1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A [X] AMENDMENT NO. 1 TO ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______ COMMISSION FILE NUMBER 0-22466 FTP SOFTWARE, INC. (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2906463 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 2 HIGH STREET, NORTH ANDOVER, MASSACHUSETTS 01845 (Address of principal executive offices) (Zip Code) (978) 685-4000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class on Which Registered NONE NONE Securities registered pursuant to Section 12(g) of the Act: Title of Class: COMMON STOCK ($.01 PAR VALUE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value of the registrant's voting stock held by non-affiliates was approximately $102,773,850 on March 20, 1998, based on the closing sales price of the registrant's Common Stock as reported on the Nasdaq National Market as of such date. The number of shares outstanding of each of the registrant's classes of common stock as of March 20, 1998 was as follows: Common Stock, $.01 par value 33,973,140 DOCUMENTS INCORPORATED BY REFERENCE The following documents are incorporated herein by reference: Part III: Portions of the registrant's definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the registrant's 1998 Annual Meeting of Stockholders. 2 Item 6 of the Annual Report on Form 10-K of FTP Software, Inc. for the year ended December 31, 1997 (the "Form 10-K") is hereby amended to correct an error in the selected financial data for 1993 appearing in the table included under that item. Item 8 of the Form 10-K is hereby amended primarily to correct certain errors in the tables appearing under the caption "Earnings per Share" in Note I to the financial statements included under that item. ITEM 6. SELECTED FINANCIAL DATA. Set forth below is certain selected financial data of the Company for each of the five years in the period ended December 31, 1997 and as of December 31, 1997, 1996, 1995, 1994 and 1993 (in thousands, except per share data). The following statement of operations data for the years ended December 31, 1997, 1996 and 1995 and balance sheet data as of December 31, 1997 and 1996 were derived from the financial statements of the Company for and as of such dates included under Item 8 of this Report. The following statement of operations data for the years ended December 31, 1994 and 1993 and balance sheet data as of December 31, 1995, 1994 and 1993 were derived from the consolidated financial statements of the Company for and as of such dates that are not included in this Report. The following data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" below and the Company's consolidated financial statements and the notes related thereto included under Item 8 of this Report. YEARS ENDED DECEMBER 31, ----------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- ------- ------- STATEMENT OF OPERATIONS DATA(1): Total revenue $ 67,734 $101,091 $128,815 $92,180 $57,616 Income (loss) from continuing operations(2) (57,816) (43,778) 29,942 24,898 15,653 Net income (loss) (56,599) (77,577) 24,634 22,975 16,324 Income (loss) per share from continuing operations: Basic $ (1.71) $ (1.46) $ 1.19 $ 1.11 $ .85 Diluted (1.71) (1.46) 1.06 .87 .59 Net income (loss) per share: Basic $ (1.67) $ (2.59) $ .98 $ 1.03 $ .89 Diluted (1.67) (2.59) .87 .80 .62 Weighted average common and common equivalent shares outstanding: Basic 33,842 29,896 25,158 22,417 18,432 Diluted 33,842 29,896 28,245 28,665 26,314 YEARS ENDED DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ------- -------- -------- -------- ------- BALANCE SHEET DATA: Working capital $43,874 $ 54,780 $ 88,785 $ 53,053 $69,242 Total assets(1) 97,475 158,908 189,629 127,368 83,711 Total liabilities 21,956 27,631 24,821 14,684 7,633 Stockholders' equity 75,519 131,277 164,808 112,684 76,078 - ------------------ 2 3 (1) During September 1996, the Company announced a formal plan to spin off, through the sale to third parties, certain lines of business and to discontinue selected product lines. Accordingly, the Company's consolidated financial statements, and all prior periods presented, have been restated to report separately the net assets and operating results of the discontinued operations. See Note D of the Notes to Consolidated Financial Statements included under Item 8 of this Report. (2) Product development expenses for 1996 included a charge of approximately $37.9 million for certain acquired in-process technology related to the acquisition of Firefox. See Note D of the Notes to Consolidated Financial Statements included under Item 8 of this Report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 3 4 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of FTP Software, Inc.: We have audited the accompanying consolidated balance sheets of FTP Software, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of FTP Software, Inc. as of December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ COOPERS & LYBRAND L.L.P. Boston, Massachusetts January 27, 1998 4 5 FTP SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) DECEMBER 31, ------------------------- 1997 1996 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 37,569 $ 22,036 Short-term investments 14,234 29,026 Accounts receivable, net of allowance for doubtful accounts of $1,100 and $1,300 for 1997 and 1996, respectively 8,282 16,586 Prepaid expenses and other current assets 2,580 4,430 Refundable income taxes 3,165 3,826 Deferred income taxes -- 1,244 Net assets of discontinued operations -- 5,263 --------- --------- Total current assets 65,830 82,411 Property and equipment, net 8,301 20,734 Purchased software, net 2,621 6,962 Investments 19,767 47,971 Other assets 956 830 --------- --------- Total assets $ 97,475 $ 158,908 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 10,976 $ 12,700 Income taxes payable 1,613 873 Accrued employee compensation and benefits 3,652 4,000 Deferred revenue 5,715 10,058 --------- --------- Total current liabilities 21,956 27,631 --------- --------- Commitments and contingencies (Note J) Stockholders' equity: Preferred stock, $.01 par value; authorized 5,000,000 shares; none issued and outstanding -- -- Common stock, $.01 par value; authorized 100,000,000 shares; issued and outstanding 33,973,140 and 33,646,203 shares in 1997 and 1996, respectively 339 336 Additional paid-in capital 136,792 136,151 Accumulated deficit (62,046) (5,447) Equity adjustments 434 237 --------- --------- Total stockholders' equity 75,519 131,277 --------- --------- Total liabilities and stockholders' equity $ 97,475 $ 158,908 ========= ========= The accompanying notes are an integral part of these financial statements. 5 6 FTP SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEARS ENDED DECEMBER 31, ----------------------------------------- 1997 1996 1995 --------- --------- --------- Revenue: Product revenue $ 50,639 $ 84,579 $ 115,715 Service revenue 17,095 16,512 13,100 --------- --------- --------- Total revenue 67,734 101,091 128,815 --------- --------- --------- Cost of revenue: Product cost 11,624 6,995 6,725 Service cost 9,505 9,801 9,127 --------- --------- --------- Total cost of revenue 21,129 16,796 15,852 --------- --------- --------- Gross margin 46,605 84,295 112,963 --------- --------- --------- Operating expenses: Sales and marketing 45,196 46,896 36,593 Product development 27,044 64,652 22,298 General and administrative 16,289 19,782 12,699 Restructuring charges 18,330 -- -- --------- --------- --------- Total operating expenses 106,859 131,330 71,590 --------- --------- --------- Operating income (loss) (60,254) (47,035) 41,373 Investment income 3,646 4,284 6,156 --------- --------- --------- Income (loss) from continuing operations before income taxes (56,608) (42,751) 47,529 Provision for income taxes 1,208 1,027 17,587 --------- --------- --------- Income (loss) from continuing operations (57,816) (43,778) 29,942 Discontinued operations, net of income tax benefits: Operating loss -- (29,039) (5,308) Gain on (provision for) disposition 1,217 (4,760) -- --------- --------- --------- Net income (loss) $ (56,599) $ (77,577) $ 24,634 ========= ========= ========= Basic income (loss) per share: Continuing operations $ (1.71) $ (1.46) $ 1.19 Discontinued operations .04 (1.13) (.21) ========= ========= ========= $ (1.67) $ (2.59) $ .98 ========= ========= ========= Weighted average number of basic common and common equivalent shares outstanding 33,842 29,896 25,158 ========= ========= ========= Diluted income (loss) per share: Continuing operations $ (1.71) $ (1.46) $ 1.06 Discontinued operations .04 (1.13) (.19) ========= ========= ========= $ (1.67) $ (2.59) $ .87 ========= ========= ========= Weighted average number of diluted common and common equivalent shares outstanding 33,842 29,896 28,245 ========= ========= ========= The accompanying notes are an integral part of these financial statements. 