UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1997 Commission File Number 0-28904 AWARD SOFTWARE INTERNATIONAL, INC. (Exact name of registrant as specified in its charter) CALIFORNIA 94-2893462 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 777 EAST MIDDLEFIELD ROAD MOUNTAIN VIEW, CALIFORNIA 94043 (Address of principal executive offices) (Zip Code) 415-968-4433 (registrant's telephone number, including area code) 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 --- --- Registrant had 6,603,013 shares of Common Stock, no par value, outstanding at April 25, 1997. 1 AWARD SOFTWARE INTERNATIONAL, INC. INDEX Page Number PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements a) Condensed Consolidated Balance Sheet as of March 31, 1997 (Unaudited) and December 31, 1996 3 b) Condensed Consolidated Statement of Income for the three months ended March 31, 1997 and 1996 (Unaudited) 4 c) Condensed Consolidated Statement of Cash Flows for the three months ended March 31, 1997 and 1996 (Unaudited) 5 d) Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 18 SIGNATURES 19 Award Software International (R) and SMSAccess are trademarks of registrant. ------ 2 PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements Award Software International, Inc. Condensed Consolidated Balance Sheet (in thousands, except share data) March 31, December 31, 1997 1996 ------- ------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $23,191 $23,248 Accounts receivable, net 2,290 2,068 Receivable from related party 815 1,015 Receivable from GCH Systems, Inc. 112 182 Other current assets 630 598 ------- ------- Total current assets 27,038 27,111 Property and equipment, net 797 683 Other assets 820 616 ------- ------- $28,655 $28,410 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $373 $215 Accrued liabilities 2,271 3,104 ------- ------- Total current liabilities 2,644 3,319 ------- ------- Shareholders' equity: Preferred stock, 5,000,000 shares authorized; no par value; no shares issued or outstanding - - Common stock, 40,000,000 shares authorized; no par value; 6,590,513 and 6,538,951 shares issued and outstanding 21,304 21,269 Deferred stock compensation (161) (180) Retained earnings 5,056 4,130 Cumulative translation adjustment (188) (128) ------- ------- Total shareholders' equity 26,011 25,091 ------- ------- $28,655 $28,410 ======= ======= See accompanying notes to condensed consolidated financial statements. 3 Award Software International, Inc. Condensed Consolidated Statement of Income (in thousands, except per share data) (Unaudited) Three months ended March 31, --------------------- 1997 1996 -------- --------- Revenues: Software license fees $ 3,494 $ 2,175 Engineering services 347 131 Related parties 645 506 ------- ------- Total revenues 4,486 2,812 ------- ------- Cost of revenues: Software license fees 139 52 Engineering services 85 26 Related parties 26 210 ------- ------- Total cost of revenues 250 288 ------- ------- Gross profit 4,236 2,524 Operating expenses: Research and development 1,522 855 Sales and marketing 917 560 General and administrative 660 590 ------- ------- Total operating expenses 3,099 2,005 ------- ------- Income from operations 1,137 519 Interest income, net 266 84 ------- ------- Income before income taxes 1,403 603 Provision for income taxes 477 217 ------- ------- Net income $ 926 $ 386 ------- ------- Net income per share $ 0.12 $ 0.06 ======= ======= Weighted average number of common and common equivalent shares outstanding 7,483 6,076 ======= ======= See accompanying notes to condensed consolidated financial statements. 4 Award Software International, Inc. Condensed Consolidated Statement of Cash Flows (in thousands) (Unaudited) Three months ended March 31, ------------------------- 1997 1996 ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $926 $386 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 92 53 Deferred stock compensation 19 19 Changes in assets and liabilities: Accounts receivable, net (221) (428) Receivable from related party 200 (347) Other current assets (37) (64) Other assets (217) (52) Accounts payable 158 (58) Accrued liabilities (837) 325 ------- ------- Net cash provided by (used in) operating activities 83 (166) ------- ------- CASH FLOWS USED IN INVESTING ACTIVITIES FOR THE PURCHASE OF PROPERTY AND EQUIPMENT (192) (233) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from common stock issuances 35 4,511 Collections on receivable from GCH Systems, Inc. 70 24 ------- ------- Net cash provided by financing activities 105 4,535 ------- ------- Effect of exchange rate changes on cash (53) (43) ------- ------- Net increase (decrease) in cash and cash equivalents (57) 4,093 Cash and cash equivalents at beginning of period 23,248 6,498 ------- ------- Cash and cash equivalents at end of period $23,191 $10,591 ======= ======= See accompanying notes to condensed consolidated financial statements. 5 AWARD SOFTWARE INTERNATIONAL, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements of Award Software International, Inc. (the "Company") as of March 31, 1997 and for the three months ended March 31, 1997 and 1996 are unaudited. The condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of the financial position, operating results and cash flows for the periods presented. The condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 1996 on Form 10-K filed on March 28, 1997 by the Company under the Securities Exchange Act of 1934. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year or for any future period. 2. NET INCOME PER SHARE Net income per share is computed using the weighted average number of common and common equivalent shares, when dilutive, from stock options and warrants (using the treasury stock method). Pursuant to a Securities and Exchange Commission Staff Accounting Bulletin, common and common equivalent shares (using the treasury stock method and the public offering price) issued by the Company within 12 months prior to the Company's initial public offering filing have been included in the calculation as if they were outstanding for all periods through the effective date of the Company's initial public offering. 