ITEM 1. BUSINESS.
COMPANY OVERVIEW
Persistence is a leading provider of transactional application servers and dynamic Web content acceleration servers -- software that processes transactions between users and back-end computer systems in electronic commerce systems. By caching data, or moving information stored in back-end computer systems closer to users, our software dramatically reduces network traffic, resulting in both better network performance and faster transaction processing. In addition, PowerTier application servers implement Sun Microsystems' full Java 2 Platform, Enterprise Edition (J2EE, formerly known as Enterprise Java Beans or EJB) standard to enable businesses to deploy sophisticated Java applications, which readily scale, or accommodate rapidly increasing numbers of users. Our PowerTier family of transactional application servers offers the speed, scalability and reliability to enable the next generation of sophisticated, high-volume electronic commerce applications. Our Dynamai Web content accelerator improves the speed and scalability of electronic commerce Web sites that rely heavily on dynamically generated content using technologies such as Java Server Pages and Active Server Pages. Our major customers include AT&T, Boeing, Cisco, FedEx, Fujitsu, Instinet, Intershop, iPIX, Lucent, Morgan Stanley Dean Witter, Motorola, Network Commerce, Nokia, Salomon Smith Barney and Wells Fargo.
INDUSTRY BACKGROUND
The Internet has evolved into a global communications medium enabling millions of people to share information and conduct business electronically. As the Internet's popularity has increased, companies in industries ranging from securities trading to book selling are extending their core business processes over the Web to conduct electronic commerce with customers, suppliers and partners. The growth of these electronic commerce offerings has led to significant growth in the number of users and transactions conducted over the Web.
While creating new business opportunities, the significant growth of electronic commerce has also created tremendous technological challenges for electronic commerce companies struggling to meet the needs of rapidly increasing numbers of users. These companies are discovering that their existing Internet software infrastructure is unable to support thousands of concurrent users or process up to thousands of transactions per second. Even casual observers of the Internet are familiar with these limitations, which include:
- Poor performance: Initial electronic commerce offerings were not designed to scale to handle large numbers of users. Internet users accessing these systems often experience lengthy delays as the number of concurrent users increases.
- System failures: Initial electronic commerce offerings did not anticipate the level of robustness required to operate 24 hours a day, 7 days a week. Internet users accessing these systems at peak volume can experience frequent system crashes.
- Limited adaptability: Initial electronic commerce offerings were built on software infrastructures that offered only limited ability for customization and personalization. To remain competitive, companies must continuously enhance and differentiate their electronic commerce offerings.
While these problems have been well-publicized in the business-to-consumer market, we believe that business-to-business interactions face even more pronounced problems due to the added complexity of
managing transactions between multiple companies. In addition, we expect the growth of the business-to-business electronic commerce market to outpace the growth of the business-to-consumer market.
In large part, the problems facing these organizations, both in business-to-business and business-to-consumer electronic commerce, are derived from the continuing evolution and increasing sophistication of web-based applications. In the early days of the Internet, organizations turned to the Web for information publishing, decision support and simple transaction processing. This first generation of web-based applications focused on extending legacy applications to the Internet. These applications were typically not business- critical, and had relatively simple interactions and limited functionality. The web application server emerged as the infrastructure used to support these first generation applications.
Today, use of the Web has changed dramatically as the Web has emerged as a leading platform for conducting electronic commerce. The number of individuals and organizations conducting transactions over the Internet has increased significantly, as organizations have offered increasingly sophisticated and feature-rich electronic commerce applications. At the same time, as organizations have begun to conduct significant volumes of business over the Internet, system failures and delays in transaction processing have ceased to be mere inconveniences and have become serious impediments to doing business. To achieve a competitive advantage in today's environment, many businesses are looking to create web-based electronic commerce offerings that are available 24 hours per day, 7 days per week and that enhance customer loyalty by leveraging partner, supplier and third party relationships. Complicating these challenges further is the need to rapidly develop and deploy these applications on "Internet time."
As the Internet has evolved into a critical business platform, the limitations of the software infrastructure used to support electronic commerce have become apparent. The first generation web application servers were not designed to accommodate the high transaction volumes and high performance requirements that characterize electronic commerce today.