6 7 FTP SOFTWARE, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (IN THOUSANDS, EXCEPT SHARE DATA) RETAINED FOREIGN NET ADDITIONAL EARNINGS EXCHANGE UNREALIZED TOTAL COMMON STOCK PAID-IN (ACCUMULATED TRANSLATION INVESTMENT STOCKHOLDERS' SHARES AMOUNT CAPITAL DEFICIT) ADJUSTMENTS GAINS (LOSSES) EQUITY ------ ------ ------- -------- ----------- -------------- ------ Balance at January 1, 1995 23,344,122 $233 $ 64,955 $ 47,496 $-- $-- $ 112,684 Issuance of common stock 3,162,607 32 8,852 -- -- -- 8,884 Tax benefit of stock option activity -- -- 18,800 -- -- -- 18,800 Net income -- -- -- 24,634 -- -- 24,634 Foreign exchange translation adjustments -- -- -- -- 14 -- 14 Net unrealized investment losses -- -- -- -- -- (208) (208) ---------- ---- -------- -------- ----- ----- --------- Balance at December 31, 1995 26,506,729 $265 $ 92,607 $ 72,130 $ 14 $(208) 164,808 Issuance of common stock 7,139,474 71 43,544 -- -- -- 43,615 Net loss -- -- -- (77,577) -- -- (77,577) Foreign exchange translation adjustments -- -- -- -- (425) -- (425) Net unrealized investment gains -- -- -- -- -- 856 856 ---------- ---- -------- -------- ----- ----- --------- Balance at December 31, 1996 33,646,203 $336 $136,151 $ (5,447) $(411) $ 648 131,277 Issuance of common stock 326,937 3 641 -- -- -- 644 Net loss -- -- -- (56,599) -- -- (56,599) Foreign exchange translation adjustments -- -- -- -- 814 -- 814 Net unrealized investment losses -- -- -- -- -- (617) (617) ---------- ---- -------- -------- ----- ----- --------- Balance at December 31, 1997 33,973,140 $339 $136,792 $(62,046) $ 403 $ 31 $ 75,519 ========== ==== ======== ======== ===== ===== ========= The accompanying notes are an integral part of these financial statements. 7 8 FTP SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) YEARS ENDED DECEMBER 31, -------------------------------------------- 1997 1996 1995 -------- -------- -------- Cash flows from operating activities: Income (loss) from continuing operations $(57,816) $(43,778) $ 29,942 Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used for) operating activities: Depreciation and amortization 12,064 9,260 6,137 Loss on disposition of property and equipment 693 422 255 Noncash write-offs in restructuring charges 7,772 -- -- Provision for doubtful accounts 200 (300) 600 Purchase of in-process technology -- 37,852 -- Amortization of discounts and premiums on investments 66 29 (1,407) Deferred income taxes 1,244 1,221 (1,324) Tax benefit of stock option activity -- -- 18,800 Changes in operating assets and liabilities, net of effects from acquisition of business: Accounts receivable 8,105 17,184 (14,741) Prepaid expenses and other current assets 1,850 895 (2,405) Refundable income taxes 661 1,521 (7,775) Other assets (126) (376) -- Accounts payable and accrued expenses (1,728) (84) 4,688 Income taxes payable 740 873 (2,044) Accrued employee compensation and benefits (348) (1,989) 568 Deferred revenue (4,343) 740 3,837 -------- -------- -------- Net cash provided by (used for) continuing operations (30,966) 23,470 35,131 Net cash provided by (used for) discontinued operations 6,382 (4,920) (1,834) -------- -------- -------- Net cash provided by (used for) operating activities (24,584) 18,550 33,297 -------- -------- -------- Cash flows from investing activities: Capital expenditures (3,530) (9,072) (11,905) Maturities (purchase) of investments 42,930 18,900 (7,454) Acquisition of business, net of cash acquired -- (3,776) -- Other investing activities, net -- (97) 15 -------- -------- -------- Net cash provided by (used for) continuing operations 39,400 5,955 (19,344) Net cash used for discontinued operations -- (32,809) (2,365) -------- -------- -------- Net cash provided by (used for) investing activities 39,400 (26,854) (21,709) -------- -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock 644 1,536 8,884 Principal payments on long-term obligations -- (1,589) (1,142) -------- -------- -------- Net cash provided by (used for) financing activities 644 (53) 7,742 -------- -------- -------- Effect of exchange rate changes on cash 73 156 11 -------- -------- -------- Net increase (decrease) in cash and cash equivalents 15,533 (8,201) 19,341 Cash and cash equivalents, beginning of year 22,036 30,237 10,896 -------- -------- -------- Cash and cash equivalents, end of year $ 37,569 $ 22,036 $ 30,237 ======== ======== ======== Supplemental disclosure of cash flow information: Income taxes paid $ 527 $ -- $ 1,952 ======== ======== ======== Noncash financing activities: Acquisition of business for stock $ -- $ 42,079 $ -- Financed purchased software $ -- $ -- $ 1,000 ======== ======== ======== The accompanying notes are an integral part of these financial statements. 8 9 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. DESCRIPTION OF BUSINESS: FTP Software, Inc. (the "Company") is engaged in the design, development, marketing and support of connectivity software applications that enable users to connect to information across TCP/IP networks, including data residing on mainframes, minicomputers and servers. These applications include terminal emulation, NFS file sharing and printing, file transfer and legacy host access. B. SIGNIFICANT ACCOUNTING POLICIES: Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Revenue Recognition Revenue is generally recognized from the license of software upon shipment when collection of the resulting receivable is deemed probable. At the time the Company recognizes revenue from licensed software products, no significant vendor or post-contract support obligations remain. Service revenue includes revenue from support, training and consulting. Payments received in advance for support contracts are initially recorded as deferred revenue and are recognized ratably over the term of the contract, typically one year. Revenue from training and consulting is recognized as the services are performed. Cash Equivalents Cash equivalents consist of money market funds, commercial paper and government obligations with original maturities of three months or less and are carried at amortized cost, which approximates market value. The Company places its temporary cash investments in money market investments with high credit quality financial institutions. Investments The Company has established guidelines for credit ratings, diversification and maturities for its investment portfolio that are intended to maintain safety and liquidity. The Company's investments are widely diversified, consisting primarily of investment grade debt securities classified as available-for-sale. Accordingly, investments are reported at market value with unrealized holding gains and losses reflected net as a separate component of stockholders' equity until realized. The cost of short-term investments and long-term investments is determined on the specific identification method and the market value is based on quoted market prices. 9 10 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Property and Equipment Property and equipment are stated at cost and depreciated using the straight-line method over their estimated useful lives, ranging from three to seven years. Leasehold improvements are amortized over the shorter of their estimated useful lives or the remaining term of the lease. Expenditures for maintenance and repairs are expensed as incurred. Upon retirement or other disposition of assets, the cost and related accumulated depreciation are eliminated from the accounts and the resulting gain or loss is included in net income (loss). Purchased Software Purchased software includes acquired technology being amortized, using the straight-line method, over the assets' estimated remaining useful lives. The Company evaluates the possible impairment of such long-lived assets whenever events or circumstances indicate that the carrying value of the assets may not be recoverable. Foreign Currency Translation The functional currency of the Company's foreign subsidiaries is the local currency. Accordingly, assets and liabilities of these operations are translated at exchange rates in effect at year-end. Income and expense items are translated at average rates of exchange for the period. Resulting translation adjustments are accumulated in a separate component of stockholders' equity. Gains and losses from foreign currency transactions, which are not material, are included in net income (loss). Product Development Costs Costs related to research, design and development of computer software are charged to product development expense as incurred. The Company capitalizes eligible software costs incurred after technological feasibility of the product has been established, which is generally demonstrated by the initial beta release. The capitalizable costs of internally developed software to date have not been material. Purchased software of approximately $.8 million, $5.6 million and $2.0 million was acquired in 1997, 1996 and 1995, respectively. These assets are being amortized over a one- to four-year period based on the expected useful lives of the products. Related amortization charges, reflected in cost of revenue, were approximately $5.2 million, $2.7 million and $2.2 million in 1997, 1996 and 1995, respectively. Accumulated amortization related to these assets amounted to $9,996 and $4,890 in 1997 and 1996, respectively. Income Taxes Deferred income tax assets and liabilities arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that are expected to result in taxable or deductible amounts in future years. The Company periodically evaluates the realizability of its deferred tax assets. A valuation allowance against net deferred tax assets is established if, based on the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. 