SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended December 31, 1998
/ / 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: 0-27838
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FORTE SOFTWARE, INC.
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(Exact name of registrant as specified in its charter)
Delaware 94-3131872
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1800 Harrison Street
Oakland, California 94612
(510) 869-3400
(Address, including zip code, of Registrant's principal
executive offices and telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by 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
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.01 par value 20,081,089
(Class of common stock) (Shares outstanding at February 1, 1999)
FORTE SOFTWARE, INC.
FORM 10-Q QUARTERLY REPORT
QUARTER ENDED DECEMBER 31, 1998
Table of Contents
PART I FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheet
At December 31, 1998 and March 31, 1998 3
Condensed Consolidated Results of Operations
For the Three and Nine Months Ended December 31, 1998 and 1997 4
Condensed Consolidated Statement of Cash Flow
For the Nine Months Ended December 31, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Part II OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
2
PART 1.
ITEM 1. FINANCIAL STATEMENTS
FORTE SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS; UNAUDITED)
-------------------------------------
December 31, March 31,
1998 1998
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ASSETS
Current assets:
Cash and cash equivalents $ 8,613 $ 13,358
Short-term investments 16,352 20,802
Accounts receivable, net 21,241 20,277
Prepaid expense and other current assets 3,462 1,635
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Total current assets 49,668 56,072
Equipment and leasehold improvements, net 5,544 7,416
Other assets 895 250
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Total assets $ 56,107 $ 63,738
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,917 $ 1,530
Accrued expenses and other liabilities 7,856 11,503
Deferred revenue 8,353 12,312
Current portion of capital lease obligations 92 695
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Total current liabilities 18,218 26,040
Capital lease obligations, due after one year 131 123
Deferred revenue 175 265
Commitments
Stockholders' equity:
Common stock 200 195
Additional paid-in capital 68,219 66,851
Accumulated deficit (31,143) (29,663)
Foreign currency translation adjustments 307 (73)
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Total stockholders' equity 37,583 37,310
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Total liabilities and stockholders' equity $ 56,107 $ 63,738
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See accompanying notes to Condensed Consolidated Financial Statements.
3
FORTE SOFTWARE, INC.
CONDENSED CONSOLIDATED RESULTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA; UNAUDITED)
Three months ended Nine months ended
December 31, December 31,
---------------------------------- ---------------------------------
1998 1997 1998 1997
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Revenue:
License fees $ 10,741 $ 9,575 $ 27,804 $ 27,459
Maintenance and services 9,625 7,770 29,230 22,048
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Total revenue 20,366 17,345 57,034 49,507
---------------- ----------------- --------------- -----------------
Cost of revenue:
Cost of license fees 194 220 540 460
Cost of maintenance and services 5,546 4,874 15,648 13,512
---------------- ----------------- --------------- -----------------
Total cost of revenue 5,740 5,094 16,188 13,972
Gross profit 14,626 12,251 40,846 35,535
Operating expenses:
Sales and marketing 9,371 12,365 27,435 32,374
Product development and engineering 3,872 4,074 11,889 10,787
General and administrative 1,152 1,933 3,841 5,387
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Total operating expenses 14,395 18,372 43,165 48,548
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Operating income (loss) 231 (6,121) (2,319) (13,013)
Interest income, net 328 462 1,073 1,530
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Income (loss) before income taxes 559 (5,659) (1,246) (11,483)
Provision for income taxes 25 630 234 35
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Net income (loss) $ 534 $ (6,289) $ (1,480) $ (11,518)
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Net income (loss) per share---basic $ 0.03 $ (0.32) $ (0.07) $ (0.60)
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Net income (loss) per share---diluted $ 0.03 $ (0.32) $ (0.07) $ (0.60)
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Shares used in per share calculation
Basic 19,962 19,424 19,839 19,275
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---------------- ----------------- --------------- -----------------
Diluted 21,009 19,424 19,839 19,275
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See accompanying notes to Condensed Consolidated Financial Statements.
4
FORTE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW
(IN THOUSANDS; UNAUDITED)
Nine Months Ended December 31,
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1998 1997
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OPERATING ACTIVITIES
Net loss $ (1,480) $ (11,518)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 3,259 2,956
Changes in operating assets and liabilities:
Accounts receivable (857) 1,646
Prepaid expenses and other assets (2,327) (942)
Accounts payable 494 (1,159)
Accrued expenses and other liabilities (3,647) (658)
Deferred revenue (3,942) (492)
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Net cash used in operating activities (8,500) (10,167)
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INVESTING ACTIVITIES
Purchases of equipment and leasehold improvements (1,387) (3,842)
Purchases of short-term investments (8,891) (10,774)
Maturities of short-term investments 13,400 10,850
Loan to officer (145) -
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Net cash provided by (used in) investing activities 2,977 (3,766)
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FINANCING ACTIVITIES
Reduction in capital lease obligations (595) (731)
Proceeds from issuance of common stock 1,373 2,652
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Net cash provided by financing activities 778 1,921
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Decrease in cash and cash equivalents (4,745) (12,012)
Cash and cash equivalents at beginning of period 13,358 35,103
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Cash and cash equivalents at end of period $ 8,613 $ 23,091
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See accompanying notes to Condensed Consolidated Financial Statements.
5
FORTE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements included
herein reflect all adjustments, consisting only of normal recurring accruals,
which in the opinion of management are necessary to fairly present the
Company's consolidated financial position, results of operations, and cash
flow for the periods presented. These condensed consolidated financial
statements should be read in conjunction with the Company's audited
consolidated financial statements as included in the Company's Annual Report
on Form 10-K for the year ended March 31, 1998. Certain information and
footnote disclosures normally included in audited financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted pursuant to the Securities and Exchange Commission
rules and regulations. The condensed consolidated results of operations for
the three and nine month periods ended December 31, 1998 are not necessarily
indicative of the results that may be expected for entire fiscal year ending
March 31, 1999. The March 31, 1998 condensed consolidated balance sheet was
derived from audited consolidated financial statements, but does not include
all disclosures required by generally accepted accounting principles.
NOTE 2. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed using the weighted
average number of shares outstanding during the period. Diluted net income
(loss) per share is computed using the weighted average number of common
shares plus the dilutive effect of outstanding stock options using the
"treasury stock" method. The following table shows the computation of basic
and diluted net income (loss) per share.
Three Months Ended Nine Months Ended
December 31, December 31,
1998 1997 1998 1997
---------------- --------------- ---------------- -----------------
(in thousands, except per share data)
Net income (loss) $ 534 $ (6,289) $ (1,480) $ (11,518)
---------------- --------------- ---------------- -----------------
Shares used in computing basic net
income (loss) per share 19,962 19,424 19,839 19,275
Effect of diluted securities (If
their inclusion would not be
antidilutive) 1,047 - - -
---------------- --------------- ---------------- -----------------
Shares used in computing diluted net
income (loss) per share 21,009 19,424 19,839 19,275
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---------------- --------------- ---------------- -----------------
Basic $ 0.03 $ (0.32) $ (0.07) $ (0.60)
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Diluted $ 0.03 $ (0.32) $ (0.07) $ (0.60)
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6
FORTE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 3. SHORT-TERM INVESTMENTS
As of December 31, 1998, all short-term investments were classified
as available-for-sale securities pursuant to the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities." Available-for-sale securities are stated at
estimated fair market value. Differences between the estimated fair market
value and cost were not material.
The following is a summary of the Company's investments and a
reconciliation of the Company's investments to the condensed consolidated
balance sheet at December 31, 1998 (in thousands).
