters of all fiscal years beginning after
our fiscal year 2001. We do not anticipate that the adoption of Statement 133
will have a significant effect on our results of operations or financial
position because of our minimal use of derivatives.
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 the coming months, 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
2000, Pervasive.SQL 7, Btrieve v6.15, ODBC Interface v2, Tango 2000, Tango v3.6
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 with respect to the current
versions of our products listed in the preceding paragraph. 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 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 information concerning the Year 2000 compliance
status of all of our customers and 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
14
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). Our Year 2000 compliance project has assessed 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. 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 completed our comprehensive contingency plan to address
situations that may result if we are unable to achieve Year 2000 compliance of
any 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The majority of our operations are based in the U.S. and, accordingly, the
majority of our transactions are denominated in U.S. Dollars. However, we do
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, we have operations in Canada, Japan,
Germany, France, Ireland, England, Belgium, and Hong Kong and conduct
transactions in the local currency of each location. We monitor our foreign
currency exposure and, from time to time will attempt to reduce our exposure
through hedging. The impact of fluctuations in the relative value of other
currencies was not material for the quarter ended September 30, 1999.
Quantitative and qualitative information about market risk was addressed in Item
7A of our Form 10-K for the fiscal year ended June 30, 1999.
15
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. Any of the following risks could harm our business, financial
condition or results of operations. In such case, the trading price of our
common stock could decline, and you may lose all or part of your investment.
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:
. Fluctuations in demand for our products in current markets and the
emerging e-business application and mobile computing markets;
. Seasonality and the timing of product sales and shipments;
. 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 customer or distributor;
. A reduction in the number of independent software vendors ("ISVs") who
embed our products;
. Increased expenses, whether related to our recently announced sales
and marketing and product development initiative or general
administration; and
. Changes in the mix of domestic and international sales.
In recent quarters, we have derived a portion of our revenues from
relatively larger orders. The sales cycles for these transactions tend to be
longer than the sales cycle on smaller orders. Also, a large percentage of these
transactions have closed in the last few days of the quarter. Accordingly, to
the extent that this trend continues, our operating results may fluctuate from
quarter to quarter based on the timing of larger orders.
In October 1999 we announced a major initiative to significantly increase
sales and marketing and development expenses over the next four quarters to
capitalize on the anticipated growth in the market for e-business and mobile
computing applications. The sales and marketing initiatives include significant
incremental spending on programs and activities intended to attract and recruit
Web application developers and Web integrators who design and deploy e-business
applications and to increase brand awareness. The increased development expenses
are intended to accelerate delivery of new features to our Tango 2000 and
Pervasive.SQL 2000 products to support deployment of e-business applications
across popular client and server environments, including the emerging market for
mobile and wireless handheld devices. We anticipate that we may incur operating
losses as a result of the increased expenses related to these initiatives. We
cannot be certain that these initiatives or future initiatives will successfully
generate license revenue from our Tango and Pervasive.SQL products.
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 are likely to be
adversely and disproportionately affected. In addition, we may reduce our prices
and have already announced plans to accelerate our investment in research and
development, and sales and marketing to pursue new
16
market opportunities. Any one of these activities may further limit our ability
to adjust spending in response to revenue fluctuations.
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.
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 in the summer months because of reduced corporate buying patterns
during the vacation season.
We Currently Operate Without a Backlog
We generally 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 379 employees at September 30,
1999, as compared to 240 at September 30, 1998. 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 Market Acceptance of Pervasive.SQL
We derive a significant portion of our revenues from the license of our
Pervasive.SQL products. Accordingly, our future operating results are
substantially dependent on continued market acceptance of Pervasive.SQL and
future enhancements. We cannot be certain that future sales of Pervasive.SQL
will continue at current rates. Continued market acceptance of Pervasive.SQL may
be influenced heavily by factors outside of our control such as new product
offerings or promotions by competitors and the product development cycles of
developers and resellers who embed our products into packaged software
applications. Although we recognized increased revenue from Pervasive.SQL in the
first quarter of fiscal 2000, 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
began to market the Tango Application Server and Tango Development Studio both
as stand-alone products and integrated with Pervasive.SQL during the third
quarter of fiscal 1999. 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
17
our Tango products in the near future. As a result, we expect to devote
significant resources to our sales and marketing efforts relating to Tango.
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. 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 further integrate Pervasive.SQL with the Tango
products;
. Our ability to recruit and train new and existing developers, value-
added resellers, systems integrators, Web integrators and consultants;
. The success of promotions involving our Tango development environment
and our ability to ultimately receive Tango Application Server revenue
from past and future promotions;
. 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 Have Significant Product Concentration
Historically, we have derived substantially all of our revenues from our
Pervasive.SQL and Btrieve data management products. On June 30, 1999, we
discontinued general availability of our Btrieve products to consolidate our
development, marketing and technical support resources behind our current
Pervasive.SQL products. Accordingly, our data management-related revenue from
licenses of Pervasive.SQL may continue to account for substantially all of our
revenues for the foreseeable future. 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 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 "Pervasive" and
"Tango" 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 for all of these
names, and we are aware of other companies that use the word "Pervasive" or
"Tango" either in their marks alone or in combination with other words. We
expect that it may be difficult or impossible to prevent third-party usage of
these names and variations of these names 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 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.
18
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.