10 11 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Net Income (Loss) Per Share The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," for the year ended December 31, 1997. This statement requires the presentation of basic and diluted net income per share. Basic net income per common share is computed using the weighted average number of common shares outstanding during the period. The Company has restated all prior period per share presented as required by SFAS No. 128. Diluted net income per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of stock options. During periods that the Company has recorded a net loss, dilutive common shares are not included in the computation as the effect would be anti-dilutive. Risks and Uncertainties The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The Company's future results of operations involve a number of risks and uncertainties. Factors that could affect the Company's future operating results and cause actual results to vary materially from expectations include, but are not limited to, competition, competitive pricing pressures, technological and other market changes, the effects of the Company's 1997 restructurings, dependence on new products, distribution risks and changes in personnel. The Company sells its products outside the United States primarily through a network of resellers in North and South America, Europe, the Middle East, Canada, Russia and Asia Pacific. In the United States, the Company distributes its products through multiple channels, including direct sales, value-added resellers, systems integrators, OEMs and distributors. The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit risk as determined by management. The Company generally requires no collateral. Accounts receivable are from customers that are geographically and industry dispersed. No one customer accounted for more than 10% of consolidated revenue for any period presented. Accounting for Stock-Based Compensation The Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation," during 1996. This Statement defines a fair value based method of accounting for stock-based employee compensation and requires that companies either recognize compensation expense for grants of stock, stock options and other equity instruments or provide pro forma disclosure of net income (loss) and net income (loss) per share in the notes to the financial statements as if such expense had been recognized. The Company has elected to continue measuring compensation costs for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations and has disclosed pro forma net loss and net loss per share for 1997 and 1996 as if the fair value based method of accounting had been 11 12 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) applied. As such, adoption of this Statement had no effect on the Company's results of operations for 1997 and 1996. New Accounting Standards In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosure about Segments of an Enterprise." SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. The Company will adopt the provisions of SFAS No. 130 for its fiscal year ending December 31, 1998; however, management has not yet evaluated the effects of this change on its reporting of comprehensive income. SFAS No. 131 changes the way public companies report information about operating segments. SFAS No. 131, which is based on the management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report entity-wide disclosures about products and services, major customers and the material countries in which the entity holds assets and reports revenue. The Company intends to adopt SFAS No. 131 for its fiscal year ending December 31, 1998. Management does not expect such adoption to have any material impact on the way it reports information. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition," which provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions and supersedes SOP 91-1, "Software Revenue Recognition." The Company will adopt SOP 97-2 for its fiscal year ending December 31, 1998 and does not expect such adoption to have any material impact on its revenue recognition policies. Reclassifications Certain prior year amounts have been reclassified to conform with the current year's presentation. C. RESTRUCTURE CHARGES: In July 1997, the Company reorganized its operations into business units and effected a worldwide workforce reduction in order to lower the Company's overall cost structure and create greater focus on specific strategic business opportunities. This restructuring resulted in a charge of approximately $17.1 million ($.50 per share) in the third quarter of 1997. This charge included severance related payments, excess facilities costs, the write-off of fixed assets and other restructuring-related items such as losses related to cancelled contracts; such costs were all substantially completed in 1997. In late December 1997, following a review of the financial results of its business units for the second half of 1997, the Company decided to further streamline its operations and to recombine its business units into one worldwide organization. This restructuring resulted in a charge of approximately $1.3 million ($.04 per share) in the fourth quarter of 1997. This charge included costs similar to those 12 13 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) incurred in connection with the third quarter restructuring; management expects these costs to be substantially completed in the first quarter of 1998. The following summarizes the 1997 restructuring charges, the related write-offs and cash paid in connection with the restructurings (dollars in thousands): Severance Excess Excess Payments Facilities Fixed Assets Other Total -------- ---------- ------------ ----- ----- 1997 restructuring charges $ 7,391 $ 3,087 $ 6,871 $ 981 $ 18,330 Noncash write-offs -- -- (7,779) -- (7,779) Cash paid (6,168) (1,553) -- (86) (7,807) Reclassifications (457) 176 908 (627) 0 ------- ------- ------- ----- -------- Accrued restructuring charges at December 31, 1997 $ 766 $ 1,710 $ 0 $ 268 $ 2,744 ======= ======= ======= ===== ======== Amounts related to severance with respect to the July 1997 workforce reduction involved approximately 300 employees, primarily in sales and marketing, product development and general and administrative functions at the Company's domestic and European locations. Amounts related to facilities reflect the cost of the lease of the excess space arising primarily from the consolidation of the Company's Massachusetts headquarters and manufacturing facilities into the Company's North Andover, Massachusetts development offices. Amounts related to severance with respect to the December 1997 workforce reduction involved approximately 21 employees, primarily in development, at the Company's European locations. Amounts related to facilities reflect the cost of the lease of excess space at the Company's U.K. facility. D. ACQUISITIONS AND DISCONTINUED OPERATIONS During 1997, the Company completed the disposition of its collaborative lines of business and selected product lines which were identified in 1996 as not specifically related to the Company's continuing network connectivity business. The accompanying consolidated financial statements have been restated to report separately in all periods presented the net assets and operating results of the discontinued operations. Prior year operating results and all footnote disclosures have been restated to reflect continuing operations. Net assets of discontinued operations consisted primarily of purchased software and fixed assets less accounts payable and accrued expenses. In 1996, the Company recorded a charge of approximately $4.8 million to write down the related assets to estimated net realizable values. In the third quarter of 1997, the Company recorded an additional $2.0 million charge in connection with the termination of a long-term agreement associated with one of the discontinued lines of business. In the fourth quarter of 1997, the Company recorded a gain of approximately $3.2 million upon the completion of the disposition of all related assets. 