3. NEW ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings per Share," and No. 129 ("SFAS No. 129"), "Disclosure of Information about Capital Structure." SFAS No. 128 establishes financial accounting and reporting standards for calculation of basic earnings per share and diluted earnings per share. SFAS No. 128 supersedes APB No. 15 and is effective for the periods ending after December 15, 1997, including interim periods. SFAS No. 129 establishes standards for disclosing information about an entity's capital structure. It eliminates the exemption of nonpublic entities from certain disclosure requirements of accounting standards previously issued. SFAS No. 129 is effective for financial statements for periods ending after December 15, 1997. The Company will adopt the standards in the year ending December 31, 1997. The cumulative effect of adopting SFAS No. 128 and SFAS No. 129 did not have a material impact on the condensed consolidated financial statements for the three months ended March 31, 1997 and 1996, respectively. 6 AWARD SOFTWARE INTERNATIONAL, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company designs, develops and markets system management software for the global computing market. On February 21, 1997, the Company acquired certain of the assets of Willows software ("Willows acquisition") for $400,000 cash, direct acquisition costs of $40,000 and the assumption of liabilities totaling $44,000. The purchase price was allocated based upon the estimated fair market value of identifiable tangible and intangible assets and liabilities assumed, including $289,000 to in-process research and development. The amount allocated to in-process research and development relates to acquired development projects that had not reached technological feasibility at the acquisition date and had no alternative future use. The following is a discussion of the financial condition and results of operations of the Company as of March 31, 1997 and for the three months ended March 31, 1997 and 1996, respectively, and should be read in conjunction with the accompanying Quarterly Condensed Consolidated Financial Information and Notes thereto and the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 1996, included in the Company's Form 10-K, and is qualified in its entirety by reference thereto. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain consolidated statement of income information as a percentage of the Company's total revenues represented by each item. The Company's historical results are not necessarily indicative of results in any future period. 7 Three months ended March 31, 1997 1996 ------ ------ Revenues: Software license fees 78% 77% Engineering services 8 5 Related parties 14 18 ------ ------ Total revenues 100 100 ------ ------ Cost of revenues: Software license fees 3 2 Engineering services 2 1 Related parties 1 7 ------ ------ Total cost of revenues 6 10 ------ ------ Gross profit 94 90 Operating expenses: Research and development 34 30 Sales and marketing 20 20 General and administrative 15 21 ------ ------ Total operating expenses 69 71 ------ ------ Income from operations 25 19 Interest income, net 6 3 ------ ------ Income before income taxes 31 22 Provision for income taxes 10 8 ------ ------ Net income 21% 14% ====== ====== 8 COMPARISON OF THREE MONTH PERIODS ENDED MARCH 31, 1997 AND 1996 REVENUES. The Company's revenues consist of software license fees and engineering services revenues. Revenues increased by $1.7 million (60%) for the three month period ended March 31, 1997 from the same period of the prior year. Software license fees increased by $1.3 million (61%) for the three month period ended March 31, 1997 from the same period of the prior year primarily due to higher unit shipments to new and existing motherboard customers in Taiwan and the U.S. and embedded systems customers in the U.S., partially offset by a decrease in software license fees from a European customer. Engineering services revenues increased by $216,000 (165%) for the three month period ended March 31, 1997 from the same period of the prior year primarily due to higher engineering services revenues from customers in the U.S. Related parties revenues increased by $139,000 (27%) for the three month period ended March 31, 1997 from the same period of the prior year primarily due to higher software license fees partially offset by lower engineering services revenues. COST OF REVENUES. Cost of revenues consist primarily of the cost of materials and freight expenses associated with software license fees and direct costs associated with engineering services revenues. Cost of revenues as a percentage of revenues decreased to 6% of revenues for the three month period ended March 31, 1997 as compared to 10% of revenues for the same period of the prior year. The decrease in cost of revenues as a percent of revenues for the three month period ended March 31, 1997 was primarily due to a decrease in cost of engineering services revenues from a related party product development effort partially offset by higher cost of software license fees and cost of engineering services revenues. RESEARCH AND DEVELOPMENT. Research and development expenses consists primarily of engineering personnel and related expenses and equipment costs. Research and development expenses increased by $667,000 (78%) for the three month period ended March 31, 1997 from the same period of the prior year primarily due to the Willows acquisition, including the hiring of engineering personnel and related expenses and a one-time charge of $289,000 for in-process research and development, and the hiring of engineering personnel and related expenses to develop new software products, such as mobile BIOS and the SMSAccess product suite. The Company anticipates that it will continue to devote substantial resources to product research and development and that such expenses will continue to increase in absolute dollars. SALES AND MARKETING. Sales and marketing expenses consist primarily of personnel and related expenses, sales commissions and travel costs. Sales and marketing expenses increased by $357,000 (64%) for the three month period ended March 31, 1997 from the same period of the prior year primarily due to the hiring of sales and marketing personnel and related expenses, higher sales commissions for increased revenues, higher advertising expenses and increased participation in trade shows. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of personnel and related expenses, professional services and facilities costs. General and administrative expenses increased by $70,000 (12%) for the three month period ended March 31, 1997 from the same period of the prior year primarily due to higher professional services fees, increased personnel and related expenses and higher facilities costs. This increase was partially offset by a one-time employee severance cost of $90,000 in the Company's European operations for the three month period ended March 31, 1996. During the second half of 1995, the Company recorded $297,000 of deferred stock compensation related to the difference between the exercise price of certain Common Stock options and the deemed fair market value of the Common Stock on the date of grant. Amortization of deferred compensation expense of $19,000 is included in general and administrative expense for the three month period ended March 31, 1997. INTEREST INCOME, NET. Interest income, net consists primarily of interest expense associated with short-term borrowings and interest 9 income on cash and cash equivalents, net of expenses. Interest income, net increased by $182,000 for the three month period ended March 31, 1997 from the same period of the prior year primarily due to an increase in interest income earned on higher cash balances. PROVISION FOR INCOME TAXES. The Company's effective tax rate decreased to 34% from 36% for the three month periods ended March 31, 1997 and March 31, 1996, respectively, primarily due to an increase in income taxable in Taiwan at rates lower than the applicable statutory rates in the U.S. and Germany. LIQUIDITY AND CAPITAL RESOURCES The Company has funded its operations primarily through the private sale of equity securities and from cash generated from operations. As of March 31, 1997, the Company had cash and cash equivalents of $23.2 million and working capital of $24.4 million. Net cash provided by operating activities was $83,000 for the three month period ended March 31, 1997 and was primarily due to higher net income and collections on accounts receivable from a related party partially offset by reductions in accrued liabilities and increases in other assets. Net cash used in investing activities was $192,000 for the three month period ended March 31, 1997 and was primarily due to the purchase of equipment resulting from the Willows acquisition. Net cash provided by financing activities was $105,000 for the three month period ended March 31, 1997 and was primarily due to collections on receivable from GCH Systems, Inc. and exercises of stock options under the Company's 1995 Stock Option Plan. On October 25, 1996, the Company consummated the initial offering of its Common Stock to the public ("IPO"). Pursuant to the IPO, the Company sold an aggregate of 1,250,000 shares of common stock at $8.00 per share, resulting in net proceeds to the Company of approximately $7.8 million. The Company believes that the net proceeds from the sale of Common Stock, together with anticipated cash flows from operations and existing cash balances, will satisfy the Company's projected expenditures through 1997 for working capital and general corporate purposes, including an increase in the Company's internal product development, staffing in connection with new product introductions and other related product development expenditures. From time to time, in the ordinary course of business, the Company enters into strategic relationships with its customers or other participants in the PC industry. Such strategic relationships may include equity investments in the Company. If additional funds are raised through the issuance of equity securities, the percentage ownership of the shareholders of the Company will be reduced, shareholders may experience additional dilution, or such equity securities may have rights, preferences or privileges senior to those of the holders of the Company's Common Stock. Other than its relationships with Vobis Microcomputer AG ("Vobis") and Advanced Micro Devices, Inc., the Company has no current commitments or agreements with respect to any strategic relationships, including any equity investments. NEW ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings per Share," and No. 129 ("SFAS No. 129"), "Disclosure of Information about Capital Structure." SFAS No. 128 establishes financial accounting and reporting standards for calculation of basic earnings per share and diluted earnings per share. SFAS No. 128 supersedes APB No. 15 and is effective for the periods ending after December 15, 1997, including interim periods. SFAS No. 129 establishes standards for disclosing information about an entity's capital structure. It eliminates the exemption of nonpublic entities from certain disclosure requirements of accounting standards previously issued. SFAS No. 129 is effective for financial statements for periods ending after December 15, 1997. The Company will adopt the standards in the year ending December 31, 10 1997. The cumulative effect of adopting SFAS No. 128 and SFAS No. 129 did not have a material impact on the condensed consolidated financial statements for the three months ended March 31, 1997 and 1996, respectively. This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21A of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below and those discussed in the Company's Form 10-K for the year ended