March 31, 1999
This Annual Report on Form 10-K and the documents incorporated herein by reference in addition to historical information contain forward-looking statements. These statements have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current expectations, estimates and projections about Inprise's industry, management's beliefs, and certain assumptions made by Inprise Corporation's management. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates", variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include, but are not limited to, those discussed in the sections entitled "Factors That May Affect Future Results and Market Price of Stock" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as those noted in the documents incorporated herein by reference. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements, whether as a result of new information, future events or otherwise. Readers should be advised
to read this Form 10-K in its entirety paying careful attention to the risk factors set forth in this and other reports or documents the Company files from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
Change in Fiscal Year End
In July 1997, the Company changed its fiscal year end from March 31 to December 31. In accordance with the rules of the Securities and Exchange Commission, this Management Discussion and Analysis of Financial Conditions and Results of Operations discusses and compares the transition period which commenced on April 1, 1997 and ended December 31, 1997 with the calendar year ended December 31, 1998 and fiscal year ended March 31, 1997.
On June 5, 1998, the Company changed its name from Borland International,
Inc. to Inprise Corporation. The Company's stock symbol has been changed to
The Company's results of operation have been restated to reflect the acquisition of Visigenic and Open Environment Corporation which were accounted as a pooling of interests. See Note 4 of the Notes to Consolidated Financial Statements in Part IV, Item 14 of this Form 10-K.
Net revenues were $189.1 million, $145.9 million and $171.0 million for the year ended December 31, 1998, nine months ended December 31, 1997 and the fiscal year ended March 31, 1997, respectively. Included in net revenues for the year ended December 31, 1998, the nine months ended December 31, 1997 and the year ended March 31, 1997 are revenues of $4.7 million, $18.5 million and $27.8 million, respectively, related to OEC and Visigenic.
The Company's non-U.S. revenues (excluding exports from the U.S.) represented approximately 49%, 57% and 54% of total net revenues for the year ended December 31, 1998, nine months ended December 31, 1997 and the fiscal year ended March 31, 1997, respectively. The decrease in the percentage of non-U.S. revenues for the year ended December 31, 1998 was principally due to a decrease in sales in certain Asia Pacific regions, including Japan, caused by the economic slowdown within those regions. Fluctuations in currency exchange rates did not have a material impact on total net revenues or operating results for the year ended December 31, 1998, nine months ended December 31, 1997 or for the fiscal year ended March 31, 1997. However, international revenues would be adversely affected if the U.S. dollar were to strengthen against certain major international currencies.
Licenses and other revenues. Licenses and other revenues represent amounts earned for granting customers licenses to use the Company's software products. Licenses and other revenues were $166.2 million, $132.1 million and $152.0 million for the year ended December 31, 1998, nine months ended December 31, 1997 and the fiscal year ended March 31, 1997, respectively. Licenses and other revenues represented 88%, 91% and 89% of total revenue for the year ended December 31, 1998, nine months ended December 31, 1997 and the fiscal year ended March 31, 1997, respectively. The Company has experienced a decline in its database desktop business, principally following the sale of Paradox to Corel Corporation during the year ended March 31, 1997. This revenue decline was offset by an increase in the revenue from client server and enterprise products. For the year ended December 31, 1998, the percentage of the licenses and other revenues associated with the Company's desktop products constituted 30% of the licenses and other revenues as compared with 45% and 62% for the nine months ended December 31, 1997 and fiscal year ended March 31, 1997, respectively. In contrast, the Company's revenues from the sale of client/server and enterprise products increased as a percentage of the
licenses and other revenues to 70% for the year ended December 31, 1998, as compared with 55% and 38% for the nine months ended December 31, 1997 and fiscal year ended March 31, 1997, respectively.
In January 1999 the Company announced a new business structure with the formation of two divisions, Inprise and borland.com. The Inprise division will focus on providing integrated enterprise solutions to Global 1000 corporations. Borland.com is developing a premier destination Web site and online community serving individual developers' needs.
Service revenues. Service revenue represents amounts earned for support, consulting and education services for the Company's software products. Net service revenues were $22.9 million, $13.9 million and $19.0 million for the year ended December 31, 1998, nine months ended December 31, 1997 and the year ended March 31, 1997, respectively. Service revenue represented 12%, 9% and 11% of total net revenue for the year ended December 31, 1998, nine months ending December 31, 1997 and fiscal year ending March 31, 1997, respectively. Service revenue attributable to client/server and enterprise markets represented 91%, 85%, and 82% of total service revenue for the year ended December 31, 1998, nine months ended December 31, 1997 and the year ended March 31, 1997, respectively. This increase of client/server and enterprise service revenue is consistent with the Company's emphasis on premium support and consulting services to enterprise and large corporate customers.
Gross margins were 84%, 82% and 79% for the year ended December 31, 1998, nine months ended December 31, 1997 and for the fiscal year ended March 31, 1997, respectively. Gross margins in the fiscal year ended December 31, 1998 improved principally due to lower manufacturing costs. Gross margins were also positively impacted by the shift to client server and enterprise products which have a higher average selling price and, in many cases, do not require additional documentation or carrier medium. Gross margins for the fiscal year ended March 31, 1997 were negatively impacted by lower revenues, resulting from lower volumes and lower selling prices. This also resulted in certain fixed costs being spread across lower revenues, as well as by charges related to the write-off of excess inventory.
Selling, General and Administrative
Selling, general and administrative expenses were $112.8 million, $86.5 million and $155.1 million for the year ended December 31, 1998, nine months ended December 31, 1997 and the fiscal year ended March 31, 1997, respectively. Such expenses were 60%, 59% and 91% of revenues for the year ended December 31, 1998, nine months ended December 31, 1997 and the fiscal year ended March 31, 1997, respectively. Selling, general and administrative expenses were reduced from prior years principally due to lower employee headcount. These reductions in company personnel during the year ended December 31, 1998 and nine months ended December 31, 1997 were attributable to the restructuring efforts of the Company in the fiscal year ended March 31, 1997. Although the selling, general and administrative expenses have decreased from the levels during the year ended March 31, 1997, the Company expects future selling, general and administrative expenses to increase over the current year levels as it continues to invest in its enterprise sales force.
Although certain selling, general and administrative expenses can be managed or controlled on a short-term basis, a substantial portion of such expenses are essentially fixed on a quarter to quarter basis. As a result, when the Company suffers adverse impacts on its net revenues or margins because of delays in new product introductions, price competition or other competitive factors, the Company generally is unable to take actions in the short term to substantially reduce expenses. As part of its efforts to attract and retain key employees, the Company has adopted certain special bonus and other severance retention programs. Such programs may have the effect of increasing the Company's selling, general and administrative expenses.
Research and Development
Research and development expenses for the year ended December 31, 1998, nine months ended December 31, 1997 and for the fiscal year ended March 31, 1997 were $47.3 million, $38.2 million, and $64.7
million, respectively. Such expenses were 25%, 26% and 38% of revenues for the year ended December 31, 1998, nine months ended December 31, 1997 and for the fiscal year ended March 31, 1997, respectively. The Company's investment in research and development resulted in several new products and new versions of products including Inprise Application Server, VisiBroker SSL Pack for Java and C++, DCE CORBA Bridge, VisiBroker Integrated Transaction Server (ITS), Delphi 4.0, JBuilder 2.0, C++ Builder Enterprise, C++ Builder 3.0, and Entera 4.0. In the year ended December 31, 1998 and the nine month period ended December 31, 1997, by focusing its research and development efforts on key strategic products, the Company reduced its research and development expenses.