13 14 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Summary operating results for the discontinued operations (which include charges of approximately $21.8 million and $1.1 million in 1996 and 1995, respectively, for certain acquired in-process technology) are as follows (in thousands): YEARS ENDED DECEMBER 31, ------------------------- 1996 1995 -------- ------- Revenue $ 9,907 $ 7,561 Gross margin 5,255 5,569 Operating loss before income taxes (31,441) (8,427) Net loss (33,799) (5,308) During 1995 and 1996, the Company made the following acquisitions: in 1995, the Company acquired substantially all of the assets of Keyword Office Technologies Ltd., a developer of document viewer and conversion software products, for approximately $2.4 million; and in 1996, the Company acquired the following for a net cash purchase price of approximately $28.7 million: the Mariner Internet software product line of Networking Computing Devices, Inc.; substantially all of the assets of HyperDesk Corporation, including its collaborative GroupWorks product; and all of the outstanding stock of Campbell Services, Inc., the developer of OnTime, a scheduling software product. All of these acquisitions were accounted for as purchases, with the majority of the purchase price recorded as in-process technology, and are reflected in discontinued operations. In July 1996, the Company acquired Firefox Communications Inc. ("Firefox"), a supplier of server-centric departmental and LAN-based IP solutions and services, for a net purchase price of approximately $61.0 million, through the merger of a wholly-owned subsidiary of the Company into Firefox (the "Firefox Merger"). Pursuant to the Firefox Merger, all of the outstanding shares of the common stock of Firefox were converted into a total of approximately 6.4 million shares of the Company's common stock, $.01 par value per share ("Common Stock"), valued at approximately $40.6 million and approximately $9.1 million in cash. In addition, outstanding employee stock options to purchase Firefox common stock were converted into options to purchase approximately 336,000 shares of Common Stock, valued at approximately $1.5 million. The Company also incurred acquisition-related costs of approximately $3.7 million and liabilities treated as assumed totaling approximately $6.1 million which are included in the net purchase price. The transaction was accounted for as a purchase. Based upon a valuation of the assets acquired, approximately $2.6 million was allocated to completed technology, which was included in purchased software and was fully amortized as of December 31, 1997; approximately $37.9 million was allocated to in-process technology and charged to product development expense in 1996; and approximately $20.5 million was allocated to the remaining assets of Firefox, primarily short-term investments and accounts receivable. Results of operations include activity from Firefox since the date of the acquisition. The unaudited pro forma consolidated results of continuing operations would have been as follows if the Firefox Merger had occurred on January 1, 1995 (in thousands, except per share amounts): 14 15 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) YEARS ENDED DECEMBER 31, ------------------------------- 1996 1995 ----------- ----------- Revenue $ 109,396 $ 148,583 Net income (loss) (9,243) 29,787 Basic net income (loss) per share $ (.31) $ 1.18 Diluted net income (loss) per share (.31) 1.05 These unaudited pro forma results are presented for informational purposes only and include certain adjustments such as additional amortization expense as a result of purchased software. They do not include the approximately $37.9 million charge to product development expense for acquired in-process technology and do not purport to be indicative of the Company's actual results of operations had the Firefox Merger occurred on January 1, 1995, nor are they indicative of the Company's results of operations for any future period. The Company allocates the purchase price of acquired technologies to completed technology and in-process technology based upon their respective fair values. Completed technology that has reached technological feasibility is valued using a risk adjusted cash flow model under which future cash flows are discounted, taking into account risks related to existing and future markets and assessments of the life expectancy of completed technology. In-process technology that has not reached technological feasibility and that has no alternative future use is valued using the same method. Expected future cash flows associated with in-process technology are discounted considering risks and uncertainties related to the viability of and to potential changes in the future target markets and to the completion of the products expected to be ultimately marketed by the Company. Amounts charged to product development expense for in-process technology are either not fully deductible in the same period or are non-deductible for tax purposes. E. INVESTMENTS: Investments consist of the following (in thousands): DECEMBER 31, 1997 DECEMBER 31, 1996 ------------------------ ------------------------ MARKET AMORTIZED MARKET AMORTIZED VALUE COST VALUE COST --------- ------------ ----------- ----------- U.S. government obligations $19,502 $19,453 $42,127 $42,707 Corporate obligations 14,499 14,517 18,727 18,822 Municipal obligations -- -- 9,171 9,153 Equity securities -- -- 6,972 5,224 ------- ------- ------- ------- $34,001 $33,970 $76,997 $75,906 ======= ======= ======= ======= At December 31, 1997 and 1996, gross unrealized investment gains amounted to approximately $.1 million and $1.9 million, respectively, and gross unrealized investment losses amounted to approximately $.1 million and $.8 million, respectively. Proceeds from dispositions of available for sale securities were approximately $28.1 million and approximately $3.0 million in 1997 and 1996, respectively. These dispositions resulted in gross gains of approximately $.1 million and gross losses of approximately $.3 million in 1997. Gross gains and gross losses from such dispositions were not significant in 1996. 15 16 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The Company's investments, at market value based on quoted market prices, mature as follows (in thousands): DECEMBER 31, ---------------------- YEARS TO MATURITY 1997 1996 ---------- ---------- 0-1 $14,234 $29,026 1-5 19,767 41,258 5-10 -- 258 Over 10 -- 6,455 ---------- ---------- $34,001 $76,997 ========== ========== Included in the above table as having 0-1 years to maturity are equity securities of approximately $7.0 million at December 31, 1996. F. PROPERTY AND EQUIPMENT: Property and equipment consist of the following (in thousands): DECEMBER 31, -------------------------- 1997 1996 ------------ ----------- Development equipment $ 4,453 $ 7,266 Equipment 9,259 21,164 Furniture and leasehold improvements 4,756 8,784 --------- -------- 18,468 37,214 Less accumulated depreciation and amortization (10,167) (16,480) --------- -------- $ 8,301 $ 20,734 ========= ======== G. PROFIT SHARING RETIREMENT PLAN: The Company sponsors a profit sharing retirement plan for eligible employees established under the provisions of Section 401(k) of the Internal Revenue Code (the "401(k) Plan"), under which participants may defer a portion of their annual compensation on a pre-tax basis. Contributions by the Company to the 401(k) Plan are at the discretion of the Company's Board of Directors (the "Board of Directors") and amounted to approximately $1.0 million, $1.2 million and $1.0 million for the years ended December 31, 1997, 1996 and 1995, respectively. While the Company expects to continue the 401(k) Plan indefinitely, it has reserved the right to modify, amend or terminate the plan. In the event of termination, the entire amount contributed under the 401(k) Plan, at the time of termination, must be applied to the payment of benefits to the participants or their beneficiaries. The Company does not currently offer post-retirement or post-employment benefits. 16 17 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) H. INCOME TAXES: The loss from continuing operations before income taxes for the years ended December 31, 1997 and 1996 for domestic operations was approximately $55.9 million and $40.2 million, respectively, and for foreign operations was approximately $.7 million and $2.6 million, respectively. The income from continuing operations before income taxes for the year ended December 31, 1995 for domestic operations was approximately $46.6 million and for foreign operations was approximately $1.0 million. The provision for income taxes consists of the following (in thousands): YEARS ENDED DECEMBER 31, --------------------------------------- 1997 1996 1995 ------- -------- -------- Current (benefit) provision: Federal $(1,210) $ (3,252) $ 15,657 State 650 210 2,859 Foreign 523 2,848 395 ------- -------- -------- (37) (194) 18,911 ------- -------- -------- Deferred (benefit) provision: Federal 1,210 982 (1,024) State 35 239 (300) ------- -------- -------- 1,245 1,221 (1,324) ------- -------- -------- $ 1,208 $ 1,027 $ 17,587 ======= ======== ======== The losses from discontinued operations resulted in tax benefits of approximately $2.5 million and $3.1 million in 1996 and 1995, respectively. There was no tax benefit from discontinued operations in 1997. The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income (loss) from continuing operations before income taxes as follows: YEARS ENDED DECEMBER 31, ------------------------------------ 1997 1996 1995 ------ ------ ------ Tax (benefit) at U.S. statutory rate (35.0)% (35.0)% 35.0% Non-deductible merger-related costs 1.0 31.1 -- Foreign tax -- 4.7 -- Operating loss with no current tax benefit 34.2 1.7 -- State income taxes net of federal tax benefit .7 .6 4.3 Other 1.2 (.7) (2.3) ------ ------ ------ 2.1% 2.4% 37.0% ====== ====== ====== The current federal and state provisions for income taxes do not reflect tax savings resulting from deductions associated with the Company's various stock plans of approximately $18.8 million in 1995, which was credited to stockholders' equity. There were no tax savings resulting from deductions associated with these stock plans in 1997 or 1996. 