December 31, 1996 on file with the Securities and Exchange Commission. BUSINESS RISKS DEPENDENCE UPON THE UNDERLYING PC INDUSTRY; DEPENDENCE ON CURRENT PC INDUSTRY - ----------------------------------------------------------------------------- STANDARDS - --------- The demand for the Company's system management software depends principally on (i) PC manufacturers and other customers licensing the Company's software rather than developing their own system management software, (ii) the market acceptance of the products incorporating the Company's software sold by the Company's original equipment manufacturer ("OEM") customers, (iii) the emergence of new PC technologies that require system management software solutions to provide functionality, user value and performance, and (iv) the technological competence of the Company's core products. Sales of PCs fluctuate substantially from time to time based on numerous factors, including general economic conditions in the markets for the Company's customers' products, new hardware and software product introductions, demand for new applications and shortages of key components. Further, the markets in the PC industry are extremely competitive and characterized by rapid and frequent price reductions. The introduction of new hardware architectures, microprocessors, peripheral equipment and operating systems within the PC industry has increased the complexity, time to market and cost to develop PCs. A number of computer manufacturers, including IBM Corporation ("IBM") and Compaq Computer Corporation ("Compaq"), develop their own BIOS products to achieve compatibility with and integrate new technologies into their products. While the Company believes that price and time-to-market pressures will continue to foster a trend among its customers and potential customers to outsource system management software requirements to third parties, there can be no assurance that this trend will continue or will not reverse itself, which would have a material adverse effect on the Company's business, financial condition and results of operations. The Company's software to date has been primarily based on central processing units ("CPUs") designed by or compatible with those of Intel Corporation ("Intel") and operating system software designed by Microsoft Corp. ("Microsoft"). If the market for Intel and Intel-compatible CPUs with x86 architecture is materially diminished or if another CPU, such as Motorola, Inc.'s "PowerPC," achieves a high degree of success, demand for the Company's current software would be reduced. In addition, most of the Company's software has been installed on computers using Microsoft's MS/DOS or Windows operating systems. If Microsoft's operating systems cease to be the dominant operating systems for the PC industry, or if PC manufacturers use other operating systems, which are not compatible with MS/DOS or Windows, the Company could experience increased product development costs and/or diminished revenues. 11 CONCENTRATION OF REVENUES FROM DESKTOP BIOS - ------------------------------------------- The Company depends on sales of desktop BIOS for a substantial majority of its revenues. The Company has not generated substantial revenues from the sale of other products to date, including sales of mobile PC products. If sales of the Company's desktop BIOS decline for any reason, the Company's business, financial condition and results of operations would be adversely affected, unless the Company is able to replace those sales with increased sales of other products. Sales of desktop BIOS could decline for a number of reasons, including a shift in the market for PCs away from desktop PCs in favor of mobile PCs. COMPETITION FROM SYSTEM MANAGEMENT SOFTWARE COMPANIES AND OTHER PARTICIPANTS, - ------------------------------------------------------------------------------- INCLUDING MICROSOFT AND INTEL, IN THE PC INDUSTRY - -------------------------------------------------- The markets for the Company's software are highly competitive. The Company faces competition primarily from other system management software companies, including American Megatrends, Inc., Phoenix Technologies Ltd. and SystemSoft Corporation, as well as in-house software development staffs of current and prospective customers. Certain of the companies with which the Company competes or may in the future compete have substantially greater financial, marketing, sales and support resources and greater brand name and technology leadership recognition than the Company. There can be no assurance that the Company will be able to develop software comparable or superior to software offered by its competitors. In addition, the PC market experiences intense price competition and the Company expects that, in order to remain competitive, it may have to decrease unit prices on some or all of its software products. Any such decrease would have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that interdependencies may develop between system management software companies and their customers, which would need to be overcome in order to replace an entrenched competitor. While the Company believes that such entrenchment may benefit the Company in its existing relationships with key participants in the desktop PC market, customer entrenchment may make it more difficult for the Company to displace entrenched competitors or increase market presence, particularly in the mobile PC market, where competitors may already have strong relationships with certain mobile PC manufacturers. Intel has entered into formal agreements with, and has become a significant shareholder in, Phoenix Technologies Ltd. and SystemSoft Corporation. In addition, SystemSoft Corporation has entered into agreements with Microsoft, IBM and Compaq to license its PC Card software. Operating system software vendors may in the future enter the Company's primary markets as direct competitors or incorporate enough features into their products so as to reduce the need for the Company's