The next generation of electronic commerce will require a fundamentally new software infrastructure, based on an application server platform optimized for high volume transaction processing over the Internet. The platform must provide:
- Real-time scalability: accommodate up to thousands of end users with consistent sub-second response times;
- High availability: handle system failures without interruption and without losing critical information for potentially thousands of concurrent users;
- Rapid adaptability: allow companies to continuously improve their business processing through automated development and management of differentiated electronic commerce offerings; and
- Business-to-business integration: enable businesses to extend their processing across organizational boundaries.
PERSISTENCE SOLUTION
Our PowerTier and Dynamai family of products consists of transactional application servers that are specifically designed to enable high volume, high performance electronic commerce applications. Our products, PowerTier for EJB, PowerTier for C++ and Dynamai, address the scalability, availability and adaptability demands that typically occur when delivering business solutions over the Internet. Our products offer the following key benefits:
Real-Time Response for Thousands of Concurrent Users. Our PowerTier and Dynamai products were designed specifically to accommodate high volume transaction processing and the data integrity requirements of distributed applications. Both PowerTier and Dynamai utilize caching technology. Caching is a process in which data is pulled out of back-end systems and into the server cache, which allows the data to be shared and manipulated by multiple users. Replication between PowerTier server caches using the PowerSync feature allows a cluster of PowerTier servers to provide highly scalable performance as the number of users increases. Dynamai is designed to use a similar clustering scheme to enable successful cooperation among multiple
caches. This architecture helps reduce the work load on back-end systems and accelerates application performance. The effect of this architecture is to minimize unnecessary network traffic and thereby enable high performance and reliability even with significant transaction volumes. We believe that both our PowerTierand Dynamai products offer superior performance and scalability to support the deployment of large-scale electronic commerce applications.
Dramatic Reductions In Time-to-Market for Electronic Commerce Applications. Our PowerTier platform decreases time to market and development cycles for sophisticated electronic commerce applications due to our proprietary and patented object-to-relational mapping technology. This technology enables the automatic generation of software code, which minimizes basic, low-level programming tasks, such as security and database access. The PowerTier platform accelerates development by giving developers access to data in a familiar way, as software components, and provides application developers with a framework to rapidly build electronic commerce applications. Similarly, the Dynamai product enhances the performance and scalability of Web-based systems through a relatively simple cache configuration process, which does not require costly re-architecture of existing back-end systems.
Protects and Leverages Existing Information Technology Investments. The PowerTier platform enables developers to build new electronic commerce applications while simultaneously integrating existing back-end systems. PowerTier's flexible architecture integrates with disparate database servers, web servers and multiple clients, while supporting multiple programming languages and computing platforms. PowerTier provides enhanced flexibility and interoperability to link existing enterprise applications and systems, allowing businesses to leverage their investments in information technology and extend them over the Internet. Similarly, the Dynamai product is designed to provide its benefits with minimal disruption of existing information technology investments.
Leadership in Emerging Standards. Customers are increasingly seeking open, standards-based technology solutions that enable them to develop and implement new applications rapidly. Our PowerTier for EJB products provide application server solutions that support the J2EE specification to enable businesses to deploy high performance, scalable Java applications for the enterprise. We worked with the Sun Microsystems consortium to define an industry-wide component standard to be used when building enterprise applications with the Java language. It is this standard upon which our PowerTier platform is built, and we believe that this emerging platform has the potential to dramatically simplify the development of distributed, multi-tier electronic commerce applications. Sun introduced the Java 2 Platform, Enterprise Edition (J2EE) in 1999, which is a suite of enterprise Java technology specifications. Persistence became one of Sun's first J2EE licensees, and we intend to continue to be a leading adopter and contributor to these technologies as they evolve.
Optimized Platform For Business-to-Business Electronic Commerce. Our transactional application server is designed and optimized to enable complex online transactions, providing the necessary scalable, reliable and secure infrastructure. Platforms designed to support the next generation of business-to-business electronic commerce applications must handle hundreds and potentially thousands of concurrent users while simultaneously providing reliability and security, and enabling connections to a myriad of existing and emerging back-end applications. In addition, we believe our PowerTier products are particularly well suited for multi-party, multi-step business-to-business transactions that require server-to-server communication.
PERSISTENCE STRATEGY
Our objective is to become a leading provider of transactional application server software and dynamic Web content acceleration products that comprise the Internet software infrastructure for high volume, high performance electronic commerce applications. To achieve this goal, we intend to:
Increase Partnerships With OEM and Reseller Partners. We intend to continue to develop and expand relationships with OEM and reseller partners. We believe these third parties can effectively market our products, particularly Dynamai, through their existing relationships with our target market customers. We believe that these relationships will provide additional marketing and sales channels for our products and
facilitate the successful deployment of customer applications. We are currently working with multiple OEM and reseller partners, including Intel, with whom we announced a reseller agreement in February 2001.