17 18 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The components of deferred income taxes are as follows (in thousands): DECEMBER 31, ------------------------ 1997 1996 -------- -------- Federal tax benefit of net operating loss carryforward and credits $ 19,456 $ -- State tax benefit of net operating loss carryforward and credits 5,499 1,616 Depreciation and amortization expense 5,041 1,551 Accounts receivable reserve 1,092 1,259 Employee compensation and benefits accruals 1,607 1,063 Foreign tax benefit of net operating loss carryforward 608 513 Other 634 283 -------- -------- 33,937 6,285 Valuation allowance for deferred tax assets (33,483) (2,676) -------- -------- 454 3,609 -------- -------- Deferred tax liabilities: Depreciation and amortization expense (454) (1,085) Purchased technology -- (1,008) Other reserves and liabilities -- (272) -------- -------- (454) (2,365) -------- -------- Current deferred income tax assets $ 0 $ 1,244 ======== ======== The realization of these deferred tax assets is dependent upon future earnings in specific tax jurisdictions. Due to the uncertainty as to when the deferred tax assets may be realized, the Company has recorded a valuation allowance for all tax assets in excess of amounts available to be recovered pursuant to tax loss carrybacks for the year ended December 31, 1997. The Company periodically reviews the need for the valuation allowance and if the valuation allowance is reduced, the tax benefit will be recorded as a reduction of the Company's income tax expense except for approximately $1.3 million which is attributable to stock options and will be credited to additional paid-in capital when realized. At December 31, 1997, the Company had a net operating loss carryforward for federal income tax purposes of approximately $46.3 million expiring at various dates beginning in 2008 through 2012 and tax credit carryforwards of approximately $3.7 million which expire in various years beginning in 1998 through 2011. At December 31, 1997, the Company had net operating loss carryforwards of approximately $53.0 million available to offset future taxable income in several state jurisdictions expiring at various dates beginning in 2000 through 2012. Similarly, research and experimentation credit carryforwards for state tax purposes of approximately $.6 million and investment tax credits of approximately $.1 million were available at December 31, 1997, expiring in 2010. In addition, the Company had a net operating loss of approximately $1.8 million available to offset future taxable income in a foreign jurisdiction with no expiration. 18 19 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) I. STOCKHOLDERS' EQUITY: Preferred Stock The Board of Directors is authorized, subject to any limitations prescribed by law, to issue up to an aggregate of 5,000,000 shares of the Company's preferred stock, $.01 par value per share ("Preferred Stock"), with such powers, designations, preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be determined by the Board of Directors in a resolution or resolutions providing for the issuance of such Preferred Stock. On December 1, 1995, pursuant to the shareholder rights plan described below, the Board of Directors designated 500,000 shares of Preferred Stock as Junior Preferred Stock, $.01 par value per share ("Junior Preferred Stock"). Dividends accrue on the Junior Preferred Stock at a quarterly rate equal to the greater of $1.00 or, subject to adjustment, 100 times the aggregate per share amount of all dividends paid during the quarter on the Common Stock. The Junior Preferred Stock carries a liquidation preference of $100 per share, is redeemable, and entitles the holder to 100 votes per share on all matters submitted to a vote of the Company's stockholders. The Company has not issued any shares of Junior Preferred Stock. Shareholder Rights Plan On December 1, 1995, the Company adopted a shareholder rights plan (the "Rights Plan") whereby each share of Common Stock issued after December 8, 1995 will have an attached right which, when exercisable, will entitle the holder to purchase 1/100th of a share of Junior Preferred Stock at a price of $150 (the "Rights"). Additionally, the Board of Directors declared a dividend of one Right for each share of Common Stock outstanding on December 8, 1995. The Rights become exercisable if a person acquires or announces a tender or exchange offer for 15% or more of the outstanding Common Stock. The Rights Plan also provides that if a person (an "Acquiring Person") acquires or obtains the right to acquire 15% or more of the outstanding Common Stock (other than pursuant to certain approved offers), each of the Rights (other than the Rights held by the Acquiring Person) will entitle the holder to purchase shares of Common Stock having a market value of twice the exercise price of the Rights. In addition, if the Company is involved in a merger or other business combination with another person in which it is not the surviving corporation or in connection with which the Common Stock is changed or converted into securities of any other person or other property, or if the Company sells or transfers 25% or more of its assets or earning power to another person, each Right that has not previously been exercised will entitle its holder to purchase shares of the common stock of such other person having a market value of twice the exercise price of the Right. In November 1996, the Company amended the Rights Plan to permit Kopp Investment Advisors, Inc. and certain of its affiliates (but not any of their transferees) to acquire up to 6,722,400 shares of Common Stock (approximately 19.9% of the outstanding shares of Common Stock as of the date of such amendment) without triggering the exercisability of the Rights. The Board of Directors may redeem the Rights at any time prior to their expiration on December 1, 2005 at a redemption price of $.01 for each of the Rights. The Company has reserved 500,000 shares of Junior Preferred Stock for issuance upon exercise of the Rights. 19 20 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Stock Option Plans In January 1987, the Company adopted the FTP Software, Inc. Stock Option Plan (the "1987 Option Plan"). Under the 1987 Option Plan, as amended, the Company had the right to grant to certain employees either incentive or non-qualified stock options to purchase up to 26,400,000 shares of Common Stock vesting over four years. The exercise price of each option could not be less than the fair market value of Common Stock on the date of grant, as determined by the Board of Directors, and the term of each option could not exceed 10 years. This plan terminated in January 1997; as a result, no additional grants may be made under this plan. In January 1997, the Company adopted the FTP Software, Inc. 1997 Employee Equity Incentive Plan. Under this plan, the Company has the right to grant to certain employees non-qualified stock options, stock appreciation rights, restricted stock and unrestricted stock. The aggregate maximum number of shares of Common Stock that may be delivered under this plan is 2,780,000 plus the number of shares subject to options granted under the 1987 Option Plan that terminate unexercised after January 20, 1997. As of December 31, 1997, the maximum number of shares of Common Stock deliverable under this plan was 5,812,740. The exercise price of the options may not be less than the fair market value of the Common Stock on the date of grant, as determined by the Board of Directors, and the term of each option may not exceed 10 years. Options are exercisable to the extent vested. Vesting generally occurs within three years from the date of the grant. In August 1996, the Company adopted the FTP Software, Inc. 1996 Executive Equity Incentive Plan, which enables the Company to grant either incentive or non-qualified stock options, stock appreciation rights, restricted stock and unrestricted stock to its executive officers. The aggregate maximum number of shares of Common Stock that may be delivered under this plan is 1,500,000. The exercise price of the options may not be less than the fair market value of the Common Stock on the date of the grant, as determined by the Board of Directors, and the term of each option may not exceed 10 years. The options vest over various dates within three to four years from the date of the grant. During 1996, the Company offered its employees (other than executive officers) the opportunity to exchange each stock option granted during 1994, 1995 and 1996 for a new option covering 50% of the number of shares of Common Stock covered