products. Microsoft includes basic PC Card software in its Windows 95 operating system and has announced the inclusion of full PC Card software support in its next generation Windows 9x and Windows NT operating systems. Microsoft's recently released Windows CE operating system includes Hardware Abstraction Layer (HAL) software that incorporates system management software features. As software developers provide greater functionality and features, user value and performance in their products that eliminate or reduce the need for the Company's system management software, the market for the Company's products could be materially diminished. In addition, chipset manufacturers, including Intel, may increase their presence in the motherboard manufacturing market, which may have an adverse effect on the Company's OEM customers. There can be no assurance that other participants in the PC industry will not develop products and solutions that reduce the demand or obviate the need for the Company's products. ABILITY TO RESPOND TO RAPID TECHNOLOGICAL CHANGE - ------------------------------------------------ The market for system management software is characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. The general trend in the PC industry is toward shorter product life cycles, resulting in rapid product and technology obsolescence. The life cycle of the Company's products is highly dependent on the life cycles of the products sold by its customers, who are primarily in the desktop PC industry. Although the Company's core products, specifically, the 12 desktop and embedded device BIOS and PC Card software, may have a life cycle as long as several years, specific customized adaptations of the Company's core products are generally expected to have a life cycle of six months to one year. The Company's future success will depend upon its ability to enhance its core software and to develop and introduce new software which keeps pace with technological developments and evolving industry standards as well as to respond to its customers' and end-users' demand for greater features and functionality. The Company is currently developing certain technologies that it will need to remain competitive. There can be no assurance that the Company will be successful in developing such enhancements or new software, or, even if successful, that it will not experience delays in achieving such developments. Any failure or delay by the Company to develop such enhancements or new software or the failure of its software to achieve market acceptance would adversely affect the Company's business, financial condition and results of operations. In addition, there can be no assurance that products or technologies developed by others will not render the Company's software or technologies non-competitive or obsolete. DEPENDENCE ON KEY CUSTOMER RELATIONSHIPS; CONCENTRATION OF CREDIT RISK - ---------------------------------------------------------------------- The Company believes that its success to date has been largely due to its relationship with participants in the desktop PC industry, particularly OEMs in the desktop PC market. The Company works closely with its customers to provide quick response to their product design needs and assists them in evaluating new technological developments as they affect future products and enhancements to be sold by the Company's customers. The loss of any one of these strategic relationships or any other significant customer in the PC industry could adversely affect the Company's product development efforts, business, financial condition and results of operations. For the three month period ended March 31, 1997, Vobis accounted for approximately 9% of the Company's total revenues. The loss of any key customer or the inability of the Company to replace revenues provided by a key customer would have a material adverse effect on the Company's business, financial condition and results of operations. Revenues from the distribution of the Company's PC Card software accounted for 2% of the Company's total revenues in the three month period ended March 31, 1997. The Company's customer base consists primarily of motherboard manufacturers and OEMs in the desktop PC market, and as a result the Company maintains individually significant receivable balances from these customers. If these customers fail to satisfy their payment obligations, the Company's business, financial condition and results of operations would be adversely affected. UNCERTAIN ACCEPTANCE IN NEW AND DEVELOPING MARKETS - -------------------------------------------------- The Company's future success is dependent on customer acceptance of new products and penetration of markets outside the desktop PC market. There can be no assurance that the Company will be able to expand its products and technologies into the mobile PC, embedded device and network computing and Internet markets or that the Company will be able to increase its market presence in the desktop PC market. Expansion of the Company's software and technology into the mobile PC market will depend primarily on the Company's ability to replace entrenched competitors. Penetration of markets outside the desktop PC market, such as the embedded device market, will depend upon the development and availability of system management software providing the necessary functionality and customer acceptance of such new technology. There can be no assurance that the Company will be able to develop or obtain from third parties the necessary software and technology to penetrate these markets, or that, if such software and technology is developed by the Company or obtained from third parties through licensing, which may include payments of license fees or royalties in advance, the Company will be able to successfully distribute such products. There can be no assurance that such products will not be developed by others rendering the Company's products non-competitive or obsolete. In addition, there can be no assurance that the Company will not