Capture Market Share in the Emerging Business-to-Business Electronic Commerce Market. We intend to become a market leader in providing software infrastructure to enable sophisticated business-to-business electronic commerce applications. To achieve this objective, we will continue to make investments in building our sales and marketing organizations by shifting to a greater focus on our indirect sales channels. We continue to launch a variety of sales and marketing programs designed to capture market share. We will continue to collaborate with our innovative and advanced customers to develop and deliver product features that address their needs. We believe that this collaboration focuses our overall product development effort and speeds our time-to-market.
Extend Technology Leadership Position in Standards-Based Platforms for Next Generation Electronic Commerce. We intend to extend our technology leadership in the transactional application server and dynamic Web content acceleration markets by enhancing our underlying technology to offer real-time scalability, high availability and rapid adaptability for the next generation of electronic commerce applications. To achieve this objective, we will continue to make investments in our research and development organization. In addition, we intend to be a leader in the definition and adoption of emerging technology standards, such as J2EE, which we believe have the potential to dramatically simplify the development of distributed, multi-tier applications. We have been a pioneer in the areas of caching and object-relational mapping, and hold several patents on core technologies. We intend to continue to innovate and create new enabling technologies for electronic commerce.
Expand Product Platform to Offer Complementary Solutions. In addition to extending our technology leadership, we intend to broaden and enhance our product platform to incorporate complementary solutions for developing and deploying sophisticated electronic commerce applications. We will continue to make investments in our research and development organization for many of these product initiatives. We will also consider, from time to time, bolstering these internal efforts with strategic acquisitions. For example, we have recently licensed real-time client notification technology, which provides the client notification infrastructure through updates of server-side information resources that are processed and routed to clients of the PowerTier for EJB application server. The addition of these complementary technologies will enable us to offer a more complete platform for our customers.
Leverage Installed Customer Base. We believe that there are significant opportunities to expand the use of our products throughout our current customer base. Although most organizations initially deploy our products on a departmental or pilot basis, we believe that initial customer success with these deployments may lead to significant opportunities for enterprise-wide adoption. Further, we believe that most companies, including our customers, are just beginning to fully capitalize on the opportunities created by the Web. As these companies increasingly migrate their core business processes to the Web, we believe they will need additional licenses of our software to support and enable their new electronic commerce applications.
Strengthen International Presence. We believe there are significant international opportunities for our products and services, in particular, in Europe and Asia. Currently, we have established direct sales operations in the United Kingdom, Germany, Hong Kong and Shanghai. In addition to our direct sales operations, we also distribute our products throughout Europe and Asia with distributors and systems integrators. We intend to extend these international third-party distributor and systems integrator relationships.
PRODUCTS
Our PowerTier platform is a family of transactional application server products that deliver scalability, high availability and rapid adaptability for high volume, high performance electronic commerce applications. Our current product line consists of PowerTier for EJB, which was released in 1998, and PowerTier for C++, which was released in 1997. The following table describes the major features and benefits of our PowerTier platform.
PowerTier for EJB
Our PowerTier for EJB application server platform incorporates our patented technologies into one of the few J2EE-based transactional application servers. The EJB and J2EE standards, as defined by the Java Software division of Sun Microsystems, are gaining rapid acceptance as a programming language for complex enterprise applications. J2EE provides a consistent way to program and integrate services for companies building distributed business-to-business applications with the Java programming language.
The EJB standard specifies container-managed persistent objects, which automate the mapping between EJB components and relational database tables. This feature allows programmers to build complex applications quickly by making relational data look like software components, which can be easily manipulated. We worked with the Sun Microsystems consortium to help define the initial EJB standard, and we continue to contribute to new versions of the EJB standard. Our PowerTier for EJB platform now runs on the Windows NT and multiple varieties of the Unix operating systems.
Our latest version of PowerTier for EJB, PowerTier 6 with PowerPage, is designed to simplify the complex task of developing high performance, scalable web applications and eliminate the need to compromise between powerful application servers and simplicity of web page creation. The PowerTier 6 application server is designed to have an end-to-end J2EE development platform that enhances development team productivity and allows scalable, flexible applications to be rolled out at internet speed.