Estimated
Fair
Value
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Commercial Paper $ 4,648
Treasury Notes 2,044
Medium Term Notes 7,796
Market Auction Preferreds 2,005
Corporate Notes 3,769
Money Market Funds 11
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Total investments $20,273
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Estimated
Fair
Value
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Cash equivalents $ 3,921
Short-term investments 16,352
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Total investments 20,273
Cash 4,692
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Total cash, cash equivalents and
short-term investments $24,965
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7
FORTE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 4. LOAN TO OFFICER
In August and September 1998, the Company issued one of its executive
officers a promissory note in the amount of $1.1 million. This non-recourse
promissory note is collateralized at 140 percent of the loan value in shares
of the Company's common stock owned by this individual, and is due and
payable to the Company in August 2000 at an interest rate of seven and
one-half percent per annum. In October and December 1998, the Company
received payments totalling $1.0 million. The outstanding balance at December
31, 1998 was $145,000 and is included in other assets. In February 1999, an
additional $0.5 million was loaned to this officer against this agreement.
NOTE 5. REVENUE RECOGNITION
Effective April 1, 1998, the Company adopted the Accounting Standards
Executive Committee ("AcSEC") of the American Institute of Certified Public
Accountants Statement of Position No. 97-2, "Software Revenue Recognition,"
("SOP 97-2") which supercedes Statement of Position No. 91-1 ("SOP 91-1").
SOP 97-2 addresses software revenue recognition matters primarily from a
conceptual level.
In March 1998, the AcSEC issued Statement of Position No. 98-4, ("SOP
98-4") "Deferral of the Effective Date of a Provision of SOP 97-2, Software
Revenue Recognition," which defers for one year the implementation of the
provisions of SOP 97-2 that defines what constitutes "vendor specific
objective evidence" ("VSOE") with regard to software revenue recognition. SOP
98-4 applies to all multiple-element software arrangements and is effective
as of March 31, 1998.
In December 1998, the AcSEC issued Statement of Position No. 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions" ("SOP 98-9"). SOP 98-9 amends paragraphs 11 and 12 of
SOP 97-2 to require recognition of revenue using the "residual method" when
(1) there is evidence of VSOE of fair value for all undelivered elements in a
multiple-element arrangement that is not accounted for using long-term
contract accounting, (2) VSOE of fair value does not exist for one or more of
the delivered elements in the arrangement, and (3) all revenue recognition
criteria in SOP 97-2 other than the requirement for VSOE of the fair value of
each delivered element of the arrangement are satisfied. Under the residual
method, (1) the fair market value is applied to all the undelivered items
based on their previously determined VSOE of fair values and is deferred
until earned based on other sections of SOP 97-2, and (2) the difference
between the total contract value and the amount deferred for the undelivered
elements is recognized as revenue related to the delivered elements. The
provisions of SOP 98-9 will be applied to all transactions in the Company's
fiscal year ending March 31, 2000.
8
NOTE 6. COMPREHENSIVE INCOME
Effective April 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income," ("SFAS 130").
SFAS 130 requires certain revenues, expenses, gains or losses that, prior to
adoption, were reported separately in stockholders' equity and excluded from
net income (loss) to be included in other comprehensive income (loss). The
Company has evaluated the impact of comprehensive income components on the
Company's consolidated financial statements and has determined that the
amounts are immaterial to the financial statements taken as a whole.
NOTE 7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131") which
establishes standards for the way public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to stockholders. In addition,
SFAS 131 establishes standards for related disclosures about products and
services, geographic areas and major customers. The Company will comply with
the requirements of SFAS 131 in its annual consolidated financial statements
for the year ending March 31, 1999.
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). The Company is required to adopt this statement for
its fiscal year ending March 31, 2001. SFAS 133 establishes methods of
accounting for derivative financial instruments and hedging activities
related to those instruments, as well as other hedging activities. The
Company is not currently able to determine the effect, if any, that adoption
will have on its consolidated financial position, results of operations or
cash flow.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING
STATEMENTS WHICH REFLECT THE COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE
EVENTS AND FINANCIAL PERFORMANCE. IN THIS REPORT, THE WORDS "ANTICIPATE,"
"BELIEVES," "EXPECTS," "INTENDS," "FUTURE," AND OTHER SIMILAR EXPRESSIONS
IDENTIFY FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING STATEMENTS ARE
SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED IN
"BUSINESS RISKS" BELOW AND IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS," THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM HISTORICAL RESULTS OR THOSE ANTICIPATED.
The following table sets forth certain unaudited condensed
consolidated results of operations data as a percentage of total revenue for
the three and nine months ended December 31, 1998 and 1997.
Three months ended Nine months ended
December 31, December 31,
1998 1997 1998 1997
--------------- ---------------- --------------- ----------------
Revenue:
License fees 52.7% 55.2% 48.7% 55.5%
Maintenance and services 47.3 44.8 51.3 44.5
--------------- ---------------- --------------- ----------------
Total revenue 100.0 100.0 100.0 100.0
--------------- ---------------- --------------- ----------------
--------------- ---------------- --------------- ----------------
Cost of revenue:
Cost of license fees 1.0 1.3 1.0 0.9
Cost of maintenance and services 27.2 28.1 27.4 27.3
--------------- ---------------- --------------- ----------------
Total cost of revenue 28.2 29.4 28.4 28.2
--------------- ---------------- --------------- ----------------
Gross profit 71.8 70.6 71.6 71.8
Operating expense:
Sales and marketing 46.0 71.3 48.1 65.4
Product development and engineering 19.0 23.5 20.9 21.8
General and administrative 5.7 11.1 6.7 10.9
--------------- ---------------- --------------- ----------------
Total operating expense 70.7 105.9 75.7 98.1
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Operating income (loss) 1.1 (35.3) (4.1) (26.3)
Interest income, net 1.6 2.7 1.9 3.1
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Income (loss) before income taxes 2.7 (32.6) (2.2) (23.2)
Provision for income taxes 0.1 3.6 0.4 0.1
--------------- ---------------- --------------- ----------------
Net income (loss) 2.6% (36.2)% (2.6)% (23.3)%
--------------- ---------------- --------------- ----------------
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10
REVENUE
The Company's total revenue consists of license fees for its Forte
Application Environment and related products, as well as associated
maintenance and services revenue. The Company licenses software under
non-cancelable license agreements and provides services including
maintenance, training and consulting. License fees revenue is recognized when
a non-cancelable license agreement has been signed, the product has been
shipped, the fees are fixed and determinable, and collectibility is
reasonably assured. License fees revenue from distributors is generally
recognized as sales to end users are reported, the product is shipped and
collectibility is reasonably assured. Fees for services are charged
separately from the license of the Company's software products. Maintenance
revenue consists of fees for ongoing support and product updates and is
recognized ratably over the term of the contract, which is typically twelve
months. Revenue from training is recognized upon completion of the related
training class. Consulting revenue is recognized as the services are
performed. Allowances for credit risks and for estimated future sales returns
are provided for upon product shipment. Returns to date have not been
material. Actual credit losses and returns may differ from the Company's
estimates and such differences could be material to the consolidated
financial statements.
The Company's license agreements typically require the payment of a
nonrefundable, one-time license fee for a license of perpetual term.
Customers make separate payments for annual maintenance and other services.
The Company can terminate the license agreement only upon a material breach
by the other party, provided that the breach is not cured within a specified
cure period.
The Company's total revenue increased 17 percent to $20.4 million
for the quarter ended December 31, 1998 from $17.3 million for the same prior
year quarter and increased 15 percent to $57.0 million for the nine months
ended December 31, 1998 from $49.5 million for the same period in the prior
year. International revenue increased by 15 percent to $9.8 million for the
quarter ended December 31, 1998, as compared to $8.5 million for the same
quarter in the prior year. International revenue increased 20 percent to
$27.0 million for the nine months ended December 31, 1998 from $22.5 million
in the same prior year period. The international revenue increase was due to
increased license, maintenance and services revenue as a result of the
Company's continued expansion of its international sales organization.