Restructuring, Merger and Other Non-Recurring Charges
In conjunction with the acquisition of Visigenic, the Company implemented a worldwide realignment of its corporate structure. In the year ended December 31, 1998, the Company recorded a $19.3 million restructuring and merger related charge of which $9.9 million related to severance costs associated with the elimination of duplicate workforce, $3.2 million to termination of certain lease agreements and the write-off of certain fixed assets and $2.5 million to other costs associated with the restructuring. Additionally, the Company charged to income approximately $3.7 million in expenses associated with the merger. As part of the first quarter restructure, the Company had recorded a restructuring charge of approximately $3.4 million for severance costs associated to the anticipated closure of certain operations. At December 31, 1998, Company did not anticipate any further severance costs associated to these operations. Accordingly, the Company reversed the charge during the quarter ended December 31, 1998.
During the fiscal year ended March 31, 1997, the Company recorded restructuring and merger related charges totaling $18.9 million. These charges included $6.2 million related to severance costs, $1.8 million for the termination of certain lease agreements and $2.0 million for other costs associated with the restructuring. In connection with the merger with OEC during fiscal year 1997, the Company incurred merger related costs of $8.9 million. See Note 4 to Consolidated Financial Statements. The charge for merger related costs included in the Consolidated Statements of Operations consist principally of severance costs, write-offs of certain assets and professional fees.
During the fiscal year ended March 31, 1997, Visigenic completed the acquisition of PostModern, a supplier of distributed object technology. In the acquisition Visigenic issued 3,099,821 shares of its common stock and paid a total of $2.3 million in exchange for all of PostModerns' outstanding shares. In connection with the purchase price allocation, Visigenic received an appraisal of the intangible assets which indicated that approximately $12.0 million of the acquired intangible assets consisted of in-process product development which had not reached technological feasibility and, in the opinion of management, had no alternative future use. The acquired in process development was charged to expense in the Company's 1997 Statement of Operations.
Gain on Sale of Corporate Assets
During the year ended December 31, 1998, Starfish Software, Inc. was merged with Motorola, Inc. and the Company's minority interest in Starfish Software, Inc. was exchanged for cash and common stock consideration. The Company recorded a gain of approximately $16.6 million upon the completion of the transaction. In addition, during the year ended December 31, 1998 the Company recorded approximately $1.1 million gain on sale of certain real estate holdings.
On a consolidated basis, the Company generated a pre-tax profit of approximately $3.9 million for the year ended December 31, 1998, a pre-tax loss of approximately $2.8 million and for the nine months ended December 31, 1997 and a pre-tax loss of approximately $127.6 million for the year ended March 31, 1997. The Company's income tax benefit for the year ended December 31, 1998 was approximately $4.4 million and income tax expense for the nine months ended December 31, 1997 and year ended March 31, 1997 was $1.1 million and $0.6 million, respectively.
During the year ended December 31, 1998 the Company recorded an income tax benefit of approximately $8.0 million resulting from a settlement reached with the U.S. Internal Revenue Service ("IRS") and the conclusion of certain non- U.S. tax audits for the years ending in 1984 through 1992. Excluding the tax benefits of $7.9 the Company would have incurred an income tax expense of approximately $3.6 million.
For U.S. federal income tax purposes, the Company has net operating loss carryforwards of approximately $208 million at December 31, 1998. There are also available U.S. federal tax credit carryforwards of approximately $23 million. These loss and credit carryforwards expire between 1999 and 2014, if not utilized. The Company also has Alternative Minimum Tax (AMT) credit carryforwards for U.S. federal income tax purposes of approximately $2 million, which does not expire. Utilization of federal and state net operating loss and tax credit carryforwards may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating loss and tax credit carryforwards before full utilization. Additionally, the Company also has approximately $19 million of net operating loss carryforwards in various foreign jurisdictions. Certain of these loss carryforwards will expire beginning in 1999, if not utilized.
At December 31, 1998, the Company had a net deferred tax asset of approximately $134 million. This asset is comprised of the tax effect of the above described loss and credit carryforwards, plus the tax effect of future reversing temporary differences. The Company believes sufficient uncertainty exists regarding the realizability of the deferred tax assets such that a full valuation allowance has been provided. Deferred tax assets and related valuation allowances of approximately $37.0 million relate to certain U.S. operating loss carryforwards resulting from the exercise of employee stock options, the tax benefit of which, when recognized, will be accounted for as a credit to additional paid-in capital rather than a reduction of the income tax provision.
Information with respect to this subject may be found in Note 14 of Notes to Consolidated Financial Statements in Part IV, Item 14 of this Form 10-K.
Liquidity and Capital Resources
Cash, cash equivalents and short-term investments were $84.4 million at December 31, 1998, a decrease of $18.2 million from a balance of $102.6 million as of December 31, 1997. Working capital decreased from $64.6 million as of December 31, 1997 to $61.5 million as of December 31, 1998.
Net cash used by the Company for operating activities during the year ended December 31, 1998 was $16.8 million. The primary use of cash was to fund ongoing operations. Net cash paid for severance and facilities costs associated with prior restructurings was approximately $7.1 million.
Net cash provided from investing activities during the year ended December 31, 1998 was $2.0 million. The Company used $18.2 million for acquisitions of property and equipment which was offset by $16.6 million from the sale of certain long term investments and $5.0 million provided by the sale of certain real estate holdings.
Cash used by financing activities of $6.8 million in 1998 consisted primarily of the repurchase of 3.5 million shares of the Company's common stock for $20.4 million offset by the private placement of an additional 220 shares of mandatorily redeemable preferred stock for $11.0 million and the exercises of employee stock options for $4.6 million.
Currency fluctuations increased the Company's cash position (U.S. dollar) during the year ended December 31, 1998 by $2.1 million due to the devaluation of the U.S. dollar against certain foreign currencies including the Dutch Guilder and the Japanese Yen. The Company cannot predict the impact such fluctuations might have on its future cash flows and there can be no assurance that foreign exchange rates will not have a material impact on future cash flows.
The Company believes that its existing cash balances and funds expected to be provided by operations will be sufficient to finance its working capital requirements at least through calendar 1999.
Factors That May Affect Future Results and Market Price of Stock
The Company operates in a rapidly changing environment that involves numerous risks, some of which are beyond the Company's control. The following discussion highlights some of these risks.
History of Operating Losses
Although the Company had a net profit for the year ended December 31, 1998, the Company had an operating loss in the year ended December 31, 1998 and has had net losses in four of the past six fiscal years, including a net loss of approximately $128.0 million for the year ended March 31, 1997. The Company's net revenues have declined each year from fiscal 1993 through 1997. Although the Company's net revenues for the twelve months ended December 31, 1998 are approximately 10% higher than the twelve months ended March 31, 1997, such revenues were essentially flat as compared to the twelve months ended December 31, 1997. The Company's ability to achieve revenue growth and profitability are substantially dependent upon the success of the Company's enterprise, Internet/intranet and client/server product strategies, upon its ability to successfully complete and introduce new products and services, market acceptance of such products and services, to successfully implement restructuring and cost control measures from time to time and to successfully integrate products and operations of acquired companies. There can be no assurance that the Company will be able to successfully accomplish the foregoing or to maintain or improve profitability in future periods.