PowerPage is designed to give web developers a head start by providing them with a pre-built HTML framework from which to work, as well as an EJB-based back-end for maintainability and scalability. PowerPage is also designed to automatically generate Java Server Pages (JSPs), which provide the interface
between the browser and the EJB server. The end result of the design is to have dynamic HTML pages with access to EJBs, thus greatly reducing the manual coding of hundreds of lines required for a distributed application.
PowerTier 6 also:
- Is designed to be security compliant with Sun's EJB 1.1 specification, providing integrated and comprehensive authorization, authentication and encryption capability for new applications
- Includes an enterprise class Servlet Engine tightly integrated with PowerTier 6, with support for Java servlets and JSPs. The Servlet Engine is designed to be scalable and fault tolerant.
PowerTier for C++
Our PowerTier for C++ product is a high-performance transactional application server platform, which is based on our patented technologies and the Common Object Request Broker Architecture, or CORBA, standard for communication between distributed applications. The CORBA standard is managed by an industry group called the Object Management Group, of which we are a contributing member. We are also one of the authors, along with Oracle, IBM and others, of an emerging component of the overall CORBA standard, called the Persistent State Service specification. Our PowerTier for C++ platform runs on the Windows NT and Unix operating systems. We have licensed the J2EE platform and are a contributor to the Java standard. Patented Technology Platform
Our application server cache software architecture and cache replication technology have been designed to serve as the foundation for a variety of scalable electronic commerce applications.
- Shared Caching. Our cache technology is the foundation for the high performance characteristics of our transactional application server. To maximize performance, dynamic information such as product inventory data is retrieved from a database into the application server cache. This in-memory information may be accessed simultaneously by multiple users, saving each user from having to access a disk-based database for that information. This feature reduces network traffic between the application server and the database, delivering higher performance.
- Transactional Caching. To enable users to get a consistent view of information within the shared cache, our technology prevents one user from seeing uncommitted changes made by another user. The ability of our shared application server cache to isolate users from dynamic changes to component information, such as inventory data, differentiates our application server cache from other caching technologies which can only manage static information, such as web pages. This feature allows high performance caching of dynamic or transactional information.
- Cache Replication. Our cache replication technology provides the foundation for the scalability, stateful availability and fault tolerance of our transactional application server. We define stateful availability as a system that can transfer a user in the middle of a complex business operation, such as a portfolio valuation, from one application server to another without interruption or losing business state, such as the user's portfolio information. To provide stateful scalability, information from one application server cache can be synchronized with information in one or more other application server caches. Companies can deploy additional replicated application server caches to increase their ability to support more users, allowing them to use several smaller computers to do the work of one larger and more expensive computer. Users' requests are automatically routed to the application server with the most free capacity, enabling high performance, notwithstanding increases in user volumes. In the event of an application server failure, that application server's responsibilities are automatically reassigned to another application server, improving system availability.
- Cluster Management. We have developed complementary, proprietary administration software, which enables remote administration for clusters of application servers, reducing both administrative costs and the possibility of error. This management software also enables centralized monitoring, via a
standard web browser, of the cluster through any individual application server. This feature contributes to greater system availability and reduced administrative costs.
- Development Automation. Our PowerTier development environment includes frameworks to automate or eliminate many development tasks. The proprietary and patented object-relational mapping feature automatically generates the software code to translate software components into relational databases. This feature reduces the programming time required to build enterprise applications. The PowerTier application server includes pre-built software services for data management, transaction management and communications, relieving the developer from having to build these services from scratch.
- Standards-based. The PowerTier application server platform uses an open architecture that is based on industry standards such as Java, C++, CORBA, Windows NT, UNIX, SQL, J2EE, EJB and others.
Dynamai
Our Dynamai Web content accelerator improves the speed and scalability of electronic commerce Web sites that rely heavily on dynamically generated content using technologies such as Java Server Pages and Active Server Pages. The Dynamai product was released in 2000. The following table describes the major features and benefits of Dynamai.
We believe that research and product development will be a key to our success as a leader in the transactional application server and dynamic Web content acceleration markets. Our research and development expenditures totaled $8.1 million for 2000, $6.4 million for 1999, and $4.2 million for 1998.
CUSTOMERS
Our software products are licensed to customers worldwide for use in a wide range of electronic commerce applications, including real-time electronic trading, supply chain management, internet network management, application outsourcing and customer relationship management. The following table lists a representative selection of customers who have purchased our products.