Further, international revenue contributed 48 percent of total revenue for
the quarter ended December 31, 1998, as compared to 49 percent of total
revenue in the same prior year quarter and contributed 47 percent for the
nine months ended December 31, 1998, as compared to 45 percent for the same
prior year period. United States revenue increased by 20 percent to $10.6
million for the quarter ended December 31, 1998 from $8.8 million in the same
prior year quarter and increased by 11 percent to $30.0 million for the nine
months ended December 31, 1998 from $27.0 for the same period in the prior
year. Significant growth in domestic maintenance and service revenue
contributed to the increase.
LICENSE FEES REVENUE. The Company's license fees revenue increased
12 percent to $10.7 million for the quarter ended December 31, 1998 from $9.6
million for the same quarter in the prior year and increased by 1 percent to
$27.8 million for the nine months ended December 31, 1998 from $27.5 million
for the same prior year period. License fees revenue increased sequentially
by 23 percent from $8.7 million for the second quarter ended September 30,
1998.
11
The growth in license fee revenue was assisted by a strong contribution from
the Company's VAR channel and by the progress realized in the realignment of
the Company's North American sales organization. Further, license revenue
growth was positively impacted by the initial performance of newly opened
sales offices in Holland and Italy.
MAINTENANCE AND SERVICES REVENUE. The Company's services revenue
increased 24 percent to $9.6 million for the quarter ended December 31, 1998
from $7.8 million for the same quarter in the prior year and increased 33
percent to $29.2 million for the nine months ended December 31, 1998 from
$22.0 million for the same period in the prior year. The increase in total
maintenance and services revenue was primarily a result of the growing
installed base in the Company's software products and the associated increase
in demand for maintenance, training and consulting services. Services revenue
as a percentage of total revenue may vary between periods as a result of
changes in demand for the Company's services and changes in the rate of
growth of license fees revenue.
INTERNATIONAL REVENUE. International revenue includes all revenue
other than from the United States. International revenue includes sales from
the Company's direct sales organizations in Europe, Canada and Australia and
export sales through distributors and resellers in Europe, Asia and other
areas of the world. Direct sales through the Company's European, Canadian and
Australian subsidiaries totaled $8.0 million and $20.2 million for the
quarter and nine months ended December 31, 1998, respectively, as compared to
$5.7 million and $15.0 million for the quarter and nine months ended December
31, 1997, respectively. The table below sets forth the Company's export sales
data from the United States for the quarter and nine months ended December
31, 1998 and 1997.
--------------------------------------- ----------------------------------------
(in thousands) (in thousands)
Three months ended December 31, Nine months ended December 31,
--------------------------------------- ----------------------------------------
1998 1997 1998 1997
---- ---- ---- ----
Total export revenue $1,778 $2,766 $ 6,749 $ 7,510
Total direct revenue 7,991 5,732 20,239 15,000
----- ----- ------ ------
Total International $9,769 $8,498 $26,988 $22,510
--------------------------------------- ----------------------------------------
The increase in international revenue for the nine months ended
December 31, 1998, as compared to the same period in the prior year, reflects
growing direct sales presence in Europe through the Company's international
direct sales organization, partially offset by lower revenue in Asia and
Canada. The economic crises in Asia has not had a material impact on the
Company's revenue. Revenue from Asian markets were less then 5 percent of
total revenue for each of the periods presented. The Company expects that
international license and related maintenance and services revenue will
continue to account for a significant portion of its total revenue in the
future. The Company believes that in order to increase sales opportunities
and market share, it will be required to continue expanding its international
sales organization. The Company has committed and continues to commit
significant management time and financial resources to developing direct and
indirect international sales and support channels. There can be no assurance,
however, that the Company will be able to maintain or increase international
market demand for Forte and related products. To the extent that the Company
is unable to do so in a timely manner, the Company's international sales will
be limited, and the Company's business, operating results and financial
condition would be materially and adversely affected.
12
COST OF REVENUE
COST OF LICENSE FEES REVENUE. Cost of license fees revenue consists
primarily of royalties paid to third-party vendors, product packaging,
documentation and production. Cost of license fees revenue was $194,000 and
$540,000 for the quarter and nine months ended December 31, 1998,
respectively, as compared to $220,000 and $460,000 for the quarter and nine
months ended December 31, 1997, respectively. The increase for the first nine
months of fiscal 1998, as compared to the same period in the prior year, was
primarily due to royalties paid to third-party vendors. Additionally, cost of
license fees revenue varies as a percentage of license fees revenue because
costs of media production and product packaging have not been material and
have been expensed as incurred. Such costs are dependent on the number of new
releases in a given quarter.
COST OF MAINTENANCE AND SERVICES REVENUE. Cost of maintenance and
services revenue consists primarily of personnel-related and facilities costs
incurred in providing customer support, training and consulting services, as
well as third-party costs incurred in providing training and consulting
services. Cost of maintenance and services revenue was $5.5 million and $15.6
million for the quarter and nine months ended December 31, 1998,
respectively, representing 58 percent and 54 percent of maintenance and
services revenue, respectively. Cost of maintenance and services revenue was
$4.9 million and $13.5 million for the quarter and nine months ended December
31, 1997, respectively, representing 63 percent and 61 percent of maintenance
and services revenue, respectively. The decrease in cost of maintenance and
services revenue for the quarter and nine months ended December 31, 1998 as a
percentage of maintenance and services revenue was primarily attributable to
improved economies of scale of the technical support center and increased
productivity from training, support and consulting personnel. The Company
does not expect its cost of maintenance and services revenue to continue to
materially decrease as a percentage of maintenance and services revenue. The
cost of services as a percentage of services revenue may vary between periods
due to the mix of services provided by the Company and the extent to which
external contractors are used to provide those services.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expense consists primarily
of salaries, commissions and bonuses earned by sales and marketing personnel,
field office expenses, travel and entertainment, promotional expenses and
advertising. Sales and marketing expense decreased to $9.4 million for the
quarter ended December 31, 1998 from $12.4 million for the same quarter in
the prior year. Sales and marketing expenses also decreased to $27.4 million
for the nine months ended December 31, 1998 from $32.4 million for the same
period in the prior year. These decreases were the result of a
re-organization of the Company's US sales organization. The direct sales
organization was reduced to reflect the Company's anticipated medium-term
revenue opportunities, and the partner channel organization is being
emphasized to leverage this distribution channel. The re-organization did not
result in a significant charge to expense for severance and other costs
associated with the re-organization. Sales and marketing expense represented
46 percent and 48 percent of total revenue for the quarter and nine months
ended December 31, 1998, respectively, and represented 71 percent and 65
percent of total revenue for the quarter and nine months ended December 31,
1997, respectively. The Company anticipates that sales and marketing expense
will decrease as a percentage of revenue over the next several
13
quarters.
PRODUCT DEVELOPMENT. Product development expense consists primarily
of salaries and other personnel-related expense, and depreciation of
development equipment. The Company believes that a significant level of
investment for product development is required to remain competitive. Product
development expense amounted to $3.9 million and $11.9 million for the
quarter and nine months ended December 31, 1998, respectively, as compared to
$4.1 million and $10.8 million for the quarter and nine months ended December
31, 1997, respectively. The increase in the current fiscal year's nine-month
period was primarily attributable to additional hiring of product development
personnel. Product development expense represented 19 percent and 21 percent
of total revenue for the quarter and nine months ended December 31, 1998,
respectively, as compared to 23 percent and 22 percent for the quarter and
nine months ended December 31, 1997, respectively. The Company anticipates
that it will continue to devote substantial resources to product development
activities. All costs incurred in the research and development of software
products, and enhancements to existing software products have been expensed
as incurred; accordingly, cost of license fees revenue includes no
amortization of capitalized software development costs.