Significant Fluctuations in Quarterly Operating Results and Seasonality
The Company's quarterly operating results have varied significantly in the past and the Company expects that such results are likely to vary significantly from time to time in the future. Such variations result from, among other matters, the following: the size and timing of significant orders and their fulfillment; demand for the Company's products; timing of revenue recognition related to license fees; the number, timing and significance of product enhancements and new product announcements by the Company and its competitors; changes in pricing policies by the Company or its competitors; the timing and extent of sales and marketing organizations within OEM customers and resellers becoming familiar with and endorsing the Company's products for resale; changes in operating expenses; changes in the Company's sales incentive plans; budgeting cycles of its customers; customer order deferrals in anticipation of enhancements or new products offered by the Company or its competitors; product life cycles; product defects and other product quality problems; personnel changes; seasonal trends and general domestic and international economic and political conditions.
Operating results can also be adversely impacted by deferral of customer orders in light of customer uncertainty regarding the Company's short- and long-term prospects. As an increasing percentage of the Company's revenues are from enterprise, Internet/intranet and client/server products, the Company expects that an increasing percentage of its revenues will be from large orders. The timing of such orders and their fulfillment may cause material fluctuations in the Company's operating results, particularly on a quarterly basis. In addition, the Company intends to continue to expand its domestic and international direct sales force. The timing of such expansion and the rate at which new sales people become productive could also cause material fluctuations in the Company's quarterly operating results.
Enterprise sales, which are principally generated by the Inprise division, typically contain multiple elements, including license for development and deployment products, technical support, maintenance, consulting and training services. Often enterprise sales will include a license and deployment fee paid upon signing of the
contracts and may include current and future payments for technical support and consulting services. Most of these elements, including the technical support, maintenance, consulting and training, are not delivered upon signing of the contract, and therefore, revenue associated to these elements must be deferred until delivery or the services rendered. By contrast, the Company's desktop sales historically have included only a license for the current version of the product with an option to purchase technical support and maintenance. With the growth of the Company's enterprise sales, a significant portion of the fees may relate to undelivered elements, requiring a portion of the revenue from the fees to be deferred. As the Company expects that an increasing percentage of its business will be from the sale of enterprise products and services, the Company expects a larger percentage of revenue may be deferred. The amount of revenue associated to these undelivered elements and the timing of recognition of the revenue may have a material affect on the Company's business, operating results and financial position.
Due to the foregoing factors, quarterly revenues and operating results are difficult to forecast. Revenues are also difficult to forecast because the market for client/server and enterprise application development software is rapidly evolving, and the Company's sales cycle for client/server and enterprise products, from initial evaluation to purchase and the provision of support services, is lengthy and varies substantially from customer to customer. Because the Company normally ships products within a short time after it receives an order, it typically does not have any material backlog. As a result, to achieve its quarterly revenue objectives, the Company is dependent upon obtaining orders in any given quarter for shipments in that quarter. Furthermore, because many customers place orders toward the end of a quarter, the Company generally recognizes a substantial portion of its revenues at the end of a quarter. As the Company's expense levels are based in significant part on the Company's expectations as to future revenues and are therefore relatively fixed in the short term, if revenue levels fall below expectations, net income is likely to be disproportionately adversely affected. 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 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 adversely affected.
In connection with the Company's acquisitions and in response to the significant losses from operations, the Company implemented a restructuring and realignment of its operations in March 1998 and January 1999, respectively. These restructurings resulted in significant reductions in workforce and other ongoing costs. Given the extent of the restructurings which the Company has undertaken, there can be no assurance that the remaining resources are sufficient for the Company to return to consistent revenue growth or profitability, nor can there be any assurance that the Company will realize the cost savings which the restructurings were designed to produce.
Regulation of the Internet and Electronic Commerce
The electronic commerce market, particularly over the Internet, is new, rapidly evolving and intensely competitive. The Company intends to expand over time its operations by promoting new or complementary products and by expanding the breadth and depth of its product and service offerings. There can be no assurance that the Company will be able to expand its operations in a cost-effective or timely manner or such expansion will be successful. Currently, there are few laws or regulations that directly apply to access or commerce on the Internet. The Company could be materially adversely affected by encryption technology and access charges for Internet service providers, as well as the continuing deregulation of the telecommunication industry. The adoption of such measures could decrease demand for the Company's products, and at the same time increase the Company's cost of selling its products. Changes in laws or regulations governing the Internet and electronic commerce could have a material adverse effect on the Company's business, operating results and financial condition.
Entering New or Developing Business Areas; Transition to Direct Sales Strategy
New Business Area. The Company's strategy is to focus on enterprise customers, software developers, and the Internet/intranet markets. Accordingly, revenues derived from the Company's products, particularly its distributed object products, will depend in large part upon the rate of adoption by businesses and end-users of distributed object technology for information processing and the Internet and intranets for commerce and communications. Critical issues concerning the Internet and intranets, including security, reliability, cost, ease of use and access and quality of service, remain unresolved at this time, inhibiting adoption by many enterprises and end-users. To the extent the Internet and intranets are not widely used by businesses and end-users, there would be a material adverse effect on the Company's business, operating results and financial condition. The Company's relatively recent entry into these markets is subject to a number of risks, including among others, the new and evolving nature of the markets themselves; the Company's need to make choices regarding the operating systems, database management systems and server software on which to focus; the ongoing transition of and investment of resources for this segment by the Company; the Company's limited experience in this area; and, the presence of several very large and well-established businesses, as well as a number of smaller very successful companies, already competing in this market. There can be no assurance that sales in these markets will meet the Company's objectives, in which case the Company's business, operating results or financial condition could be materially adversely affected.
The Company's VisiBroker products are based on several standards, including Common Object Request Broker Architecture ("CORBA") and Internet Inter-ORB Protocol ("IIOP"). These standards are intended to facilitate the management and communication of applications created in object oriented programming languages such as C + + and Java. These new standards are just beginning to gain widespread acceptance, and compete with proprietary solutions such as Microsoft's ActiveX and DCOM. The distributed object software market is relatively young, and there are few proven products. Further, some of the VisiBroker products are designed specifically for use in applications for the Internet and intranets. If CORBA or IIOP are not adopted or are adopted more slowly than anticipated or if product offerings from competitors are chosen in lieu of the Company's products, there could be a material adverse effect on the Company's business, operating results or financial condition.
The Company's VisiChannel for Java Database Connectivity ("JDBC") database access product based on the JDBC standard was developed to enable applications to access data from JDBC compliant data sources. While the JDBC standard is supported by most of the major database and software vendors, it is a recent standard that has not yet gained widespread acceptance and it currently co- exists with proprietary database access solutions from many of these same database and software vendors. If JDBC is not adopted or is adopted more slowly than anticipated or if product offerings from competitors are chosen in lieu of the Company's products, there could be a material adverse effect on the Company's business, operating results or financial condition.