experience difficulties that could delay or prevent 13 the successful development, introduction and marketing of such new products, or that such products will achieve market acceptance. Any increase in the demand for the Company's embedded device products is dependent upon the increasing use and complexity of embedded computer systems in new and traditional products. No assurance can be given that this trend will continue or, even if it does, that the Company will be able to design system management software that will address the unique requirements of the embedded device market. Further, since the Company's experience and expertise are based on Intel x86 architecture, the Company's success in the embedded device market is significantly dependent on Intel's continued commitment to, and the increased presence of x86 architecture in, this market. There can be no assurance that Intel will not de-emphasize or withdraw its support of the embedded device market, or that the trend toward x86 architecture in the embedded device market will continue, any of which could result in a material adverse effect on the Company's growth strategies, financial condition and results of operations. Certain of the markets for the Company's existing and future products, such as the Internet and private internet protocol networks ("Intranet"), have only recently begun to develop and are rapidly evolving. Demand and market acceptance for recently introduced or developing products are subject to a high level of uncertainty and risk. Critical issues concerning the commercial use of the Internet remain unresolved and could adversely affect the growth of Internet use. There can be no assurance that commerce and communication over the Internet or Intranet will become widespread, or that the Company's planned products addressing the Internet and Intranet markets will become widely accepted. Because these markets for the Company's existing and developing products are new and rapidly emerging, it is difficult to predict the future growth rate, if any, and size of these markets. There can be no assurance that such markets for the Company's existing and developing products and technology will develop or that such products will be accepted. If these markets fail to develop, develop more slowly than anticipated or become saturated with competitors, or if the Company's products do not obtain customer acceptance, the Company's business, financial condition and results of operations could be materially adversely affected. FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; SEASONALITY - -------------------------------------------------------- The Company has experienced and expects to continue to experience fluctuations in its quarterly results of operations. The Company's revenues are affected by a number of factors, including the demand for PCs and embedded devices, timing of new product introductions, product mix, volume and timing of customer orders, activities of competitors and the ability of the Company to penetrate new markets. The Company's business is seasonal with revenues generally increasing in the fourth quarter as the result of increased PC shipments during the holiday season. Consequently, during the three quarters ending in March, June and September, the Company has historically not been as profitable as in the quarter ending in December. In addition, the Company's revenues and profits have historically decreased in the first quarter of each year as compared with the fourth quarter of the previous year. The Company generally ships orders as they are received and, as a result, has little or no backlog. Quarterly revenues and results of operations therefore depend on the volume and timing of orders received during the quarter, which are difficult to forecast. Because the Company's staffing and other operating expenses are based on anticipated revenues, delays in the receipt of orders can cause significant variations in results of operations from quarter to quarter. The Company also may choose to reduce prices, increase spending in response to competition or pursue new market opportunities, each of which decisions may adversely affect the Company's business, financial condition and results of operations. Therefore, the Company believes that period-to-period comparisons of its revenues and operating results are not necessarily meaningful and should not be relied upon as indicators of future performance. Due to all of the foregoing factors, it is likely that in some future quarters the Company's operating results will be below the expectations of public market analysts and investors. Regardless of the general outlook for the Company's business, the announcement of quarterly results of operations below 14 analyst and investor expectations is likely to result in a decline in the trading price of the Company's Common Stock. VARIATIONS IN OPERATING RESULTS - ------------------------------- The revenue growth rates experienced by the Company to date may not be indicative of future growth rates and there can be no assurance that the Company will remain profitable in the future. Future results of operations may fluctuate significantly based upon numerous factors including the demand for PCs and embedded devices, the timing of new product introductions, product mix, volume and timing of customer orders, activities of competitors and the ability of the Company to penetrate new markets. The volume and timing of new contracts and delays in the achievement of milestones could have a significant impact on operating results for a particular quarter. DEPENDENCE ON KEY PERSONNEL; ABILITY TO ATTRACT AND RETAIN KEY TECHNICAL - ------------------------------------------------------------------------ EMPLOYEES - --------- The Company's success to date has depended to a significant extent upon a number of key management and technical employees. The loss of services of one or more of these key employees, particularly George C. Huang, the Company's Chairman of the Board, President and