by the original option, having a new exercise price fixed at the date of exchange and otherwise having the same or similar terms as the original option. During the option exchange offer period, options to purchase approximately 2,130,000 shares of Common Stock at exercise prices ranging from $9.50 to $31.75 per share were exchanged for options to purchase approximately 1,065,000 shares of Common Stock at exercise prices ranging from $7.25 to $9.063 per share. In September 1993, the Company adopted the 1993 Non-Employee Directors' Stock Option Plan, which provides for the automatic grant of options upon the election or re-election of each non- employee director and for discretionary option grants to such directors. A maximum of 500,000 shares of Common Stock may be issued under this plan. The exercise price of each option may not be less than the fair market value of Common Stock on the date of the grant, as determined by the Board of Directors, and the term of each option may not exceed 10 years. The original automatic grant provisions generally provided for the grant of an option to purchase 30,000 shares of Common Stock upon the election or re- 20 21 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) election of such a director, vesting over three years. As amended in December 1997, this plan now generally provides for the automatic grant of an option to purchase 20,000 shares upon the election or re-election of a non-employee director, vesting over three years, and the automatic grant of an additional option to purchase 10,000 shares of Common Stock on each of the first and second anniversaries of such election or re-election, provided such director is still serving as such, vesting in full upon grant. Prior to the Company's acquisition of Firefox, Firefox granted options to certain of its employees under the Firefox 1994 Share Option Scheme, prior to Firefox's initial public offering. Options granted under that plan were generally scheduled to vest over three years and were required to be exercised no later than seven years from the date of grant. Pursuant to the Firefox Merger, each option outstanding under this plan was converted into an option to purchase shares of Common Stock at a new exercise price determined in accordance with the merger agreement. In addition, each optionholder had the right to have the Company assume the holder's converted options, in which case the converted options would otherwise continue on the same terms and conditions that applied prior to the conversion of the options. If a holder chose not to have the Company assume a converted option, the converted option became exercisable in full for a period of six months beginning on July 22, 1996 (the closing date of the Firefox Merger) and ending on January 22, 1997. Prior to the Company's acquisition of Firefox, Firefox also maintained the Firefox 1995 Stock Option Plan. This plan provided for the grant of incentive stock options and non-qualified stock options at an exercise price not less than 100% and 85%, respectively, of the fair market value of Firefox's common stock at the date of grant. Options granted under this plan were generally scheduled to vest over four years and were required to be exercised no later than 10 years from the date of grant. Pursuant to the Firefox Merger, each option outstanding under this plan was automatically assumed by the Company and converted into an option to purchase shares of Common Stock at a new exercise price determined in accordance with the merger agreement, but otherwise continued on the same terms and conditions that applied prior to the conversion of the options. Holders of options granted under this plan had the opportunity to participate in the option exchange offer described above. Stock option activity under the Company's various stock option plans is summarized as follows: WEIGHTED-AVERAGE SHARES EXERCISE PRICE ---------- ---------------- Outstanding, January 1, 1995 7,445,029 $ 7.21 Granted 1,754,286 30.59 Exercised (3,137,635) 2.71 Canceled (1,795,361) 6.25 ---------- Outstanding, December 31, 1995 4,266,319 20.54 Granted 5,414,978 9.60 Converted Firefox options 336,424 5.44 Exercised (703,332) 1.80 Canceled (3,759,520) 22.29 ---------- Outstanding, December 31, 1996 5,554,869 10.16 Granted 5,328,003 4.06 Exercised (297,270) 1.76 Canceled (3,933,873) 10.13 ---------- Outstanding, December 31, 1997 6,651,729 $ 5.67 ========== 21 22 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Information about stock options outstanding at December 31, 1997 is summarized as follows: OUTSTANDING EXERCISABLE - ---------------------------------------------------------------------- -------------------- WEIGHTED- AVERAGE REMAINING WEIGHTED- CONTRACTUAL WEIGHTED- AVERAGE RANGE OF EXERCISE LIFE AVERAGE EXERCISE EXERCISE PRICES SHARES (IN YEARS) PRICE SHARES PRICE - ----------------- --------- ------------- ------------------ --------- ---------- $ .14 $ .14 977 3.54 $ .14 977 $ .14 1.74 1.97 589,500 9.19 1.82 55,500 1.74 2.81 4.13 2,939,700 9.25 3.79 20,000 3.00 4.42 6.50 1,037,340 9.00 5.43 73,500 6.25 6.88 9.88 1,759,436 7.99 8.20 546,451 8.33 12.50 13.63 237,068 8.12 12.55 84,021 12.53 25.75 31.75 87,708 6.84 28.16 83,599 28.02 --------- -------- $ .14 $ 31.75 6,651,729 8.80 $ 5.67 864,048 $ 9.91 ========= ======== The weighted-average grant-date fair value of options granted during 1997, 1996 and 1995 was $3.55, $6.34 and $17.80 per share, respectively. Employee Stock Purchase Plans Effective January 1, 1994, the Company adopted the FTP Software, Inc. Employee Stock Purchase Plan. This plan provides a maximum of 1,000,000 shares of Common Stock for purchase by eligible employees at 85% of the fair market value of Common Stock on the first or last trading day of each six-month purchase period under the plan, whichever is lower. During 1997, 1996 and 1995, 24,897, 31,301 and 12,580 shares of Common Stock, respectively, were issued under this plan at a weighted-average purchase price of $3.41, $6.11 and $25.07 per share, respectively, and a fair value of $4.01, $7.18 and $29.49 per share, respectively. In October 1995, the Company adopted the FTP Software, Inc. Non-Qualified Stock Purchase Plan for Employees of Certain Subsidiaries. This plan is for the benefit of non-U.S. employees employed outside of the United States by subsidiaries of the Company approved for participation in the plan by the Compensation Committee of the Board of Directors. This plan provides a maximum of 100,000 shares of Common Stock for purchase by eligible employees at 85% of the fair market value of the Common Stock on the first or last trading day of each six-month purchase period under the plan, whichever is lower. The first purchase period under the plan began on January 1, 1996. Accordingly, no shares of Common Stock were issued under this plan during 1995. During 1997 and 1996, 2,423 and 3,564 shares of Common Stock were issued under this plan at a weighted-average purchase price of $4.15 and $6.20 per share, respectively, and a fair value of $4.88 and $7.30 per share, respectively. 22 23 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Stock-Based Compensation The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," issued in October 1995. In accordance with SFAS No. 123, the Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its option plans, and accordingly does not record compensation costs. If compensation cost for the Company's stock-based compensation plans had been determined based on the fair value at the grant dates as calculated in accordance with SFAS No. 123, the cost would have amounted to $3,538, $6,655 and $5,326 for the years ended December 31, 1997, 1996 and 1995, respectively. The Company's net income (loss) and net income (loss) per share for the years ended December 31, 1997, 1996 and 1995 would have been reported as the pro forma amounts indicated below (in thousands, except per share amounts): YEARS ENDED DECEMBER 31, ---------------------------------------------- 1997 1996 1995 ---------- ---------- ---------- Net income (loss) as reported $ (56,599) $ (77,577) $ 24,634 Pro forma net income (loss) (60,137) (84,232) 19,308 Basic net income (loss) per share as reported $ (1.67) $ (2.59) $ .98 Pro forma basic net income (loss) per share (1.78) (2.81) .77 Diluted net income (loss) per share as reported $ (1.67) $ (2.59) $ .87 Pro forma diluted net income (loss) per share (1.78) (2.81) .68 The pro forma amounts include the effects of all activity under the Company's stock-based compensation plans since January 1, 1996. The Company anticipates that it will have additional activity under these plans in the future. For the purpose of providing pro forma disclosures, the fair value of each stock option granted was estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions: an expected life of 5.0 years as of 1997 and 4.8 years as of 1996 and 1995; expected volatility of 80%, 83.4% and 64.4% in 1997, 1996 and 1995, respectively; no expected dividends; and a risk-free interest rate of 6.13%, 6.1% and 5.5% in 1997, 1996 and 1995, respectively. At December 31, 1996 and 1995, the number of shares of Common