Transition To Direct Sales Strategy. In order for the Inprise division enterprise software products to achieve market acceptance, the Company will need to continue to adjust to longer sales cycles and successfully transition from the channel sales model for its traditional desktop products to a direct sales model for its enterprise software products. Sales of these enterprise products are expected to be made predominately to large companies, institutions, and government entities. These types of customers generally commit significant resources to an evaluation of enterprise software and require the vendor to expend substantial time, effort, and money educating them about the value of the vendor's solution. As a result, sales to these types of customers generally require an extensive sales effort throughout the customer's organization, and often require final approval by an executive officer or senior level employee.
The Company has experienced and will likely continue to experience delays following initial contact with a prospective customer and expend substantial funds and management effort in connection with these sales. As the Company has relatively little experience with these types of sales, there can be no assurance that the Company can successfully transition to the direct sales model. In order to complete these types of sales, the Company will be required to restructure its direct sales force, extensively train and effectively manage its sales personnel, invest greater resources in the sales effort, and educate the authorized resellers. The Company may not be able to
accomplish any of the foregoing on a timely and cost-effective basis. Failure to do so could have a material adverse effect on the Company's business, operating results, or financial condition. Additionally, the Company will need to add trained technical personnel to help it implement solutions for its enterprise software customers relating to enterprise software products. Personnel with the sufficient level of expertise and experience for these positions are in great demand, and the Company may not be able to hire and retain a sufficient number of qualified personnel for these purposes. Failure to do so could have a material adverse effect on the Company's business, operating results, or financial condition.
In 1998 and early 1999, the Company made changes to its sales compensation programs. Although such changes are intended to enhance overall revenues, such changes could have a material adverse impact on revenues and sales related expenses.
Decline In Revenue From Desktop Products
A significant portion of the borland.com division's revenues to date has been attributable to its desktop products. Revenues derived from the sale of these products, particularly the Company's desktop database products, have declined over the last six fiscal years. The decline in revenues has been caused by a number of factors, including, among others, the success of product "suites" offered by competitors which have had an adverse impact on the sale of individual products; the sale by the Company of its Quattro Pro and Paradox product lines; and the continued competitive pricing pressures that have resulted in lower average sales prices for desktop products.
While the Company expects the decline in revenues associated with the borland.com desktop products to continue, revenues from the sales of the borland.com desktop products currently continue to represent an important portion of the Company's revenue. Although the Company plans to invest in the development, sales, marketing and support of such products on a limited basis, there can be no assurance that revenues from desktop products will not decline faster than expected. If revenues from such products decline materially or at a more rapid rate than currently anticipated, the Company's business, operating results and financial condition would be materially adversely affected.
Extremely Competitive Industry
The computer software industry is an intensely competitive industry. Rapid change, uncertainty due to new and emerging technologies and fierce competition characterize the industry. The pace of change has recently accelerated due to the Internet/intranet and new programming languages, such as Java. The Company competes with a number of other companies, including Microsoft, Computer Associates, Oracle, Sybase, and Symantec. Certain of its competitors have substantially greater financial, management, marketing and technical resources than the Company. In the past, competitors have utilized their greater resources to provide substantial signing bonuses and other inducements to lure away the Company's management and other key personnel. In addition, Microsoft is the developer of the Windows operating environments. To the extent that the Company is unable to obtain information regarding existing and future operating systems from the developer of such systems, the release of the Company's products for such systems may be delayed or may not be competitive. The VisiBroker products are targeted at the emerging markets for standards-based distributed object software products. The markets for these products are intensely competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. The Company's principal competitive factors in these markets are product quality, performance and price, vendor and product reputation, product architecture and quality of support. In the standards-based distributed object market, the VisiBroker products compete principally against offerings by Iona Technologies, Expersoft and BEA Systems. These products also compete against existing or proposed distributed object solutions from hardware vendors such as Hewlett-Packard, ICL, IBM and Sun. In addition, because there are relatively low barriers to entry in the software market and because the products are based on publicly available standards, the Company expects to experience additional competition in the future from other established and emerging companies if the market for distributed object software continues to develop and expand. In particular, operating system vendors such as ICL, Hewlett-
Packard, IBM, Microsoft and Sun may offer standards-based distributed object products bundled with their operating systems. For instance, Microsoft has introduced DCOM for Microsoft operating systems, which could reduce or eliminate the need for CORBA-compliant ORBs, such as those offered by the products acquired from Visigenic.
Many existing competitors and potential competitors have well-established relationships with current and potential customers of the Company, have extensive knowledge of the markets serviced by the Company's customers, more extensive development, sales and marketing resources and are capable of offering single vendor solutions. Increased competition could result in price reductions, fewer customer orders, reduced gross margins and loss of market share, any one of which could materially 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, thereby increasing the ability of their products to address the needs of the Company's current and prospective customers. Accordingly, it is possible that new competitors may emerge, or alliances among current and new competitors may be formed that may rapidly gain significant market share. Certain competitors have been known to license software for free to gain competitive advantage. Such competition could materially 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 its products and related services, which could materially adversely affect the Company's business, operating results and financial condition. Commercial acceptance of the Company's products and services could be adversely affected by critical or negative statements or reports by brokerage firms, industry and financial analysts, and industry periodicals concerning the Company and its products, business, or competitors, or the advertising or marketing efforts of competitors that could affect customer perception. There can be no assurance that the Company will be able to compete successfully against current and future competition, and the failure to do so would have a material adverse effect upon the Company's business, operating results and financial condition.
The advent of the Internet/intranet as a computing, communication and collaboration platform as well as a low cost and efficient distribution vehicle, on-line services, and electronic commerce increases competition and creates uncertainty as to future technology directions. The Company faces intense competition in the development and marketing of Internet/intranet and Java development software from a wide variety of companies. There can be no assurances that the Company will be able to compete effectively for business opportunities as they arise on the Internet/intranet, on-line services, electronic commerce and other emerging areas.
New Product Introduction; Rapid Technological and Market Change
The Company's future sales will depend substantially on its ability to continue to successfully design and market new products and upgrades of current products for existing and new computer platforms and operating environments. There can be no assurances that sales of such new products and versions will meet the Company's expectations, due to various factors. For example, the Company may introduce certain of such products later to market than expected or later to market than competitors' introductions, or competitors may introduce competitive products at lower prices. In addition, product upgrades (which enable users to upgrade from earlier versions of the Company's products or competitor's products) have lower prices and margins than new products. The acceptance of the Company's new products is dependent, in part, on the continued adoption of the Internet as a new computing paradigm and the adoption of the Java programming language.
From time to time, the Company has made and expects to make announcements to its customers with respect to the timeframes within which new products are expected to be shipped. Such announcements are made for the purpose of providing customers with a general idea of the expected availability of products for planning purposes, are based only upon estimates and are not a prediction of the exact availability date for such products. In the past, certain of the Company's products shipped later, and in some cases substantially later, than the timeframe within which the Company originally anticipated that the products would be available. Some of the VisiBroker products are based on technology licensed from third parties, and the Company has limited control over whether and when these technologies are updated. The failure or delay in enhancements of technology licensed from third parties could have a material adverse effect on the Company's ability to develop and enhance
its products. Due to the inherent uncertainties of software development, it is likely that such situations will occur from time to time in the future. Moreover, the loss of key employees may increase the risk of delays in product availability from timeframes originally anticipated. Consequently, announcements regarding the Company's expectations of when products may ship should not be considered a prediction by the Company that the products will ship in any particular quarter or otherwise be relied upon by investors as a basis for predicting the Company's results for any future period. Delays in the shipment of such products and product enhancements could have a material adverse impact on the Company. Without the introduction of such new products and product enhancements, the Company's products may become technologically obsolete, and as a result the Company's business, operating results and financial condition could be materially adversely affected.