GENERAL AND ADMINISTRATIVE. General and administrative expense
consists of costs for the Company's human resources, finance, information
technology and general management functions. General and administrative
expense decreased to $1.2 million and $3.8 million for the quarter and nine
months ended December 31, 1998, respectively, from $1.9 million and $5.4
million for the quarter and nine months ended December 31, 1997,
respectively. General and administrative expense represented 6 percent and 7
percent of total revenue for the quarter and nine months ended December 31,
1998, respectively, as compared to 11 percent for both the quarter and nine
months ended December 31, 1997, respectively. The reduction in general and
administrative expense from prior year was primarily the result of the sublet
of excess office space and the reduction in the number of employees in this
functional area. The Company believes that its general and administrative
expense will increase in dollar amount in the future as a result of the
expansion of the Company's administrative staff to support its growing
operations.
PROVISION FOR INCOME TAXES. There was no provision for federal or
state income taxes for the quarter and nine months ended December 31, 1998
and December 31, 1997, respectively, as the Company incurred net operating
losses, and there can be no assurance that the Company will realize the
benefit of the net operating loss carryforwards. The Company's provision for
income taxes in fiscal 1999 represents foreign income tax withholdings on
certain license fees paid to the Company by foreign licensees.
RISKS ASSOCIATED WITH THE YEAR 2000 ISSUE. The Year 2000 Issue is
the result of computer programs being written using two digits rather than
four to define the applicable year. Any of the Company's computer programs or
hardware that have date-sensitive software or embedded chips may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
The Company's plan to resolve the Year 2000 Issue involves the
following four phases:
14
assessment, remediation, testing, and implementation. At present, the Company
is nearly complete with regards to the assessment of all systems that could
be significantly affected by the Year 2000, including the Company's products,
its internal Information Technology, supplier and service provider compliance
and operating equipment with embedded chips or software (e.g. laptop
computers). The Company has substantially completed the remediation phase and
expects to complete this phase of the process by its fiscal first quarter
beginning April 1, 1999. Further, the Company plans to begin the testing
phase during this same quarter and will begin any required implementations
subsequent to the completion of the testing phase. A Year 2000 Team
representing key operations management has been formed and has taken action
to catalogue the environment issues and their solutions, implement a Year
2000 laboratory for testing key environments, and communicate through
designated e-mail and intranet accounts the current status of research and
progress.
The costs incurred in addressing the Year 2000 Issue are being
expensed as incurred in compliance with generally accepted accounting
principles. None of these costs are expected to materially impact the results
of operations in any one period. Funding of these costs will come from the
Company's normal working capital.
The Company believes that its products are fully Year 2000
compliant. All Forte products use four digit years for all internal
manipulations and representations. In addition, for customers who require the
storage and manipulation of two digit years, the Company's current products
provide the ability to specify a range of years for comparison and
calculation. For example, the customer may specify that the years 0-39 are
interpreted as 2000-2039 and the years 40-99 are interpreted as 1940-1999.
Using this feature, a customer can save on the amount of data stored and
manipulated by the Company. The Company regularly runs regression tests on
its software, including tests for the above functionality at the rollover to
the Year 2000. Based on the above, it is not expected that the Company's
products will be adversely affected by date changes in the year 2000.
However, there can be no assurance that the Company's products contain, or
will contain, all features and functionality considered necessary by
customers, distributors, resellers and system integrators to be Year 2000
compliant.
The Company believes that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues in a variety of ways.
Many companies are expending significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may
result in reduced funds available to purchase enterprise application software
products such as those offered by the Company. Conversely, Year 2000 issues
may cause other companies to accelerate purchases of application development
and deployment software to replace non-Year 2000 compliant applications,
causing a short-term increase in demand for the Company's products. There is
no assurance that such an increase in demand will be realized, or that
companies will resume application development if and when they resolve their
Year 2000 issues. Either of the foregoing could have a material adverse
effect upon the Company's business, operating results and financial
condition. Further, the Company believes that, as the second half of calendar
year 1999 approaches, some of its current and potential customers may reduce
or suspend a significant amount of their development, deployment and
integration projects in favor of an intense focus and increased efforts on
their Year 2000 Issue compliance projects. This would have a material adverse
effect on the Company's business, financial performance and cash resources.
15
The Company has queried its significant suppliers and service
providers that do not share information systems with the Company. To date,
the Company is not aware of any supplier or service provider with a Year 2000
Issue that would materially impact the Company's business, operating results
or financial condition. However, the Company has no means of ensuring that
suppliers and service providers will be Year 2000 ready. The inability of
suppliers and service providers to complete their Year 2000 resolution
process in a timely fashion could materially impact the Company. The effect
of non-compliance by any of the Company's suppliers or service providers is
not determinable.
The Company has prepared a draft contingency plan for certain
critical applications and expects to have a finalized draft in the near
future. This business recovery plan discusses classified disasters and
provides a list of priorities including, for example, customer service,
billing and invoicing, and engineering.
Although the Company is not aware of any material operational issues
or costs associated with preparing its internal systems for the Year 2000,
there can be no assurance that the Company will not experience serious
unanticipated negative consequences and/or material costs caused by
undetected errors or defects in the technology used in its internal systems,
which include third-party software and hardware technology. Management of the
Company believes it has an effective program in place to resolve the Year
2000 Issue in a timely manner. However, disruptions in the economy generally
resulting from Year 2000 issues could also materially adversely affect the
Company. The Company could be subject to litigation for computer systems
product failure, for example, equipment shutdown or failure to properly date
business records. The amount of potential liability and lost revenue cannot
be reasonably estimated.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations and investments in equipment
and leasehold improvements through an initial public offering of common stock
on March 11, 1996 with net proceeds of $34.3 million. The Company used cash
of $8.5 million in operating activities for the nine months ended December
31, 1998, as compared to cash used in operating activities of $10.2 million
for the same prior year period. The net cash used in operating activities
during the nine months ended December 31, 1998 resulted primarily from the
net loss for the period, an increase in prepaid expenses and other assets,
and decreases in accrued expenses and other liabilities, and deferred
revenue, partially offset by an increase in accounts payable.
The Company's investing activities consisted primarily of the
purchases of interest-bearing securities representing a shift from cash
equivalents to short-term investments, as well as purchases of property and
equipment. Capital expenditures were $1.4 million for the nine months ended
December 31, 1998 compared to $3.8 million for the nine months ended December
31, 1997. Capital expenditures consisted of purchases of computer equipment
and office furniture. For the nine months ended December 31, 1997, the
Company was in the process of expanding its headquarter offices, and thus
incurred significant equipment and leasehold improvement addition
expenditures compared to the nine months ended December 31, 1998. At December
31, 1998, the Company did not have any material commitments for capital
expenditures.
At December 31, 1998, the Company had $25.0 million in cash, cash
equivalents, and short-term investments and $31.5 million in working capital.
The Company believes that its
16
existing cash, cash equivalents, and short-term investments will be adequate
to meet its cash needs for at least the next 12 months. The Company, however,
may require additional funds to support its working capital requirements or
for other purposes and may seek to raise such additional funds through public
or private equity financings or from other sources. There can be no assurance
that additional financing will be available at all or that, if available,
such financing will be obtainable on terms favorable to the Company and would
not be dilutive. Further, the Company believes that, as the second half of
calendar year 1999 approaches, some of its current and potential customers
may reduce or suspend a significant amount of their development, deployment
and integration projects in favor of an intense focus and increased efforts
on their Year 2000 Issue compliance projects. This would have a material
adverse effect on the Company's business, financial performance and cash
resources.