- ---------------
* Denotes customers who have ordered at least $500,000 in products.
In 2000, sales of products and services to Salomon Smith Barney accounted for 16% of our total revenues. In 1999, sales of products and services to Cisco accounted for 13% of our total revenues. In 1998, sales of software licenses to Cisco accounted for 14% of total revenues, and sales of software licenses to Instinet accounted for 17% of total revenues.
The following case studies illustrate how selected customers have used our products to address their electronic commerce and core business application needs. These case studies are based on information supplied by these customers, however we believe the information is accurate in all material respects. Reuters, the parent of Instinet, and Cisco are both stockholders in our company.
Real-Time Electronic Trading Network
Instinet Corporation. Instinet is the world's largest electronic agency broker in equity securities. Historically, trading in fixed income securities occurred almost exclusively over the telephone. Instinet revolutionized this telephone-based fixed income trading with a global electronic broker trading service for fixed income dealers that can accommodate up to 1,000 transactions per second. It has designed a system that was just brought live in the U.S., which is expected to use hundreds of replicated PowerTier application servers operating in concert when fully deployed to meet the performance and scalability requirements of its electronic fixed income broker service. In 1998, sales of software licenses to Instinet accounted for 17% of total revenues.
Intranet Supply Chain Management
Federal Express Corporation. The world's largest express transportation company, FedEx transports more than three million items to over 200 countries each business day, using a fleet of more than 620 aircraft and 44,000 vehicles. In its effort to improve on-time deliveries, FedEx has built a global operations center to monitor and control the movement of shipments worldwide. The global operations center functions as the nerve center of the FedEx transportation system, handling daily occurrences including changing flight schedules, emergency maintenance, inclement weather and excess package volumes. Because the company's existing mainframe systems lacked the required flexibility and performance, FedEx turned to us for help in building a high performance intranet system. By managing complex flight schedule information from multiple data sources within a PowerTier application server cache, the global operations center can provide real-time contingency plans, enabling FedEx to provide consistently high on-time package delivery rates and superior customer service. FedEx estimates that, using the PowerTier development environment, it has been able to significantly reduce development time for new system functionality compared to development in its traditional mainframe environment.
Internet Service Provider Network Management
Cisco Systems, Inc. A worldwide leader in networking for the Internet, Cisco Systems is committed to delivering hardware and software solutions that enable Service Providers to meet the rapid growth of the Internet. The Cisco Service Management System, or CSM, gives Service Providers sophisticated tools to automate time-consuming network management tasks. For this system, Cisco required a highly scalable, standards-based application server platform for deploying network management applications for managed business services such as virtual private networks, Internet telephony and electronic commerce. To meet these requirements, Cisco chose the PowerTier platform. For the Cisco IP Manager product within the CSM system, PowerTier application server caching enables real-time simulation of network configuration changes, preventing costly network outages. The PowerTier development environment also enables Cisco to create a common component framework that can be reused to reduce development time for future CSM network services. In 1999, sales of products and services to Cisco accounted for 13% of our total revenues, and in 1998, sales of software licenses to Cisco accounted for 14% of total revenues.
Application Outsourcing over the Internet
Celera Genomics. Celera provides gene discovery and characterization services for drug discovery and development. Celera's GeneTag technology is a novel gene expression analysis method that enables pharmaceutical companies to develop new and potentially life-saving drugs by discovering and monitoring genes involved in disease. Celera's BioScope software application allows customers to access their data securely and remotely over the Internet. To allow clients to quickly analyze and view the GeneTag results, Celera needed a sophisticated software platform that could process hundreds of thousands of gene expression comparisons while avoiding data bottlenecks. Celera selected PowerTier to achieve these goals. The BioScope application utilizes the PowerTier application server cache for high volume data analysis. With the PowerTier development environment, Celera has been able to use both the Java and C++ languages to deliver the BioScope software application in only four months.
Dynamic Visual Content Delivery over the Internet
Internet Pictures Corporation. IPIX is a leader in delivering dynamic visual content for the Internet. Its technology is used by several of the Internet's most popular brands, such as eBay, Yahoo! and Realtor.com. iPIX's Virtual Tours for real estate are the daily destination for hundreds of thousands of real estate buyers and sellers worldwide. These tours allow potential buyers to view immersive 360-degree tours of properties at their leisure. IPIX chose Dynamai to speed up the performance of its back-end servers, handle traffic spikes gracefully and reduce the cost of building out its infrastructure to support a growing customer base. They were able to put Dynamai into production in a matter of days, achieving a 35x improvement in site scalability with almost no changes to their existing infrastructure.