Dependence on Java; Risks Associated with Encryption Technology
Certain of the Company's products are based on Java, an object-oriented programming language developed by JavaSoft, a subsidiary of Sun Microsystems. Java was developed primarily for Internet/intranet applications. Java to date has a limited history, thereby inhibiting adoption of Java on a wide spread basis. Additionally, there is a very limited number of commercially significant Java-based products, and it is too early to determine whether Java will become a significant technology. Alternatives to Java have been announced by several companies, including Microsoft. If Java is not adopted or is adopted more slowly than anticipated, there could be a material adverse effect on the Company's business, operating results or financial condition.
The Company plans to use encryption technology in certain of its future products to provide the security required for the exchange of confidential information. Encryption technologies have been breached in the past. There can be no assurance that there will not be a compromise or breach of the security technology used by the Company. If any such compromise or breach were to occur, it could have a material adverse effect on the Company's business, results of operations or financial condition. Additionally, the export of encryption technology is subject to government regulation. The inability to obtain approval for the export of such technology could have a material adverse effect on the Company's business, operating results or financial condition.
Risks Associated With International Operations and Sales
A substantial portion of the Company's revenue is derived from international sales. These sales are subject to risks inherent in doing business on an international level, including the general economic conditions in each country, overlap of different tax structures, the difficulty of managing an organization spread over various countries, changes in regulatory requirements, compliance with a variety of laws and regulations, longer payment cycles in certain countries, export restrictions, tariffs and other trade barriers, political instability, fluctuations in currency exchange rates, and seasonal reductions in business activity during the summer months in Europe and certain other parts of the world. The Company experienced a large decline in revenue in Asia Pacific during 1998 in part, due to the economic difficulties that have occurred throughout this region. There can be no assurance that these economies will recover in the near term or that the Company's net revenues from this geographic region will return to previous levels if a recovery occurs. There can be no assurance that one or more of such factors will not have a material adverse effect on the Company's future international operations and, consequently, on the Company's business, operating results and financial condition. In addition, the Company's subsidiaries generally operate in local currencies, and their results are translated monthly into US dollars. If the value of the US dollar increases relative to foreign currencies, the Company's business, operating results and financial condition could be materially adversely affected.
Hiring and retention of employees
The success of the Company depends in large part upon the ability of the Company to recruit and retain qualified employees, particularly highly skilled engineers. The competition for such personnel is intense, and there can be no assurance that the Company will be successful in retaining or recruiting such personnel. In prior years, certain management and other key personnel were hired away by competitors who offered very substantial signing bonuses and compensation packages that would have been very difficult for the Company to match. There can be no assurance that the Company will not be subject to further losses of management and other key
personnel. In addition, the Company has had and may continue to be required to substantially increase the compensation, bonuses, stock options or other fringe benefits offered to employees in order to attract and retain management and other key personnel. Further, new government regulations, poor stock performance, or other factors could diminish the value of the stock option program and force the Company to pay more cash compensation. The loss of management and other key personnel, and the delays which may be experienced in recruiting new management and other personnel as well as the additional costs which may be incurred in retaining or attracting new personnel, may have a material adverse affect on the Company, its product launches, its operating results and financial condition.
Reliance on VAR & ISV
A significant element of the Company's strategy is to embed and bundle the technology in products offered by VAR and ISV customers, such as Cisco, Compuware, Healtheon, Hewlett-Packard, Microsoft, Hitachi, Netscape, Novell, Oracle, Platinum Technology and Sybase. Historically, a relatively small number of VAR and ISV customers accounted for a significant percentage of Visigenic's revenues. The Company continues to secure similar distribution arrangements with other VARs and ISVs to embed distributed object technology in their products. To date, the terms and conditions, including prices and discounts, of agreements with VAR and ISV customers have been highly negotiated and vary significantly among customers. Substantially all such agreements are non-exclusive and do not require the VAR or ISV to make minimum purchases. The Company has no control over the shipping dates or volumes of systems shipped by its VAR and ISV customers, and there can be no assurance that the VARs and ISVs will ship products incorporating the Company's products in the future. Furthermore, the Company's license agreements with its VAR and ISV customers generally do not require the VARs and ISVs to recommend or offer the Company's products exclusively.
Many of the markets for the VAR and ISV products in which technology is being embedded are new and evolving and, therefore, will be subject to the same risks faced by the Company in the markets for its other products.
If the Company is unsuccessful in maintaining its current relationships and continuing to secure license agreements with additional VARs and ISVs on commercially reasonable terms or at all, or if the Company's VAR and ISV customers are unsuccessful in selling their products, the Company's business, financial condition and results of operations could be materially adversely affected.
Retail Distribution Channel. A significant portion of the borland.com division's sales are made through the retail distribution channel, which is subject to fluctuations in customer demand. The Company's retail distribution customers also carry the products of competitors. These retail distributors may have limited capital to invest in inventory, and their decisions to purchase borland.com products is partly a function of pricing, terms and special promotions offered by borland.com. Competitors also offer such pricing terms and marketing incentives over which the Company has no control and which it cannot predict.
The Company's pattern of net revenues and earnings may be affected by "channel fill." Distributors may fill their distribution channels in anticipation of price changes, sales promotions or incentives. Distributors purchases may be decreased between the date borland.com announces a new version or new product and the date of release, because distributors, dealers and end users often delay purchases, cancel orders or return products in anticipation of availability of new version or new product. The impact of channel fill is somewhat mitigated by the Company's deferral of revenue associated with distributors and resellers inventories which are estimated to be in excess of appropriate levels; however, net revenues may still be materially affected favorably or adversely by the effects of channel fill, particularly in periods where a large number of new products are simultaneously introduced.
Product returns can occur when borland.com introduces upgrades and new versions of products or when distributors or retailers have excess inventories. The Company's return policy allows its distributors, subject to certain limitations, to return purchased products in exchange for new products or for credit towards future purchases. End users may return products through dealers and distributors within a reasonable period from the date of purchase for a full refund, and retailers may return older versions of the products. The Company estimates
and maintains reserves for product returns. However, future returns could exceed the reserves established by the Company, which could have a material adverse affect on the operating results of the Company.
Impact of the Year 2000
The information provided below constitutes a "Year 2000 Readiness Disclosure" for purposes of the Year 2000 Information and Readiness Disclosure Act.
The "Year 2000" issue is pervasive and complex, since many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. As the Year 2000 approaches, these code fields will need to accept four digit entries to distinguish years beginning with a "19" from those beginning with a "20". This, as well as other date related processing issues, may cause systems to fail or malfunction unless corrected. As a result, in less than one year, computer systems and/or software products used by many companies may need to be upgraded to comply with such Year 2000 issues. The Company has organized a corporate-wide initiative led by executives from information systems, research & development, marketing, legal and finance. The initiative includes the identification of Year 2000 issues in the following three areas: (1) product readiness, which concerns product functionality; (2) internal infrastructure readiness, which concerns internal hardware and software, including both information technology such as financial and order entry systems and non-information technology systems such as phones and facilities; and (3) third party readiness, which concerns the preparedness of third party's with whom the Company has business relationships.