BUSINESS RISKS
IN EVALUATING THE COMPANY'S BUSINESS, READERS SHOULD CAREFULLY CONSIDER
THE BUSINESS RISKS DISCUSSED IN THIS SECTION IN ADDITION TO THE OTHER
INFORMATION PRESENTED IN THIS QUARTERLY REPORT ON FORM 10-Q. THIS REPORT ON FORM
10-Q CONTAINS FORWARD-LOOKING STATEMENTS WHICH REFLECT THE COMPANY'S CURRENT
VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE. IN THIS REPORT,
THE WORDS "ANTICIPATE," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE," AND OTHER
SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING
STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE
DISCUSSED BELOW, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR THOSE ANTICIPATED.
LIMITED OPERATING HISTORY; HISTORY OF OPERATING LOSSES. The Company
was founded in February 1991 and first shipped product in August 1994. After
achieving profitability from December 1995 through March 31, 1997, the
Company incurred net losses for each subsequent quarter through the quarter
ended June 30, 1998. The Company has shown a modest profit for each of the
two quarters ended September 30, 1998 and December 31, 1998, respectively. At
December 31, 1998, the Company had an accumulated deficit of $31.1 million. A
substantial portion of the accumulated deficit is due to the deployment of
significant resources to the Company's product development, sales and
marketing organizations. The Company expects to continue to devote
substantial resources in these areas and as a result will need to
significantly increase revenue to return to profitability. There can be no
assurance that any of the Company's business strategies will be successful or
that the Company will be profitable in any future quarter or period.
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; UNCERTAINTY
OF FUTURE OPERATING RESULTS; SEASONALITY. The Company's quarterly operating
results have varied significantly in the past and are likely to vary
significantly in the future, depending on factors such as the size and timing
of significant orders and their fulfillment, demand for the Company's
products, changes in pricing policies by the Company or its competitors, the
number, timing and significance of product enhancements and new product
announcements by the Company and its competitors, the ability of the Company
to develop, introduce and market new and enhanced versions of the Company's
products on a timely basis, the rate of adoption and use of the Company's
products by third-party system integrators and value added resellers, changes
in the level of operating expenses, changes in the Company's sales incentive
plans, budgeting cycles of its customers, customer order deferrals
17
due to intervening information technology projects of a higher priority such
as, the Year 2000 Issue, or in anticipation of enhancements or new products
offered by the Company or its competitors or other causes, the cancellation
of licenses during the warranty period or non-renewal of maintenance
agreements, product life cycles, software bugs and other product quality
problems, personnel changes, changes in the Company's strategy, the level of
international expansion, seasonal trends, and general domestic and
international economic and political conditions, among others. A significant
portion of the Company's total revenue has been, and the Company believes
will continue to be, derived from a limited number of orders placed by large
organizations, and the timing of such orders and their fulfillment has caused
and could continue to cause material fluctuations in the Company's operating
results, particularly on a quarterly basis. In addition, competition for
sales personnel is intense, and there can be no assurance that the Company
can retain its existing sales personnel or that it can attract, assimilate
and retain highly qualified sales personnel in the future. The timing of the
Company's hiring of new sales personnel and the rate at which new sales
people become productive could also cause material fluctuations in the
Company's quarterly operating results. Due to the foregoing factors,
quarterly revenue and operating results are difficult to forecast. Revenue is
also difficult to forecast because the market for distributed enterprise
application development software is rapidly evolving, and the Company's sales
cycle, from initial evaluation to purchase and the provision of support
services, is lengthy and varies substantially from customer to customer.
Product orders are typically shipped shortly after receipt of the order, and
consequently, order backlog at the beginning of any quarter has in the past
represented only a small portion of that quarter's total revenue. As a
result, license fees revenue in any quarter is substantially dependent on
orders booked and shipped in that quarter. Due to all of the foregoing,
revenue for any future quarter is not predictable with any significant degree
of accuracy. Accordingly, the Company believes that period-to-period
comparisons of its operating results are not necessarily meaningful and
should not be relied upon as indications of future performance. The prior
revenue growth experienced by the Company should not be considered indicative
of future revenue growth, if any, or of future operating results. Failure by
the Company, for any reason, to increase total revenue would have a material
adverse effect on the Company's business, operating results and financial
condition.
To achieve its quarterly revenue objectives, the Company is
dependent upon obtaining orders in any given quarter for shipment in that
quarter. Furthermore, the Company has often recognized a substantial portion
of its revenue in the last month, or even weeks or days, of a quarter. The
Company's expense levels are based, in significant part, on the Company's
expectations as to future revenue and are therefore relatively fixed in the
short term. If revenue levels fall below expectations, net income or loss is
likely to be disproportionately adversely affected because a proportionately
smaller amount of the Company's expense varies with its revenue. There can be
no assurance that the Company will be able to maintain profitability on a
quarterly or annual basis in the future. Due to all the foregoing factors, it
is likely that in some future quarter the Company's operating results will be
below the expectations of public market analysts and investors. In such
event, the price of the Company's Common Stock would likely be materially and
adversely affected.
The operating results of many software companies reflect seasonal
trends, and the Company expects to be affected by such trends in the future.
RISKS ASSOCIATED WITH THE YEAR 2000 ISSUE. The Year 2000 Issue is
the result of computer programs being written using two digits rather than
four to define the applicable year. Any of the
18
Company's computer programs or hardware that have date-sensitive software or
embedded chips may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in a system failure or miscalculations
causing disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities.
The Company's plan to resolve the Year 2000 Issue involves the
following four phases: assessment, remediation, testing, and implementation.
At present, the Company is nearly complete with regards to the assessment of
all systems that could be significantly affected by the Year 2000, including
the Company's products, its internal Information Technology, supplier and
service provider compliance and operating equipment with embedded chips or
software (e.g. laptop computers). The Company has substantially completed the
remediation phase and expects to complete this phase of the process by its
fiscal first quarter beginning April 1, 1999. Further, the Company plans to
begin the testing phase during this same quarter and will begin any required
implementations subsequent to the completion of the testing phase. A Year
2000 Team representing key operations management has been formed and has
taken action to catalogue the environment issues and their solutions,
implement a Year 2000 laboratory for testing key environments, and
communicate through designated e-mail and intranet accounts the current
status of research and progress.
The costs incurred in addressing the Year 2000 Issue are being
expensed as incurred in compliance with generally accepted accounting
principles. None of these costs are expected to materially impact the results
of operations in any one period. Funding of these costs will come from the
Company's normal working capital.
The Company believes that its products are fully Year 2000
compliant. All Forte products use four digit years for all internal
manipulations and representations. In addition, for customers who require the
storage and manipulation of two digit years, the Company's current products
provide the ability to specify a range of years for comparison and
calculation. For example, the customer may specify that the years 0-39 are
interpreted as 2000-2039 and the years 40-99 are interpreted as 1940-1999.
Using this feature, a customer can save on the amount of data stored and
manipulated by the Company. The Company regularly runs regression tests on
its software, including tests for the above functionality at the rollover to
the Year 2000. Based on the above, it is not expected that the Company's
products will be adversely affected by date changes in the Year 2000.
However, there can be no assurance that the Company's products contain, or
will contain, all features and functionality considered necessary by
customers, distributors, resellers and system integrators to be Year 2000
compliant.
The Company believes that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues in a variety of ways.
Many companies are expending significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may
result in reduced funds available to purchase enterprise application software
products such as those offered by the Company. Conversely, Year 2000 issues
may cause other companies to accelerate purchases of application development
and deployment software to replace non-Year 2000 compliant applications,
causing a short-term increase in demand for the Company's products. There is
no assurance that such an increase in demand will be realized, or that
companies will resume application development if and when they resolve their
Year 2000 issues. Either of the foregoing could have a material adverse
effect upon the Company's business,
19
operating results and financial condition. Further, the Company believes
that, as the second half of calendar year 1999 approaches, some of its
current and potential customers may reduce or suspend a significant amount of
their development, deployment and integration projects in favor of an intense
focus and increased efforts on their Year 2000 Issue compliance projects.