Stock for which options were exercisable totaled 864,048 and 1,159,729, respectively, at a weighted-average exercise price of $9.91 and $9.87 per share, respectively. At December 31, 1997, the number of shares of Common Stock available for future stock option grants amounted to 2,934,309. Earnings Per Share The earnings per share ("EPS") amounts have been computed in accordance with SFAS No. 128, "Earnings per Share." A reconciliation of the income (loss) and share information used in the basic and diluted per share computation for 1997, 1996 and 1995 is as follows (in thousands, except per share amounts): 23 24 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) YEAR ENDED DECEMBER 31, 1997 INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ---------- ------------ ---------- BASIC EPS Loss from continuing operations $(57,816) 33,842 $ (1.71) ======== Effect of dilutive securities -- -- -------- -------- DILUTED EPS Loss from continuing operations $(57,816) 33,842 $ (1.71) ======== ======== ======== YEAR ENDED DECEMBER 31, 1996 INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- ----------- BASIC EPS Loss from continuing operations $(43,778) 29,896 $ (1.46) ======== Effect of dilutive securities -- -- -------- ------ DILUTED EPS Loss from continuing operations $(43,778) 29,896 $ (1.46) ======== ====== ======== YEAR ENDED DECEMBER 31, 1995 INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------ --------- BASIC EPS Income from continuing operations $29,942 25,158 $ 1.19 ======= Effect of dilutive securities: Options -- 3,087 ------- ------- DILUTED EPS Income from continuing operations $29,942 28,245 $ 1.06 ======= ======= ======= For 1997 and 1996, the diluted EPS computations did not include approximately 6,652 and 5,555 additional shares at a weighted-average exercise price of $5.67 and $10.16, respectively, because these shares are attributable to outstanding options where the effect would have been anti-dilutive. J. COMMITMENTS AND CONTINGENCIES: Lease Commitments The Company leases its corporate and administrative office facilities under long-term non-cancelable operating lease agreements expiring at various dates through 2011. The agreements generally require the payment of utilities, real estate taxes, insurance and repairs. Total rent expense for the years ended December 31, 1997, 1996 and 1995 amounted to approximately $4.4 million, $4.8 million and $3.0 million, respectively. 24 25 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) At December 31, 1997, future minimum annual rental payments, net of sublease rental payments of approximately $10.4 million, required under the operating lease agreements are as follows (in thousands): 1998 $ 3,884 1999 3,703 2000 3,586 2001 3,004 2002 1,782 Thereafter 3,091 ------- $19,050 ======= Litigation In March 1996, a class action lawsuit was filed in the United States District Court for the District of Massachusetts, naming the Company and certain of its current and former officers as defendants. The lawsuit, captioned Lawrence M. Greebel v. FTP Software, Inc., et al., Civil Action No. 96-10544, alleges that the defendants publicly issued false and misleading statements and omitted to disclose material facts necessary to make such statements not false and misleading, which the plaintiffs contend caused an artificial inflation in the price of the Company's Common Stock. Specifically, the original complaint alleged that the defendants knowingly concealed adverse facts and made false or misleading forward and non-forward looking statements concerning the operating results and financial condition of the Company, the effects of the Company's July 1995 corporate restructuring and changing competitive factors in the Company's industry. The lawsuit, which is purportedly brought on behalf of a class of purchasers of the Company's common stock during the period from July 14, 1995 to January 3, 1996, alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Rule 10b-5 thereunder and seeks relief in the form of unspecified compensatory damages, costs and expenses and such other relief as the court deems proper and just. In August 1996, plaintiffs filed an amended complaint adding allegations concerning what plaintiffs claim were wrongful sales and accounting practices by the Company during the class period, but asserting the same causes of action as the original complaint. In October 1996, the Company filed a motion to dismiss the complaint on the grounds that the plaintiffs had not met the pleading requirements of the Private Securities Litigation Reform Act of 1995. The motion was denied by the court on February 13, 1997. On February 13, 1998, FTP filed a motion for partial summary judgment and renewed motion to dismiss; plaintiffs filed their response on March 20, 1998. FTP intends to request the court to permit it to file a reply memorandum in further support of such motion. If permitted to do so, FTP will file its reply memorandum by April 10, 1998, after which time the motion will be before the court for resolution. The Company has reviewed the allegations in the lawsuit, believes them to be without merit, and intends to defend itself and its officers vigorously. In order to support an adequate defense, the Company has spent and expects to continue to spend substantial sums for legal and expert fees and costs. The cost of defending the litigation and the outcome of the litigation are uncertain and cannot be estimated. If the lawsuit were determined adversely to the Company, the Company could be required to 25 26 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) pay a substantial judgment, which could have a material adverse effect on the Company's business, financial condition and results of operations. In February 1996, a class action lawsuit, captioned Richard Zeid and Siom Misrah, et al. v. John Kimberley, Frank M. Richardson, Mark A. Rowlinson and Firefox Communications, Inc., Case No. C96 20136, was filed in the United States District Court for the Northern District of California, San Francisco Division (transferred to the San Jose Division), naming Firefox and certain of its current and former officers and former directors as defendants. The original complaint alleged that the defendants misrepresented or failed to disclose material facts about Firefox's operations and financial results, which the plaintiffs contended resulted in an artificial inflation in the price of Firefox's common stock. The suit was purportedly brought on behalf of a class of purchasers of Firefox's common stock during the period from August 3, 1995 to January 2, 1996. The complaint alleged claims for violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 thereunder and sought relief in the form of unspecified compensatory damages, pre- and post-judgment interest, attorneys' and expert witness fees and such extraordinary, equitable and/or injunctive relief as permitted by law, equity and the federal statutory provisions under which the suit was brought. In June 1996, the District Court entered an order dismissing plaintiffs' complaint. In the order, the court dismissed with prejudice certain of plaintiffs' claims that warnings and disclosures in Firefox's Form 10-Qs were false and misleading, while granting plaintiffs permission to amend their complaint as it concerned certain of plaintiffs' claims that Firefox was responsible for false and misleading analysts reports, Firefox statements and financial statements. In July 1996, plaintiffs filed their amended complaint. The amended complaint alleged that defendants misrepresented or failed to disclose material facts about Firefox's operations and financial results which the plaintiffs contended resulted in an artificial inflation of the price of Firefox's common stock. The amended complaint was purportedly brought on behalf of a class of purchasers of Firefox's common stock during the period from July 20, 1995 to January 2, 1996. The amended complaint again alleged claims for violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 thereunder and sought relief in the form described above. Specifically, the amended complaint alleged that defendants knew allegedly material adverse non-public information about Firefox's financial results and business conditions which allegedly was not disclosed, that they improperly directed that certain sales and revenues be recognized and failed to keep adequate reserves and that they participated in drafting, reviewing and/or approving allegedly misleading statements, releases, analysts reports and other public representations, including disclaimers and warnings of and about Firefox. The amended complaint also alleged that John A. Kimberley, then an officer and director of Firefox, and Frank Richardson, a former officer and director of Firefox, were liable as "controlling persons" of Firefox. In September 1996, Firefox filed a motion to dismiss the amended complaint on the grounds that the plaintiffs had not met the pleading requirements of the Private Securities Litigation Reform Act of 1995. On May 8, 1997, the court dismissed the amended complaint on such grounds, without leave to amend. Plaintiffs