Product Readiness. The Company is in the process of gathering, testing, and producing information about its products with respect to Year 2000 readiness. The Company has classified its main products into categories of Year 2000 readiness: ready, ready with issues, not ready and will not be tested. The Company generally believes the most recent versions of its products are Year 2000 ready. Older versions of the Company's products may not be Year 2000 ready and the Company continues to sell some of these older versions. Where possible the Company has been encouraging customers to migrate to current product versions. The Company's products are subject to ongoing review and analysis with respect to Year 2000 readiness issues. Despite such analysis and review the Company's products may contain undetected errors or defects associated with Year 2000 date functions, that may result in material costs to the Company. Furthermore, use of the Company's products in connection with other products, which may or may not be Year 2000 ready, including hardware, software and firmware, may result in the inaccurate exchange of date data resulting in performance issues and system failures. To the extent the Company's products or third party products that include the Company's products, prove not to be Year 2000 ready or in the event of disputes with customers regarding whether the Company's products are ready, the Company's business, results of operations and financial condition could be materially adversely affected. Moreover, the Company's customers could choose to convert to other Year 2000 ready products or to develop their own products in order to avoid such malfunctions, and such actions by customers could have a material adverse effect on the Company's business, financial condition or results of operations. To date, the cost of the readiness program for products are primarily costs of existing internal resources largely absorbed within existing engineering spending levels. These costs have not been reported separately from other product engineering costs.
Year 2000 readiness issues may give rise to legal claims against the Company, notwithstanding standard provisions in the Company's license agreements with its customers which disclaims all express and implied warranties for such defects and/or which limit the Company's obligations with respect to such issues. The Company is aware of a growing number of lawsuits against software vendors. Because of the unprecedented nature of such litigation, it is uncertain to what extent the Company may be affected by it. Such legal claims could have a materially adverse impact on the Company's business, financial condition or results of operations.
It is unknown how Year 2000 issues may affect customer-spending patterns. As customers focus their attention and capital budgets in the near term on preparing their business for the Year 2000, they may either delay or accelerate software and related purchases. Any reductions in the Company's revenues resulting from such delayed purchases could have a material adverse effect on the Company's business, results of operations and financial condition.
In addition, certain countries where the Company either operates or sells its products may impose requirements in connection with the Year 2000 which are in addition to or different from those in the United States. Such requirements could have a material adverse effect on the Company's business, financial condition and results of operations.
Internal Infrastructure Readiness. The Company is assessing the readiness of its internal systems for handling the Year 2000. These systems include software products provided by third-party vendors, the Company's own internal software and hardware supplied by third party vendors. The Company is implementing new internal systems and as part of the implementation is testing its new systems for Year 2000 readiness. The Company currently plans to have its review and testing substantially completed by mid-1999. Although the assessment is still underway, the Company does not believe that it will incur any material costs or experience material disruptions in its business associated with preparing its internal systems for the Year 2000, but there can be no assurances that the Company will not experience serious unanticipated negative consequences and/or material costs caused by undetected errors or defects in its internal systems, which are composed of third-party software, hardware and the Company's own software products. In addition to application and information technology systems, the Company is in the process of assessing, testing and remediating its non-information technology systems, including embedded systems, facilities and other operations, such as its financial, banking, security and utility systems. A contingency plan addressing issues related to the Company's internal infrastructure will be developed when ongoing testing and remediation activities are complete.
Material Third- Party Relations Readiness. The Company has initiated formal communications with its key suppliers, contract manufacturers, distributors, vendors and partners in order to determine whether their operations and the products and services they provide are Year 2000 ready and to monitor the progress of their remediation efforts toward Year 2000 readiness. Based on the Company's assessment of each third party's progress to adequately address Year 2000 issues, the Company expects to develop a third party action list and contingency plans by mid-1999. In the event any such third party cannot provide in a timely manner the Company with products, services, or systems that are Year 2000 ready, this event could have material adverse effect on the Company's business, financial condition and results of operations. The Company could be materially adversely affected by costs or complications arising from Year 2000 issues relating to code changes, testing and implementation for its own systems or similar issues faced by its distributors, suppliers, customers, vendors and the financial service organizations with which the Company does business. The Company is working to identify and analyze the most reasonably likely worst case scenarios for third party relationships affected by the Year 2000. These scenarios could possibly include possible infrastructure collapse, the failure of power and water supplies, major transportation disruptions, unforeseen product shortages and failures of communications and financial systems, any of which could have a material adverse effect on the Company's business, results of operations and financial condition.
Costs related to our efforts to address Year 2000 issues have been expended as incurred and have not been material to date. The Company expects to fund the Year 2000 related costs through funds provided by operations and does not expect these costs to have a material adverse impact on the Company's operations. The Company's estimates of the cost of Year 2000 readiness issues is based partially on numerous assumptions about future events. There can be no assurance that these estimates will be correct, and actual costs could differ materially from these estimates.
Contingency plans will be developed if it appears the Company or its key suppliers and vendors will not be Year 2000 ready, if such condition is likely to have a material adverse impact on the Company's operations. It is expected that assessment, remediation and contingency planning activities will be on going through 1999 with the goal of resolving all material internal systems and third party issues.
Although the Company is dedicating resources toward becoming Year 2000 ready, there is no assurance it will be successful in its efforts to identify and address all Year 2000 issues. Even if the Company acts in a timely manner to complete its assessments, identify, develop and implement its remediation plans (if necessary) some problems may not be identified or corrected in time to prevent material adverse consequences to the Company. The discussion above regarding estimated completion dates, costs, risks and other forward-looking statements
regarding the Year 2000 is based on the Company's best estimates given information that is currently available and is subject to change. As the Company continues to make progress with its Year 2000 initiative, it may discover that actual results will differ materially from these estimates. The impact of the Year 2000 issue on future results of the Company is difficult to discern but is a risk which should be considered in evaluating future prospects for this Company.
European Monetary Union (EMU)
The Company is implementing new internal systems in Europe, and as part of the implementation, is testing its new system for EMU compliance. The Company currently plans to have its review and testing substantially completed by mid 1999. Although the assessments is still underway, the Company does not believe that it will incur material cost or experience material disruption in its business associated with preparing its internal systems for EMU compliance, but there can be no assurance that the Company will not experience serious unanticipated negative consequences or material costs caused by undetected errors or defects.
Software Defects And Liability Claims
Software products frequently contain errors or defects, especially when first introduced or when new versions or enhancements are released. Although the Company has not experienced any 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 or enhancements after commencement of commercial shipments, which could result in delay or loss of revenue, delay in market acceptance, diversion of development resources, damage to the Company's reputation, increased service and warranty costs, any of which could have a material adverse effect upon the Company's business, operating results and financial condition.
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. 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.