This would have a material adverse effect on the Company's business,
financial performance and cash resources.
The Company has queried its significant suppliers and service
providers that do not share information systems with the Company. To date,
the Company is not aware of any supplier or service provider with a Year 2000
Issue that would materially impact the Company's business, operating results
or financial condition. However, the Company has no means of ensuring that
suppliers and service providers will be Year 2000 ready. The inability of
suppliers and service providers to complete their Year 2000 resolution
process in a timely fashion could materially impact the Company. The effect
of non-compliance by any of the Company's suppliers or service providers is
not determinable.
The Company has prepared a draft contingency plan for certain
critical applications and expects to have a finalized draft in the near
future. This business recovery plan discusses classified disasters and
provides a list of priorities including, for example, customer service,
billing and invoicing, and engineering.
Although the Company is not aware of any material operational issues
or costs associated with preparing its internal systems for the Year 2000,
there can be no assurance that the Company will not experience serious
unanticipated negative consequences and/or material costs caused by
undetected errors or defects in the technology used in its internal systems,
which include third-party software and hardware technology. Management of the
Company believes it has an effective program in place to resolve the Year
2000 Issue in a timely manner. However, disruptions in the economy generally
resulting from Year 2000 issues could also materially adversely affect the
Company. The Company could be subject to litigation for computer systems
product failure, for example, equipment shutdown or failure to properly date
business records. The amount of potential liability and lost revenue cannot
be reasonably estimated.
PRODUCT CONCENTRATION; IMPACT OF MARKET FACTORS. All of the
Company's revenue has been attributable to sales of Forte and related
products and services. The Company currently expects Forte and related
products and services to account for all or substantially all of the
Company's future revenue. As a result, factors adversely affecting the
pricing of or demand for Forte and related products, such as competition or
technological change, could have a material adverse effect on the Company's
business, operating results and financial condition. The Company's future
financial performance will depend, in significant part, on the successful
development, introduction and customer acceptance of new and enhanced
versions of Forte and related products. There can be no assurance that the
Company will continue to be successful in marketing the Forte product,
related products or other products. The Company's prior revenue growth should
not be considered indicative of future revenue growth, as there can be no
assurance that the market for Forte and related products, or the market for
products used in the development, deployment and management of distributed
applications, will continue to grow. Recently, industry analysts and
competitors have noted that market demand in the enterprise application
development sector appears to be slowing, and predicted that the prior
success achieved by that sector may not continue in future periods, due to a
variety of factors including but not limited to (1) a diversion of customer
resources from enterprise application development
20
to the Year 2000 Issue and other higher priority information technology
projects, (2) a general shortage of qualified programmers and a shift of
available programming resources from corporate users to systems integrators,
(3) market confusion caused by the complex and rapidly changing mix of
alternative technologies for enterprise application development, and (4) the
increased availability and popularity of packaged software applications.
Additionally, recent instability in the economies and financial markets in
the Asia-Pacific region, which had previously been regarded as a potentially
strong source of revenue growth for enterprise software vendors, has
introduced additional uncertainty concerning the sector. If the market for
Forte and related products or enterprise application development products
used in the development, deployment and management of distributed
applications fails to grow, or grows more slowly than the Company currently
anticipates, the Company's business, operating results and financial
condition would be materially and adversely affected.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a
significant degree upon the continuing contributions of its key management,
sales, marketing, software development and customer support personnel, and
its ability to attract and retain such highly-skilled personnel. The loss of
key personnel could materially and adversely affect the Company. Competition
for qualified personnel is intense, particularly in the sales and software
development areas, and there can be no assurance that the Company can retain
its existing personnel or that it can attract, assimilate and retain
additional highly qualified personnel in the future. The timing of the
Company's hiring of new sales personnel and the rate at which new sales
people become productive could also cause material fluctuations in the
Company's quarterly operating results. The Company has at times experienced
and continues to experience difficulty in recruiting and retaining qualified
personnel. The Company has experienced significant turnover in its North
America sales organization during fiscal year 1998 and the first three
quarters of fiscal 1999. Competitors and others have in the past and may in
the future attempt to recruit the Company's employees. Failure to attract and
retain key personnel could have a material adverse effect on the Company's
business, operating results and financial condition.
RISKS ASSOCIATED WITH EXPANDING DISTRIBUTION. To date, the Company
has sold its products through its direct and indirect sales force, systems
integrators, distributors and value added resellers. The Company's customers
and potential customers often rely on third-party system integrators and
value added resellers to develop and deploy distributed applications. The
Company's ability to achieve significant revenue growth in the future will
depend in large part on its success in recruiting, training and retaining
sufficient sales personnel and establishing and maintaining relationships
with distributors, resellers and systems integrators. Although the Company is
currently investing, and plans to continue to invest significant resources to
maintain and selectively expand its sales force and to develop relationships
with third-party distributors, resellers and systems integrators, the Company
has at times experienced and continues to experience difficulty in recruiting
and retaining qualified sales personnel and in establishing necessary
third-party relationships. There can be no assurance that the Company will be
able to successfully hire, train and retain needed sales personnel or develop
and maintain sufficient third-party relationships, or that such efforts will
result in an increase in revenue. Any failure by the Company to maintain a
sufficiently large and trained sales force and continue to establish other
distribution channels would materially and adversely affect the Company's
business, operating results and financial condition.
COMPETITION. The market for distributed software used in the
development, deployment
21
and management of distributed applications is intensely competitive and
characterized by rapidly changing technology, evolving industry standards,
frequent new product introductions and rapidly changing customer
requirements. Distributed applications that can be developed and deployed
using the Company's Forte environment can also be implemented by integrating
a combination of application development tools and more powerful server
programming techniques such as stored procedures in relational databases and
C or C++ programming, along with networking and database middleware to
connect the various components. As such, the Company effectively experiences
its primary competition from potential customers' decisions to pursue this
type of approach as opposed to utilizing an application environment such as
Forte. As a result, the Company must continuously educate existing and
prospective customers, and third-party systems integrators on whom
prospective customers are increasingly relying for expertise, on the
advantages of the Company's products over the approach of integrating a
combination of products. There can be no assurance that these customers,
potential customers or systems integrators will perceive sufficient value in
the Company's products to justify purchasing or recommending them.
The Company has also experienced and expects to continue to
experience increased competition from a number of vendors that market
software products specifically targeted for building distributed
applications. Actual and potential competitors include: providers of
application development software, such as Compuware/Uniface, Dynasty
Technologies, Inc., International Business Machines Corporation, Microsoft
Corporation, NAT Systems, Inc., Oracle Corporation, Seer Technologies, Inc.,
Sterling Software, Inc., and the Powersoft unit of Sybase, Inc.; web-based
development tools targeting production enterprise Internet applications;
middleware companies advocating a middleware-centric approach to building
enterprise applications; developers of packaged applications and application
components, templates and frameworks; and integration software vendors.
Many of these competing vendors have or will have significantly
greater financial, technical, marketing and other resources than the Company,
and may be able to respond more quickly to new or emerging technologies.