SALES AND MARKETING
We sell our products through both a direct sales force and third party distributors. As of December 31, 2000, we had 68 people in our sales and marketing organization, of which 41 were in the United States, 18 were in European offices, and 9 were in our Asian offices. To support the complex enterprise nature of our sales, our direct sales force is organized into two-member teams of one sales representative and one sales engineer. We intend to increase the size of our sales force focused on indirect distribution channels.
Our sales cycle is relatively long, generally between three and nine months. A successful sales cycle typically includes presentations to both business and technical decision makers, as well as a limited pilot program to establish technical fit.
We have engaged in, and may engage in a variety of targeted marketing activities, including focused advertising, public relations, seminars, trade shows and customer-oriented web site management. We have also made substantial marketing investments in education and training for the EJB and C++ markets. We hold periodic seminars in order to train developers in the EJB community. Our web site allows developers to download a demonstration version of our products.
We intend to continue to develop and expand relationships with OEM and reseller partners. We believe these third parties can effectively market our products, particularly Dynamai, through their existing relationships with our target market customers. We believe that these relationships will provide additional marketing and sales channels for our products and facilitate the successful deployment of customer applications. We are currently working with multiple OEM and reseller partners, including Intel, with whom we announced a reseller agreement in February 2001.
In international markets, we plan to expand our sales through indirect channels, such as distributors and original equipment manufacturers. As of December 31, 2000, we were represented by seven international distributors, who sell our products in Europe, Asia and Latin America.
COMPETITION
The market for our products is intensely competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. We believe that the principal competitive factors in our market are:
- performance, including scalability, integrity and availability;
- ability to provide a complete software platform;
- flexibility;
- use of standards-based technology;
- ease of integration with customers' existing enterprise systems;
- ease and speed of implementation;
- quality of support and service;
- security;
- company reputation; and
- price.
Our competitors for both PowerTier and Dynamai include both publicly and privately-held enterprises, including BEA Systems (WebLogic), Secant Technologies, IBM (WebSphere), Oracle (OAS) and Sun Microsystems (iPlanet). Many customers may not be willing to purchase our PowerTier or Dynamai products because they have already invested heavily in databases and other enterprise software components offered by these competing companies. Many of these competitors have pre-existing customer relationships, longer operating histories, greater financial, technical, marketing and other resources, greater name recognition and larger installed bases of customers than we do. In addition, some competitors offer products that are less complex than our PowerTier products and require less customization to implement with potential customers' existing systems. Thus, potential customers engaged in simpler business-to-business e-commerce transactions may prefer these "plug-and-play" products to our more complex offerings. Moreover, there are other very large and established companies, including Microsoft, who offer alternative solutions and are thus indirect competitors. Further, dozens of companies have announced their intention to support EJB/J2EE and may compete against us in the future. These competitors and potential competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we can. See also "Risk Factors -- Because we compete with Sun Microsystems, who controls the EJB/J2EE standard, we face the risk that they may develop this standard to favor their own products" and "-- Microsoft has established a competing application server standard, which could diminish the market potential for our products if it gains widespread acceptance."
In addition, in the PowerTier for C++ market, many potential customers build their own custom application servers, so we effectively compete against our potential customers' internal information technology departments.
In the Dynamai market, similar dynamic Web content acceleration technology is available from a variety of sources, including but not limited to internal development, application server vendors such as Oracle, electronic commerce software vendors such as Intershop and ATG, content delivery networks such as Akamai and epicRealm, and emerging software and hardware appliance vendors such as Chutney and Cachier, who are directly targeting Dynamai's market.
INTELLECTUAL PROPERTY RIGHTS
Our performance may depend on our ability to protect our proprietary rights to the technologies used in our principal products. If we are not adequately protected, our competitors can use the intellectual property
that we have developed to enhance their products and services, which would harm our business. We rely on a combination of patents, copyright and trademark laws, trade secrets, confidentiality provisions and other contractual provisions to protect our proprietary rights, but these legal means afford only limited protection. As of February 28, 2001, we had five issued United States patents and two pending United States patent applications with allowable subject matter. Despite any measures taken to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries may not protect our proprietary rights as fully as do the laws of the United States. Thus, the measures we are taking to protect our proprietary rights in the United States and abroad may not be adequate. Finally, our competitors may independently develop similar technologies.