Dependence on Third Party Licenses
The Company is dependent on licenses from third-party suppliers for certain elements of its products. In particular, the Company is dependent upon certain licenses from Microsoft, which is both a licensor to the Company and a significant competitor. If any such third-party licenses were terminated or not renewed or if these third parties fail to develop new products in a timely manner, the Company would be unable to redistribute certain components of its products and would be required to develop an alternative approach to developing its products. Furthermore, such products may not be successful in providing the same level of functionality. Such delays, increased costs or reduced functionality could materially adversely affect the Company's business, operating results and financial condition.
Enforcement Of The Company's Intellectual Property Rights
The Company relies on a combination of patent, copyright, trademark, and trade secret laws, non-disclosure agreements and other intellectual property protection methods to protect its proprietary technology. Despite the Company's efforts to protect its intellectual property rights, it may be possible for unauthorized third parties to copy certain portions of the Company's products or to reverse engineer or obtain and use technology or other information that the Company regards as proprietary. In addition, the laws of certain foreign countries do not protect the proprietary rights to the same extent as do the laws of the United States. Accordingly, there can be no assurance the Company will be able to protect its proprietary technology against unauthorized third party copying or use, which could adversely affect the Company's competitive position.
The Company from time to time receives notices from third parties claiming infringement by the Company's products of third party patent and other intellectual property rights. The Company expects that software products will increasingly be subject to such claims as the number of products and competitors in the Company's industry segment grows and the functionality of products overlap. Regardless of its merit, responding to any such claim could be time consuming, result in costly litigation, and require the Company to enter into royalty and licensing agreements which may not be offered or available on terms acceptable to the Company. If a successful claim is made against the Company and the Company fails to develop or license a substitute technology, the Company's business, results of operation or financial condition could be materially adversely effected.
The Company's Stockholders' Rights Plan and certain provisions of the Company's Certificate of Incorporation may discourage or prevent certain types of transactions involving an actual or potential change in control of the Company, including transactions in which the stockholders might otherwise receive a premium for their shares over then current market prices, and may limit the ability of stockholders to approve transactions that they may deem to be in their best interests. In addition, the Company's Board of Directors has the authority to fix the rights and preferences of and issue shares of Preferred Stock without action by the stockholders, which may have the effect of delaying or preventing a change in control of the Company.
Superior rights and preferences of Series B Preferred Stock
The Company has authorized the issuance of up to 1,470 shares of its Series B Preferred Stock, of which 738 shares were outstanding as of December 31, 1998. The Series B Preferred Stock has certain rights and preferences, which are superior to those of Common Stock. In particular, each share of Series B Preferred Stock is entitled to vote the number of shares of Common Stock into which such share of Series B Preferred Stock is convertible, on matters on which all stockholders of the Company are entitled to vote as compared to one vote per share of Common Stock. In addition, upon any liquidation, dissolution or winding up of the Company, each share of Series B Preferred Stock is entitled to be paid the original purchase price per share, or $50,000, from the assets of the Company prior to any payments to the holders of Common Stock. The Company's Board of Directors, without stockholder approval, is authorized to issue up 1,000,000 shares of the Company's Preferred Stock (including the 1,470 authorized shares of Series B Preferred Stock) with voting, conversion or other rights that could adversely affect the voting power and other rights of the holders of Common Stock or the market price of the Common Stock.
Potential Dilutive Effect Of Conversion And Additional Issuance Of Series B Preferred Stock
The number of shares of Common Stock which may be issued upon conversion of the Series B Preferred Stock is dependent upon the trading price of Common Stock at the time of conversion. To the extent that the trading price of Common Stock is lower than $6.94 per share (or $6.88 per share for the Series B shares purchased on July 27, 1998) at the time of any conversion of the currently outstanding shares of Series B Preferred Stock, the number of shares of Common Stock issuable upon such conversion will increase.
Upon at least twenty trading days' written notice, the Company may elect to redeem, on the date which is the second, third, or fourth anniversary of effectiveness of the registration statement, all of the outstanding Series B Shares, at 110% of par. Subject to certain conditions, the Company also has a right to call for redemption for all or a portion of the Series B Shares if the Conversion Rate is less than $6.00 per share.
Risks Associated with Potential Business Combinations
As a part of the Company's business strategy, the Company will review acquisition prospects that would complement the Company's existing product offerings, augment the Company's market coverage or enhance its technological capabilities, or that may otherwise offer growth opportunities. The Company may make acquisitions of businesses, products or technologies in the future. Future acquisitions by the Company could
result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities and amortization expenses related to goodwill and other intangible assets, any of which could materially adversely affect the Company's operating results and/or the market price of the Common Stock. Acquisitions entail numerous risks, including difficulties in the assimilation of acquired operations, technologies and products, diversion of management's attention to other business concerns, risks of entering markets in which the Company has no or limited prior experience and potential loss of key employees of acquired organizations. No assurance can be given as to the ability of the Company to successfully integrate any businesses, products, technologies or personnel that might be acquired in the future, and the failure of the Company to do so could materially adversely effect the Company's business, financial condition and operating results.
Extreme Volatility Of Stock Price
Like the stock of other high technology companies, the market price of the Company's Common Stock has experienced significant fluctuations and may continue to be extremely volatile. During the period from January 1, 1996 to March 15, 1999, the closing market price of the Company's Common Stock has ranged from a high of $20.00 to a low of $4.53. The market price of the Common Stock may be significantly affected by factors such as the announcement of new products or product enhancements by the Company or its competitors, technological innovation by the Company or its competitors, quarterly variations in the Company's or competitors' results of operations, changes in prices of the Company's or its competitors' products and services, changes in revenue and revenue growth rates for the Company as a whole or for specific geographic areas, business units, products or product categories, changes in earnings estimates by market analysts, speculation in the press or analyst community, and general market conditions or market conditions specific to particular industries. Such fluctuations may have a significant impact on the market price of the Company's Common Stock.
The Company's corporate headquarters, including most of its research and development operations, are located in Northern California, a region known for seismic activity. A natural disaster, such as an earthquake, could have a material adverse impact on the Company's business, financial condition and operating results.