Also, many current and potential competitors have greater name recognition
and more extensive customer bases that could be leveraged, thereby gaining
market share to the Company's detriment. The Company expects to face
additional competition as other established and emerging companies enter the
distributed application development market and new products and technologies
are introduced. Increased competition could result in price reductions, fewer
customer orders, reduced gross margins and loss of market share, any of which
could materially and adversely affect the Company's business, operating
results and financial condition. In addition, current and potential
competitors may make strategic acquisitions or establish cooperative
relationships among themselves or with third-parties, thereby increasing the
ability of their products to address the needs of the Company's prospective
customers. Accordingly, it is possible that new competitors or alliances
among current and new competitors may emerge and rapidly gain significant
market share. Such competition could materially and adversely affect the
Company's ability to sell additional licenses and maintenance and support
renewals on terms favorable to the Company. Further, competitive pressures
could require the Company to reduce the price of Forte licenses and related
products and services, which could materially and adversely affect the
Company's business, operating results and financial condition. There can be
no assurance that the Company will be able to compete successfully against
current and future competitors, and the failure to do so would have a
material adverse effect upon the Company's business, operating results and
financial condition.
22
The principal competitive factors affecting the market for Forte are
ease of application development, deployment and management functionality and
features, product architecture, product performance, reliability and
scaleability, product quality, price and customer support. The Company
believes it presently competes favorably with respect to each of these
factors. However, the Company's market is still evolving and there can be no
assurance that the Company will be able to compete successfully against
current and future competitors and the failure to do so successfully will
have a material adverse effect upon the Company's business, operating results
and financial condition.
NEW ACCOUNTING STANDARDS. Statement of Position ("SOP") 97-2,
"Software Revenue Recognition," as amended by Statements of Position 98-4 and
98-9, was issued in October 1997 and addresses software revenue recognition
matters. The SOP supersedes SOP 91-1 and is effective for transactions
entered into for fiscal years beginning after December 15, 1997. The Company
was required to adopt this SOP in its first quarter of fiscal year 1999 and
restatement of prior financial statements was prohibited. Based upon
interpretation of SOP 97-2, the Company believes its current revenue
recognition policies and practices are materially consistent with the SOP.
However, implementation guidelines for this standard have not yet been issued
and a wide range of potential interpretations are being discussed by the
accounting profession. Once available, such implementation guidance could
lead to unanticipated changes in the Company's current revenue accounting
practices, and such changes could materially and adversely affect the
Company's future revenue and operating results.
Such implementation guidance may necessitate substantial changes in
the Company's business practices in order for the Company to continue to
recognize a substantial portion of its license fees revenue upon delivery of
its software products. Such changes may reduce demand, extend sales cycles,
increase administrative costs and otherwise adversely affect operations. In
addition, the Company may be put at a competitive disadvantage relative to
foreign based competitors not subject to U.S. generally accepted accounting
principles.
LENGTHY SALES CYCLE. The Company's products are typically used to
develop applications that are critical to a customer's business, and the
purchase of the Company's products is often part of a customer's larger
business process reengineering initiative or implementation of distributed
computing. As a result, the license and implementation of the Company's
software products generally involves a significant commitment of management
attention and resources by prospective customers. Accordingly, the Company's
sales process is often subject to delays associated with a long approval
process that typically accompanies significant initiatives or capital
expenditures. In addition, there are a large number of alternative methods or
technologies to develop applications which can require significant time for
potential customers to evaluate, and implementation of a favorable decision
to license the Company's products may be subject to delay due to higher
priority projects such as Year 2000 compliance. For these and other reasons,
the sales cycle associated with the license of the Company's products is
often lengthy and subject to a number of significant delays over which the
Company has little or no control. There can be no assurance that the Company
will not experience these and additional delays in the future. Therefore, the
Company believes that its quarterly operating results are likely to vary
significantly in the future.
RISK ASSOCIATED WITH NEW VERSIONS AND NEW PRODUCTS; RAPID
TECHNOLOGICAL CHANGE. The software market in which the Company competes is
characterized by rapid technological change,
23
frequent introductions of new products, changes in customer demands and
evolving industry standards. The introduction of products embodying new
technologies and the emergence of new industry standards can render existing
products obsolete and unmarketable. For example, the Company's customers have
adopted a wide variety of hardware, software, database, networking and
Internet-based platforms, and as a result, to gain broad market acceptance,
the Company has had to support Forte on many of such platforms. The Company's
customers use the Company's proprietary development language to develop
applications using the Company's products, and customers may desire to
utilize other widely-used programming languages to develop Internet-based and
other distributed applications. The Company's future success will depend upon
its ability to address the increasingly sophisticated needs of its customers
by supporting existing and emerging hardware, software, programming language,
database, networking and Internet-based platforms and by developing and
introducing enhancements to Forte, related products and new products on a
timely basis that keep pace with such technological developments and emerging
industry standards and changing customer requirements. There can be no
assurance that the Company will be successful in developing and marketing
enhancements to Forte and related products that respond to technological
change, evolving industry standards or changing customer requirements, that
the Company will not experience difficulties that could delay or prevent the
successful development, introduction and sale of such enhancements or that
such enhancements will adequately meet the requirements of the marketplace
and achieve any significant degree of market acceptance. The Company has in
the past experienced delays in the release dates of enhancements to Forte. If
release dates of any future Forte enhancements or new products are delayed or
if when released they fail to achieve market acceptance, the Company's
business, operating results and financial condition would be materially and
adversely affected. In addition, the introduction or announcement of new
product offerings or enhancements by the Company or the Company's competitors
may cause customers to defer or forgo purchases of current versions of Forte
and related products, which could have a material adverse effect on the
Company's business, operating results and financial condition.
LIMITED DEPLOYMENT; DEPENDENCE ON SYSTEM INTEGRATORS AND VALUE ADDED
RESELLERS. The Company first shipped Forte in August 1994. To date, only a
limited number of the Company's customers have completed the development and
deployment of distributed applications using Forte and related products. If
any of the Company's customers are not able to successfully develop and
deploy distributed applications with Forte and related products, the
Company's reputation could be damaged, which could have a material adverse
effect on the Company's business, operating results and financial condition.
In addition, the Company expects that a significant percentage of its future
revenue will be derived from sales to existing customers. If existing
customers have difficulty deploying applications built with Forte and related
products or for any other reason are not satisfied with Forte products, the
Company's business, operating results and financial condition would be
materially and adversely affected. The Company's customers and potential
customers often rely on third-party system integrators and value added
resellers to develop and deploy distributed applications. If the Company is
unable to adequately train a sufficient number of system integrators and
value added resellers or if, for any reason, a large number of such
integrators and value added resellers adopt a product or technology other
than Forte, the Company's business, operating results and financial condition
would be materially and adversely affected.
RISK OF SOFTWARE DEFECTS. Software products as internally complex as
Forte and related products frequently contain errors or defects, especially
when first introduced or when new versions or enhancements are released. The
Company introduced Release 2.0 of Forte in November 1995,
24
Release 3.0 of Forte in August in 1997 and the initial release of Forte
Conductor in September 1997. Despite extensive product testing by the
Company, the Company has discovered software errors in its releases after
their introduction. Although the Company has not experienced material adverse
effects resulting from any such defects or errors to date, there can be no
assurance that, despite testing by the Company and by current and potential
customers, defects and errors will not be found in current versions, new
versions, new product or enhancements to existing products after commencement
of commercial shipments, resulting in loss of revenue or delay in market
acceptance, which could have a material adverse effect upon the Company's
business, operating results and financial condition.