have appealed the dismissal to the Ninth Circuit Court of Appeals. The appeal is fully briefed; the court has not yet set a date for oral argument. Firefox has reviewed the allegations in the lawsuit, believes them to be without merit, and intends to defend itself and its officers and directors vigorously. In order to support an adequate defense, Firefox has spent and expects to continue to spend substantial sums for legal and expert fees and costs. The cost of defending the litigation and the outcome of the litigation are uncertain and cannot be 26 27 FTP SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) estimated. If the lawsuit were determined adversely to Firefox, Firefox could be required to pay a substantial judgment, which could have a material adverse effect on Firefox's business, financial condition and results of operations. K. SEGMENT INFORMATION: The Company is active in only one business segment: designing, developing, marketing and supporting connectivity and other software products. The Company's export sales can be grouped into the following geographic areas (in thousands): YEARS ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ------- ------- ------- Geographic area: North and South America (other than U.S.) $ 1,852 $ 6,142 $ 9,789 Asia Pacific 3,792 8,965 9,601 Europe 21,861 27,282 38,075 Other 354 170 1,693 ------- ------- ------- Total $27,859 $42,559 $59,158 ======= ======= ======= Sales, marketing and development operations outside the United States are conducted through subsidiaries and branches located principally in Europe. For the year ended December 31, 1997, the Company's foreign operations reported management fee income of approximately $22.0 million, of which approximately $17.5 million is attributable to the United Kingdom. The management fee income is primarily based upon revenue generated from the geographic area. In addition, the loss from foreign operations amounted to approximately $.7 million and identifiable assets associated with foreign operations amounted to approximately $3.1 million. The Company's United States operations accounted for greater than 90% of the Company's revenue, income (loss) from operations and identifiable assets for each of the years ended December 31, 1996 and 1995. 27 28 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. The following documents are filed as part of this Report: FINANCIAL STATEMENTS: Report of Independent Accountants Consolidated Balance Sheets at December 31, 1997 and 1996 Consolidated Statements of Operations For the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 1995, 1996 and 1997 Consolidated Statements of Cash Flows For the Years Ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements FINANCIAL STATEMENT SCHEDULES: Report of Independent Accountants on Financial Statement Schedule Schedule II -- Valuation and Qualifying Accounts EXHIBITS: EXHIBIT NO. TITLE - ----------- ----- 3.1 Restated Articles of Organization of the Company(1) 3.2 Certificate of Designation, Preferences and Rights of Junior Preferred Stock of the Company(1) 3.3 Articles of Amendment to Restated Articles of Organization of the Company(3) 3.4 Amended and Restated Bylaws of the Company(1) 4.1 Specimen common stock certificate(1) 4.2 Rights Agreement dated as of December 1, 1995 between the Company and State Street Bank and Trust Company, as Rights Agent (including form of Rights Certificate)(1) 4.3 Amendment to Rights Agreement dated as of November 7, 1996 between the Company and State Street Bank and Trust Company, as Rights Agent(2) 10.1 Indenture of Lease between the Company and North Andover Mills Realty dated November 19, 1991(1) 10.2 Amendment No. 1 to Indenture of Lease between the Company and North Andover Mills Realty dated as of September 1, 1992(1) 10.3 Amendment No. 2 to Indenture of Lease between the Company and North Andover Mills Realty dated as of January 6, 1993(1) 28 29 EXHIBIT NO. TITLE - ----------- ----- 10.4 Amendment No. 3 to Indenture of Lease between the Company and North Andover Mills Realty dated as of June 18, 1993(1) 10.5 Amendment No. 4 to Indenture of Lease between the Company and North Andover Mills Realty dated as of September 30, 1993(1) 10.6 Amendment No. 5 to Indenture of Lease between the Company and North Andover Mills Realty Limited Partnership dated August 12, 1995(1) 10.7 Employment Agreement between the Company and Glenn C. Hazard dated as of July 29, 1996(2) 10.8 Amendment No. 1 to Employment Agreement between the Company and Glenn C. Hazard dated as of June 19, 1997(4) 10.9 Amendment No. 2 to Employment Agreement between the Company and Glenn C. Hazard dated as of September 4, 1997(5) 10.10 Amended and Restated Employment Agreement between the Company and Glenn C. Hazard dated as of December 12, 1997(6) 10.11 Employment Agreement between the Company and Douglas F. Flood dated as of July 23, 1996(2) 10.12 Amendment No. 1 to Employment Agreement between the Company and Douglas F. Flood dated as of June 19, 1997(4) 10.13 Amendment No. 2 to Employment Agreement between the Company and Douglas F. Flood dated as of September 4, 1997(5) 10.14 Amended and Restated Employment Agreement between the Company and Douglas F. Flood dated as of December 12, 1997(6) 10.15 Employment Agreement between the Company and John A. Kimberley dated as of the "Effective Date" of the Firefox merger(2) 10.16 Amendment No. 1 to Employment Agreement between the Company and John A. Kimberley dated as of June 19, 1997(4) 10.17 Employment Agreement between the Company and Dennis Leibl dated as of December 12, 1997(6) 10.18 Employment Agreement between the Company and Peter R. Simkin dated as of the "Effective Date" of the Firefox merger, together with Amendment No. 1 thereto dated August 24, 1996(2) 10.19 Amendment No. 2 to Employment Agreement between Company and Peter R. Simkin dated as of December 15, 1996(3) 10.20 Amendment No. 3 to Employment Agreement between Company and Peter R. Simkin dated as of June 19, 1997(4) 10.21 Employment Agreement between the Company and James A. Tholen dated as of April 6, 1997(4) 10.22 Amended and Restated Employment Agreement between the Company and James A. Tholen dated as of December 12, 1997(6) 10.23 FTP Software, Inc. Stock Option Plan(1) 10.24 FTP Software, Inc. 1996 Executive Equity Incentive Plan(2) 29 30 EXHIBIT NO. TITLE - ----------- ----- 10.25 FTP Software, Inc. 1997 Employee Equity Incentive Plan(3) 10.26 Composite FTP Software, Inc. 1993 Non-Employee Directors' Stock Option Plan incorporating Amendment No. 1 effective as of June 2, 1995, Amendment No. 2 effective as of August 22, 1996 (2), as amended by Amendment No. 3 effective as of December 18, 1997(6) 10.27 Indenture of Lease between the Company and Andover Mills Realty Limited Partnership dated as of October 1, 1993(1) 10.28 Amendment No. 1 to Indenture of Lease between the Company and Andover Mills Realty Limited Partnership dated as of February 10, 1994(1) 10.29 Amendment No. 2 to Indenture of Lease between the Company and Andover Mills Realty Limited Partnership dated as of June 7, 1995(1) 10.30 Amended and Restated Agreement and Plan of Merger by and among the Company, Firefox Acquisition Corp. and Firefox Communications Inc. dated as of May 21, 1996(7) 21 List of Subsidiaries(6) 23 Consent of Coopers & Lybrand L.L.P.* 27 Financial Data Schedule* 99 Cautionary Factors(8) - --------------------- *Filed with this Report. (1) Included as an exhibit to, and incorporated in this Report by reference to, the Company's Registration Statement on Form S-4 (No. 333-06917) filed with the Securities and Exchange Commission (the "Commission") on June 26, 1996. (2) Included as an exhibit to, and incorporated in this Report by reference to, the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 filed with the Commission on November 14, 1996. (3) Included as an exhibit to, and incorporated in this Report by reference to, the Company's Annual Report on Form 10-K for the year ended December 31, 1996 filed with the Commission on March 31, 1997. (4) Included as an exhibit to, and incorporated in this Report by reference to, the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 filed with the Commission on August 14, 1997. (5) Included as an exhibit to, and incorporated in this Report by reference to, the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 filed with the Commission on November 14, 1997. (6) Included as an exhibit to, and incorporated in this Report by reference to, the Company's Annual Report on Form 10-K for the year ended December 31, 1997, filed with the Commission on March 30, 1998. (7) Included as Appendix A to, and incorporated in this Report by reference to, the Company's Joint Proxy Statement/Prospectus filed with the Commission on July 1, 1996. 30 31 (8) Included as, and incorporated by reference to, Appendix A to this Report. REPORTS ON FORM 8-K: None. 31 32 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on this 14th day of May, 1998. FTP SOFTWARE, INC. By: /s/ James A. Tholen ---------------------------------------------- James A. Tholen Senior Vice President, Chief Operating Officer and Chief Financial Officer 32