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
three months ended September 30, 1999, one distributor accounted for
approximately 11% of revenues, and in the three months ended September 30, 1998,
two distributors combined accounted for approximately 21% of revenues. 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 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. In addition, market acceptance of new product
releases, including our recently announced Pervasive.SQL 2000 for, mobile
devices, embedded systems and smart cards may be substantially dependent on
strategic relationships with device manufacturers. 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 Schlumberger, Oracle, Red Hat, Wind River, IBM, Novell,
19
Apple and Macromedia, in areas such as product development, 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 our current 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 occurs. 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.
Although we are not aware that any of our products infringe upon the
proprietary rights of third parties, we may be subjected to claims of
intellectual property infringement by third parties 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. 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 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;
20
. 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 Pervasive.SQL and Btrieve are designed to be Year
2000 compliant. An earlier release of the predecessor to Pervasive.SQL, Scalable
SQL v3.0, 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.
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
21
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.
Recently, a Federal District ruled that Microsoft wielded monopoly power in
personal computer operating systems. There is substantial uncertainty regarding
the impact of this ruling on the software industry including the short-term and
long-term demand for software designed for Microsoft's application products,
including SQL Server, and the Windows operating system.
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's small memory footprint database software product, Adaptive
Server Anywhere and Microsoft's product, SQL Server, directly compete 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
two years, Netscape acquired Kiva Software, Sun Microsystems acquired
NetDynamics and BEA Systems acquired WebLogic. Oracle, Microsoft and IBM have
each 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 and Bluestone.
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. In addition,
some competitors have demonstrated a willingness to, or may willingly in the
future, incur substantial losses as a
22
result of deeply discounted product offerings or aggressive marketing campaigns.
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, Oracle or IBM 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 have derived substantially all of our historical 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. Further, this shift may
result in a change in revenue models from licensing of client/server and web-
based applications to renting of applications from application service
providers. 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. For the three months
ended September 30, 1999, we derived 46% of our revenues outside North America.
Our international operations are generally subject to a number of risks. These
risks include:
. Costs of translating and localizing 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;
23
. Quality control of certain development activities; and
. Political and economic instability.
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. 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.
Our Executive Officers and Directors' Substantial Influence Over Stockholder
Voting
As of November 12, 1999, the executive officers, directors and entities
affiliated with them, in the aggregate, beneficially owned approximately 31% of
our outstanding common stock. These stockholders may be able to exercise
substantial influence over matters requiring approval by our stockholders, such
as the election of directors and approval of significant corporate transactions.
This concentration of ownership may also have the effect of delaying or
preventing a change in control of our Company.
We Have Anti-Takeover Provisions
The Company's Restated Certificate of Incorporation and Bylaws contain
certain provisions that may have the effect of discouraging, delaying or
preventing a change in control of the Company or unsolicited acquisition
proposals that a stockholder might consider favorable, including provisions:
authorizing the issuance of "blank check" preferred stock; establishing advance
notice requirements for stockholder nominations for elections to the Board of
Directors or for proposing matters that can be acted upon at stockholders'
meetings; eliminating the ability of stockholders to act by written consent;
requiring super-majority voting to approve certain amendments to the
24
Restated Certificate of Incorporation; limiting the persons who may call special
meetings of stockholders; and providing for a Board of Directors with staggered,
three-year terms. In addition, certain provisions of Delaware law and the
Company's 1997 Stock Incentive Plan (the "1997 Plan") may also have the effect
of discouraging, delaying or preventing a change in control of the Company or
unsolicited acquisition proposals.
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
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements in this Report on Form 10-Q under "Management's
Discussion and Analysis of Financial Condition and Results of Operations," "Risk
Factors," and elsewhere in this Report constitute forward-looking statements
within the meaning of Section 21E of the Securities and Exchange Act of 1934.
Forward-looking statements include statements regarding the Company's
expectations, beliefs, hopes, intentions or strategies regarding the future.
These statements involve known and unknown risks, uncertainties, and other
factors that may cause our or our industry's actual results, levels of activity,
performance, or achievements to be materially different from any future results,
levels of activity, performance, or achievements expressed or implied by such
forward-looking statements. Such factors include, among other things, those
listed under "Risk Factors" and elsewhere in this Report on Form 10-Q.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," or "continue" or the negative of such
terms or other comparable terminology.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance, or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of such
statements. We are under no duty to update any of the forward-looking
statements after the date of this Report to conform such statements to actual
results.
26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A class action complaint was filed on November 4, 1999 in the U.S.
District Court for the Western District of Texas against the Company and
certain of its officers and directors. The complaint alleges that the
Company and certain of its officers and directors violated certain
provisions of the federal securities laws, including Rule 10b-5 under the
Securities Exchange Act of 1934, by making false statements, failing to
disclose material information and taking other actions intending to
artificially inflate and maintain the market price of the Company's common
stock during the Class Period of July 15, 1999 and October 21, 1999.
Plaintiffs seek designation of the suit as a class action on behalf of all
persons who purchased shares of the Company's common stock during the class
period and monetary damages in an unspecified amount. While this
proceeding is at a very early stage, the Company believes the suit is
without merit and intends to defend itself vigorously.
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
10.8* 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
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 for the fiscal year ended June 30, 1998 (File No. 000-230431).
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter ended September
30, 1999.
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: November 15, 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
10.8* 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
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 for the
fiscal year ended June 30, 1998 (File No. 000-230431).
29