PRODUCT LIABILITY. The Company markets Forte to customers for the
development, deployment and management of distributed applications. The
Company's license agreements with its customers typically contain provisions
designed to limit the Company's exposure to potential product liability
claims. It is possible, however, that the limitation of liability provisions
contained in the Company's license agreements may not be effective as a
result of existing or future federal, state or local laws or ordinances, or
unfavorable judicial decisions. Although the Company has not experienced any
product liability claims to date, the sale and support of Forte by the
Company may entail the risk of such claims, which are likely to be
substantial in light of the use of Forte in business-critical applications. A
successful product liability claim brought against the Company could have a
material adverse effect upon the Company's business, operating results and
financial condition.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. Revenue from foreign
subsidiaries and export sales accounted for 48 percent and 49 percent of the
Company's total revenue for the quarters ended December 31, 1998 and 1997,
respectively. The Company currently has international sales offices located
in Australia, Belgium, Canada, France, Germany, Holland, Switzerland, Italy
and the United Kingdom which have generated substantially all direct
international revenue recognized by the Company to date. The Company believes
that in order to increase sales opportunities and regain profitability, it
will be required to continue to expand its international operations. The
Company has committed, and continues to commit, significant management time
and financial resources to developing direct and indirect international sales
and support channels. There can be no assurance, however, that the Company
will be able to maintain or increase international market demand for Forte
and related products. To the extent that the Company is unable to do so in a
timely manner, the Company's international sales will be limited, and the
Company's business, operating results and financial condition would be
materially and adversely affected.
International operations are subject to inherent risks, including
the impact of possible recessionary environments in economies outside the
United States, costs of localizing products for foreign markets, longer
accounts receivable collection periods and greater difficulty in accounts
receivable collection, unexpected changes in regulatory requirements,
difficulties and costs of staffing and managing foreign operations, reduced
protection for intellectual property rights in some countries, potentially
adverse tax consequences, and political and economic instability. There can
be no assurance that the Company or its distributors or resellers will be
able to sustain or increase international revenue from licenses or from
maintenance and service, or that the foregoing factors will not have a
material adverse effect on the Company's future international revenue and,
consequently, on the Company's business, operating results and financial
condition. The Company's direct international revenue is generally
denominated in local currencies. The Company does not
25
currently engage in hedging activities. Revenue generated by the Company's
distributors and resellers are generally paid to the Company in United States
dollars. Although exposure to currency fluctuations to date has been
insignificant, there can be no assurance that fluctuations in currency
exchange rates in the future will not have a material adverse impact on
revenue from international sales and thus the Company's business, operating
results and financial condition.
PROPRIETARY RIGHTS, RISKS OF INFRINGEMENT AND SOURCE CODE RELEASE.
The Company relies primarily on a combination of patent, copyright and
trademark laws, trade secrets, confidentiality procedures and contractual
provisions to protect its proprietary rights. The Company also believes that
factors such as the technological and creative skills of its personnel, new
product developments, frequent product enhancements, name recognition and
reliable product maintenance are essential to establishing and maintaining a
technology leadership position. The Company seeks to protect its software
documentation and other written materials under trade secret and copyright
laws, which afford only limited protection. The Company currently has one
issued United States patent that expires in 2012 and corresponding patent
applications pending in Canada, Australia, Japan and several member countries
within the European Patent Organization. There can be no assurance that the
Company's patent will not be invalidated, circumvented or challenged, that
the rights granted thereunder will provide competitive advantages to the
Company or that any of the Company's pending or future patent applications,
whether or not being currently challenged by applicable governmental patent
examiners, will be issued with the scope of the claims sought by the Company,
if at all. Furthermore, there can be no assurance that others will not
develop technologies that are similar or superior to the Company's technology
or design around the patents owned by the Company. The Company has obtained
registration of the FORTE trademark in six countries and has trademark
registration applications pending in numerous additional countries. Despite
the Company's efforts to protect its proprietary rights, unauthorized parties
may attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized
use of the Company's products is difficult, and while the Company is unable
to determine the extent to which piracy of its software products exists,
software piracy can be expected to be a persistent problem. In addition, the
laws of some foreign countries do not protect the Company's proprietary
rights as fully as do the laws of the United States. There can be no
assurance that the Company's means of protecting its proprietary rights in
the United States or abroad will be adequate or that competition will not
independently develop similar technology. The Company has entered into source
code escrow agreements with a limited number of its customers and resellers
requiring release of source code in certain circumstances. Such agreements
generally provide that such parties will have a limited, non-exclusive right
to use such code in the event that there is a bankruptcy proceeding by or
against the Company, if the Company ceases to do business or if the Company
fails to meet its support obligations. In addition, Digital Equipment
Corporation ("Digital") and Mitsubishi Corporation ("Mitsubishi") each
currently possess copies of Forte source code for certain limited purposes,
subject to the terms of separate written agreements each company has entered
into with the Company. Digital has an option to purchase a non-exclusive,
fully-paid license of the Forte source code. Digital's option becomes
exercisable if the Company is acquired and the acquiror fails to agree to
assume the Company's contractual obligations to Digital. The provision of
source code may increase the likelihood of misappropriation by third parties.
The Company is not aware that it is infringing any proprietary
rights of third-parties. There can be no assurance, however, that
third-parties will not claim infringement by the Company of their
intellectual property rights. The Company expects that software product
developers will
26
increasingly be subject to infringement claims as the number of products and
competitors in the Company's industry segment grows and the functionality of
products in different industry segments overlaps. Any such claims, with or
without merit, could be time consuming to defend, result in costly
litigation, divert management's attention and resources, cause product
shipment delays or require the Company to enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company, if at all. In the event of a
successful claim of product infringement against the Company and failure or
inability of the Company to license the infringed or similar technology, the
Company's business, operating results and financial condition would be
materially and adversely affected.
The Company relies upon certain software that it licenses from
third-parties, including software that is integrated with the Company's
internally developed software and used in Forte to perform key functions.
There can be no assurance that these third-party software licenses will
continue to be available to the Company on commercially reasonable terms. The
loss of, or inability to maintain, any such software licenses could result in
shipment delays or reductions until equivalent software could be developed,
identified, licensed and integrated which would materially and adversely
affect the Company's business, operating results and financial condition.
VOLATILITY OF STOCK PRICE. The Company's Common Stock has
experienced significant price volatility and such volatility may occur in the
future. Factors, such as announcements of the introduction of new products by
the Company or its competitors and quarter-to-quarter variations in the
Company's operating results, as well as market conditions in the technology
and emerging growth company sectors, may have a significant impact on the
market price of the Company's Common Stock. Further, the stock market has
experienced extreme volatility that has particularly affected the market
prices of equity securities of many high technology companies and that often
has been unrelated or disproportionate to the operating performance of such
companies. These market fluctuations may adversely affect the price of the
Common Stock.
EFFECT OF CERTAIN CHARTER PROVISIONS; ANTI-TAKEOVER EFFECTS OF
RIGHTS PLAN, CERTIFICATE OF INCORPORATION, DELAWARE LAW AND CERTAIN
AGREEMENTS. The Company's Board of Directors has the authority to issue up to
5,000,000 shares of Preferred Stock and to determine the price, rights,
preferences, privileges and restrictions, including voting and conversion
rights of such shares, without any further vote or action by the Company's
stockholders. The rights of the holders of Common Stock will be subject to,
and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock could
have the effect of making it more difficult for a third-party to acquire a
majority of the outstanding voting stock of the Company. The Company has no
current plans to issue shares of Preferred stock. Further, the Company has
adopted a stockholder rights plan that, in conjunction with certain
provisions of the Company's Certificate of Incorporation and of Delaware law,
could delay or make more difficult a merger, tender offer, or proxy contest
involving the Company.
27
PART II
ITEM 1. LEGAL PROCEEDINGS
The Company is not aware of any pending or threatened litigation that
could have a material adverse effect upon the Company's business, operating
results or financial condition.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial data schedule.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K have been filed during the quarter
ended December 31, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as
amended, the Registrant has duly caused this Report on Form 10-Q to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Oakland, State of California, on this 12th day of February, 1999.
FORTE SOFTWARE, INC.
By:
Bob L. Corey
SENIOR VICE PRESIDENT, FINANCE AND
ADMINISTRATION, CHIEF FINANCIAL OFFICER
AND SECRETARY
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