Chief Executive Officer; Lyon T. Lin, General Manager, Taiwan and President, Award Software Hong Kong Limited, Taiwan Branch; and Maurice W. Bizzarri, the Company's Vice President, Engineering could have a material adverse effect on the Company's business, financial condition and results of operations. Except for the Company's employees in Germany, none of the Company's employees is party to an employment agreement with the Company. The Company believes that its future success will also depend in large part upon its ability to attract and retain highly skilled technical, management and sales and marketing personnel. Moreover, because the development of the Company's software requires knowledge of computer hardware, operating system software, system management software and application software, key technical personnel must be proficient in a number of disciplines. Competition for such technical personnel is intense, and the failure of the Company to hire and retain talented technical personnel or the loss of one or more key employees could have an adverse effect on the Company's business, financial condition and results of operations. Future growth, if any, of the Company will require additional engineering, sales and marketing, financial and administrative personnel, to expand customer services and support and to expand operational and financial systems. There can be no assurance that the Company will be able to attract and retain the necessary personnel to accomplish its growth strategies or that it will not experience constraints that will adversely affect its ability to satisfy customer demand in a timely fashion. If the Company's management is unable to manage growth effectively, the Company's business, financial condition and results of operations could be adversely affected. MANAGEMENT OF GROWTH - -------------------- The growth of the Company's business and, in particular, the Company's customer base, has placed, and is expected to continue to place, a strain on the Company's management systems and resources. The Company's ability to compete effectively and manage future growth, if any, will require the Company to continue to improve its financial and management controls, reporting systems and procedures on a timely basis and expand, train and manage its work force. There can be no assurance that the Company will be able to do so successfully, and the failure to do so would have a material adverse effect upon the Company's business, financial condition and results of operations. The Company's success will depend to a significant degree on the ability of its executive officers and other members of its senior management, none of whom has any prior experience managing public companies in their current roles, to manage future growth, if any. 15 INTERNATIONAL OPERATIONS; CURRENCY FLUCTUATIONS; INTERNATIONAL UNREST - --------------------------------------------------------------------- The Company operates on a multinational basis, and a significant portion of its business is conducted in currencies other than the U.S. Dollar. As a result, the Company is subject to various risks, including exposure to currency fluctuations, greater difficulty in administering its global business, multiple regulatory requirements and other risks associated with international sales, such as import and export licenses, political and economic instability, overlapping or differing tax structures, trade restrictions, changes in tariff rates, different legal regimes, difficulty in protecting intellectual property, enforcing agreements and collecting accounts receivable. During the three month period ended March 31, 1997, approximately 44% and 3% of the Company's revenues were denominated in New Taiwan Dollars and German Marks, respectively. While the impact of foreign exchange rate movements have not had a material impact on the Company's financial statements, there can be no assurance that fluctuation in foreign currency exchange rates will not have a material adverse effect on the Company's business, financial condition and results of operations. The Company does not currently engage in foreign currency hedging transactions. There can be no assurance that exchange rate fluctuations will not have a material adverse effect on the Company's business, financial condition or results of operations. The Company's business, financial condition or results of operations could be adversely affected by factors associated with international operations such as changes in foreign currency exchange rates, uncertainties relative to regional economic circumstances, political instability in emerging markets, and difficulties in staffing and managing foreign operations, as well as by other risks associated with international activities. Award Software Hong Kong Limited, the company's wholly owned subsidiary, is incorporated under the laws of Hong Kong ("Award Hong Kong"). Substantially all of the Company's Asian desktop motherboard and OEM manufacturing and design facilities are operated through Award Hong Kong's branch office located in Taipei, Taiwan. These operations could be severely affected by national or regional political instability in China, including instability which may occur in connection with a change in leadership in China, change of control of Hong Kong from the United Kingdom to China, by evolving interpretation and enforcement of legal standards, by conflicts, embargoes, increased tensions or escalation of hostilities between China and Taiwan and by other trade customs and practices that are dissimilar to those in the United States. Interpretation and enforcement of China's laws and regulations continues to evolve and the Company expects that differences in interpretation and enforcement will continue in the foreseeable future. INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS - -------------------------------------------- The Company's success depends in significant part on the development, maintenance and protection of its intellectual property. The