Selected Quarterly Data
Amounts in thousands, expect per share amounts, percentages and stock prices:
Three Months Ended ------------------------------------------------ December 31, September 30, June 30, March 31, 1998 1998 1998 1998 ------------ -------------- -------- --------- Licenses and other revenues.. $41,518 $42,481 $41,172 $ 41,043 Service revenues............. 6,622 5,482 5,351 5,443 ------- ------- ------- -------- Net revenues................. 48,140 47,963 46,523 46,486 Cost of licenses and other revenues.................... 4,613 3,857 4,287 2,926 Cost of service revenues..... 4,318 4,180 3,446 3,458 ------- ------- ------- -------- Cost of revenues............. 8,931 8,037 7,733 6,384 ------- ------- ------- -------- Gross profit................. 39,209 39,926 38,790 40,102 ------- ------- ------- -------- Selling, general and administrative.............. 31,055 28,450 25,974 27,302 Research and development..... 12,737 11,509 11,907 11,171 Restructuring and merger related charges............. (3,434) -- -- 19,282 ------- ------- ------- -------- Operating income (loss)...... (1,149) (33) 909 (17,653) ------- ------- ------- -------- Net income (loss)............ $ 3,499 $16,405 $ 1,884 $(13,442) ======= ======= ======= ======== Income (loss) per share-- basic....................... $ 0.07 $ 0.32 $ 0.04 $ (0.27) Income (loss) per share-- diluted..................... $ 0.06 $ 0.29 $ 0.03 $ (0.27)Shares used in computing basic income (loss) per
share....................... 47,987 50,509 51,166 50,863 Shares used in computing diluted income (loss) per share....................... 55,233 56,812 57,572 50,863 Percentage of net revenue: Gross profit................ 81.4 % 83.2 % 83.4% 86.3 % Operating (loss) income..... (2.4)% (0.1)% 2.0% (38.0)% Net income (loss)........... 7.3 % 34.2 % 4.0% (28.9)% Stock Price: High........................ $ 6.81 $ 8.44 $ 11.38 $ 9.81 Low......................... $ 4.94 $ 5.13 $ 6.94 $ 6.69
Three Months Ended ------------------------------------------------ December 31, September 30, June 30, March 31, 1997 1997 1997 1997 ------------ -------------- -------- --------- Licenses and other revenues.. $44,855 $43,267 $43,953 $ 38,224 Service revenues............. 4,837 4,797 4,227 5,197 ------- ------- ------- -------- Net revenues................. 49,692 48,064 48,180 43,421 Cost of licenses and other revenues.................... 5,481 6,100 6,564 5,405 Cost of service revenues..... 2,553 2,373 2,619 2,277 ------- ------- ------- -------- Cost of revenues............. 8,034 8,473 9,183 7,682 ------- ------- ------- -------- Gross profit................. 41,658 39,591 38,997 35,739 ------- ------- ------- -------- Selling, general and administrative.............. 28,613 29,763 28,169 41,448 Research and development..... 12,386 12,446 13,417 16,123 Restructuring and merger related charges............. -- -- -- 5,976 Other non-recurring charges.. -- -- -- 17,100 ------- ------- ------- -------- Operating income (loss)...... 659 (2,618) (2,589) (44,908) ------- ------- ------- -------- Net income (loss)............ $ 730 $(2,098) $(2,526) $(44,536) ======= ======= ======= ======== Loss per share basic......... $ 0.01 $ (0.05) $ (0.05) $ (0.97) Loss per share diluted....... $ 0.01 $ (0.05) $ (0.05) $ (0.97)Shares used in computing basic income (loss) per
share....................... 50,428 49,869 48,702 45,966 Shares used in computing diluted income (loss) per share....................... 57,738 49,869 48,702 45,966 Percentage of net revenue: Gross profit................ 83.8% 82.4 % 80.9 % 82.3 % Operating income (loss)..... 1.3% (5.4)% (5.4)% (103.4)% Net income (loss)........... 1.5% (4.4)% (5.2)% (102.6)% Stock Price: High........................ $ 7.63 $ 10.25 $ 7.00 $ 8.56 Low......................... $ 7.25 $ 10.06 $ 6.75 $ 5.69
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risks relating to the Company's operations result primarily from changes in interest rates and foreign exchange rates, as well as credit risk concentrations. To address the foreign exchange rate risk the Company enters into various hedging transactions as described below. The Company does not use financial instruments for trading purposes.
Foreign Currency Risk. The Company transacts business in various foreign countries, including Japan, Canada and certain countries within Europe and South East Asia. The Company has established a foreign currency hedging program utilizing foreign currency forward exchange contracts to hedge intercompany balances and other monitory assets denominated in foreign currencies. The goal of the hedging program is to offset the earnings impact of foreign denominated balances. The Company does not use foreign currency forward exchange contracts for trading purposes. At month end, the foreign denominated balances and the forward exchange contracts are marked-to-market and unrealized gains and losses are included in current period net income.
During the year ending December 31, 1998, the Company has recorded foreign exchanges losses on intercompany receivables due to the dollar strengthening against many foreign currencies including Japanese Yen, Australia Dollar and Singapore Dollar during the first quarter and several European currencies decreasing value against the Dutch Guilder during the third quarter. Such losses have been mostly offset by the Company's foreign exchange contracts. It is uncertain that these currencies trends will continue. If these currencies trends continue, the Company will continue to experience foreign exchange losses on their intercompany receivables to the extent that the Company has not hedged the exposure with foreign currency forward exchange contracts. Such foreign exchange losses could have a materially adverse affect on the Company's operating results and cash flows.
The table below provides information about the Company's derivative financial instruments, comprised of foreign currency forward exchange contracts. The information is provided in U.S. Dollar equivalents amounts, as presented in the Company's financial statements. For foreign currency forward exchange contracts, the table presents the notional amounts (at the contract exchange rates) and the weighted average contractual foreign currency exchange rates. All instruments mature within twelve months.
December 31, 1998 Notional Average Estimated Amount Contract Rate Fair Value ----------- ------------- ------------ Foreign currency forward exchange contracts: Australian Dollar..................... 5,606,327 0.62 (56,127) Canadian Dollar....................... 1,300,259 1.54 10,712 Italian Lira.......................... 1,195,876 1635.77 (10,168) Hong Kong Dollar...................... 4,698,635 7.77 10,867 Dutch Guilder......................... (4,351,866) 1.86 35,415 New Taiwan Dollar..................... 1,509,265 32.38 2,334 Others................................ 3,234,208 24,837 ----------- ------- Total............................... $13,192,704 $17,870 =========== =======Interest Rate Risk. The Company's exposure to market risk for changes in interest rates relates primarily to the Company's investment portfolio. The Company does not use derivative financial instruments in its investment portfolio. The Company places its cash equivalents and short-term investments in a variety of financial instruments such as commercial paper. The Company, by policy, limits the amount of credit exposure to any one financial institution or commercial issuer.
The Company mitigates default risk by investing in only the safe and high credit quality securities and by constantly positioning its portfolio to respond appropriately to a significant reduction in the credit rating of any investment issuer. The portfolio includes only marketable securities with active secondary and resale markets to ensure portfolio liquidity.
The Company has no interest rate exposure due to rate changes for long-term debt obligations. The Company primarily enters into debt and capital lease obligations to financial capital expenditures. Such debt and capital lease obligations have a fixed rate of interest.
The table below presents principal (or notional) amounts and related weighted average interest rates by year of maturity for the Company's investment portfolio and debt obligations.
In thousands 1999 2000 2001 2002 2003 Thereafter Total ------------ ------- ---- ---- ---- ---- ---------- ------ ASSETS Cash Equivalents................. $81,137 Fixed rate..................... 4.87% Short-term investments........... $ 3,225 Fixed rate..................... 1.00% LONG-TERM DEBT................... $ 145 $161 $180 $200 $222 $8,341 $9,249 Fixed Rate..................... 10.75%The short term investment balances are primarily invested in non-U.S. countries, principally Japan.
Credit Risks. The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash equivalents and trade receivables. The Company's cash equivalents are in high quality securities placed with major banks and financial institutions. Concentrations of credit risk with respect to receivables are limited due to the large number of customers and their dispersion across geographic areas. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. One customer located in United States accounts for approximately 11% of total receivable. No other single group or customer represents greater than 10% of total accounts receivable.
ITEM 8. Financial Statements and Supplementary Data
The Company's financial statements included with this Form 10-K are set forth under Item 14 hereof.
ITEM 9. Changes in or Disagreements with Accountants on Accounting and Financial Disclosure