Company regards all of its software as proprietary and attempts to protect it with a combination of patents, copyrights, trademarks and trade secrets, employee and third-party nondisclosure agreements and other methods of protection. Despite these precautions and the protection of copyright laws, it may be possible for unauthorized third parties to copy the Company's software or to reverse engineer or obtain and use information that the Company regards as proprietary. The Company has patent applications pending in the U.S. and/or abroad on six inventions, three of which are owned jointly with a third party. There are currently no issued patents covering the Company's products. However, the Company does not generally rely on patents to protect its products. The Company licenses its object and source code under written license agreements. Certain provisions of such licenses, including provisions protecting against unauthorized use, copying, transfer and disclosure of the licensed programs, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign jurisdictions, including Taiwan, do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that the protections put in place by the Company will be adequate. Significant and protracted litigation may be necessary to protect the Company's intellectual property to determine the scope of the proprietary rights of others or to defend against claims of infringement. Moreover, although the Company is not currently involved in any litigation with respect to intellectual property rights, in the past there have been allegations that certain portions of the Company's core BIOS infringed on a third party's copyrights. In response, the Company rewrote certain software routines in a 16 "clean room" procedure and upgraded its customers to the new version of such software routines in order to avoid any further allegations of infringement. The Company believes that its software does not infringe the copyrights of any third parties. However, there can be no assurance that other parties will not make allegations of infringement in the future. Such assertions could require the Company to discontinue the use of certain software codes or processes, to cease the manufacture, use and sale of infringing products, to incur significant litigation costs and expenses and to develop non-infringing technology or to obtain licenses to the alleged infringing technology. Although the Company has been able to acquire licenses from third parties in the past, there can be no assurance that the Company would be able to develop alternative technologies or to obtain such licenses or, if a license were obtainable, that the terms would be commercially acceptable to the Company in the event such assertions are made in the future. VOLATILE MARKET FOR STOCK - ------------------------- The market for the Company's stock is highly volatile. The trading price of the Company's Common Stock has been and will continue to be subject to fluctuations in response to financial condition and results of operations, announcements of technological innovations or new products by the Company and its competitors, changes in the Company's or its competitors' product mix or product direction, changes in the Company's revenue mix and revenue growth rates, changes in expectations of growth for the PC industry, as well as other events or factors which the Company may not be able to influence or control. Statements or changes in opinions, ratings or earnings estimates made by brokerage firms and industry analysts relating to the market in which the Company does business, companies with which the Company competes or relating to the Company specifically could have an immediate and adverse effect on the market price of the Company's stock. In addition, the stock market has from time to time experienced extreme price and volume fluctuations that have particularly affected the market price for many high-technology companies and that often have been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. SHARES ELIGIBLE FOR FUTURE SALE - ------------------------------- Sales of a substantial number of shares of Common Stock in the public market could adversely affect the market price for the Company's Common Stock. Certain shares of Common Stock held by existing shareholders are "restricted securities" as such term is defined in Rule 144 under the Securities Act of 1933, as amended (the "Act") (the "Restricted Shares"). Restricted Shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144, 144(k) or 701 or Regulation S promulgated under the Act. Recently, the Securities and Exchange Commission enacted a new rule effective April 29, 1997 shortening the holding periods under Rule 144 to permit resales of limited amounts of Restricted Shares after one year and unlimited amounts of Restricted Shares by non-affiliates of the Company after two years. Further, the Company, all directors and executive officers and certain shareholders of the Company had agreed not to sell or otherwise dispose of any shares of Common Stock for a period of 180 days after October 24, 1996, which period expired April 23, 1997. 17 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits The following exhibits are filed herewith: Exhibit 10.18 1997 Compensation Plan. Exhibit 11.1 Computation of Net Income per Share. Exhibit 27 Financial Data Schedule. (b) Reports on form 8-K No reports on Form 8-K were filed during the three month period for which this report is filed. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AWARD SOFTWARE INTERNATIONAL, INC. May 9, 1997 By: /s/ George C. Huang ------------------- George C. Huang Chairman of the Board, President and Chief Executive Officer May 9, 1997 By: /s/ Kevin J. Berry ------------------ Kevin J. Berry Vice President, Finance, Chief Financial Officer, Treasurer and Secretary 19 EXHIBIT INDEX Exhibit No. Description Page Number Exhibit 10.18 1997 Compensation Plan. 21 Exhibit 11.1 Computation of Net Income per Share. 23 Exhibit 27 Financial Data Schedule. 24 20