The software industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement and the violation of other intellectual property rights. As the number of entrants into our market increases, the possibility of an intellectual property claim against us grows. For example, we may be inadvertently infringing a patent of which we are unaware. In addition, because patent applications can take many years to issue, there may be a patent application now pending of which we are unaware, which will cause us to be infringing when it issues in the future. To address these patent infringement claims, we may have to enter into royalty or licensing agreements on disadvantageous commercial terms. Alternatively, we may be unable to obtain a necessary license. A successful claim of product infringement against us, and our failure to license the infringed or similar technology, would harm our business. In addition, any infringement claims, with or without merit, would be time-consuming and expensive to litigate or settle and would divert management attention from administering our core business.
In March 1998, we entered into a license agreement with Sun Microsystems, pursuant to which we granted Sun Microsystems rights to manufacture and sell, by itself and not jointly with others, products under a number of our patents and Sun Microsystems granted us rights to manufacture and sell, by ourselves and not jointly with others, products under a number of Sun Microsystems' patents. As a result, Sun Microsystems may develop and sell competing products that would, in the absence of this license agreement, infringe our patents. Under this agreement, Sun Microsystems made a one-time payment to us. Neither Sun Microsystems nor we can transfer the license without the consent of the other party.
EMPLOYEES
As of December 31, 2000, we had 152 full-time employees, including 68 in sales and marketing, 51 in research and development, 12 in professional services and 21 in general and administrative functions. Our relationships with our employees are generally good. From time to time, we also employ independent contractors to support our sales and marketing, research and development, professional services and administrative organizations.
EXECUTIVE OFFICERS
The following table sets forth specific information regarding our executive officers as of February 28, 2001:
Each executive officer serves at the sole discretion of the Board of Directors.
Christopher T. Keene co-founded Persistence and has served as Chief Executive Officer and a director since June 1991 and as Chairman of the Board since April 1999. From June 1991 to April 1999, Mr. Keene also served as President. Before founding Persistence, Mr. Keene was a Manager at McKinsey & Co., a management consulting firm, from July 1987 to June 1991. Mr. Keene holds a B.S. degree in Mathematical Sciences with honors from Stanford University and an M.B.A. degree from The Wharton School at the University of Pennsylvania.
James H. Barton has served as Vice President of Strategic Technology and Chief Technology Officer since February 2000, as Director of Strategic Technology from November 1999 to February 2000, and as Senior Field Engineer from October 1997, when he joined Persistence, to November 1999. From June 1996 to October 1997, Mr. Barton was Director of Internet Products and Services for Applied Reasoning Systems, an information technology company. From July 1994 to June 1996, he was a Senior Systems Engineer with ParcPlace Systems, a pioneering company in distributed object technology. Previously, he held field engineering positions at information technology companies Object Design, Rational Software, and IBM. Mr. Barton holds a B.S. degree in Electrical Engineering from Tennessee Technological University, an M.S. degree in Computer Engineering from Carnegie Mellon University, and an M.B.A. degree from the University of Maryland.
Derek Henninger co-founded Persistence and has served as Vice President of Engineering since June 1991. Previously, Mr. Henninger worked as a senior software engineer in the Data Interpretation Division of Metaphor Corporation, a software and hardware company, from September 1990 to June 1991. Mr. Henninger holds a B.A. degree in Economics and a B.S. degree in Computer Science and Mathematics from the University of California at Davis.
Mark Palmer joined Persistence in June 2000 as Senior Vice President of Worldwide Field Operations. He leads the company's global sales organization. From April 1999 through June 2000 Mr. Palmer was on a personal sabbatical. From May 1994 to April 1999, Mr. Palmer has served as President and Chief Executive Officer of TriMark Technologies, a company that designed insurance industry software. Earlier in his career, Mr. Palmer managed sales operations at Sun Microsystems, a leading hardware and software company, where he helped reengineer an alternate distribution channel. Mr. Palmer held senior level sales and executive management positions in various software companies including Inforex and Data General Corporation.
Christine Russell joined Persistence in October 1997 and has served as Chief Financial Officer and Secretary since December 1997. Previously, she served as Chief Financial Officer for Cygnus Solutions, an open source platform software company, from October 1995 to October 1997. From April 1992 to October 1995, Ms. Russell served as Chief Financial Officer of Valence Technology, a developer of lithium polymer batteries. Previously, she served as Chief Financial Officer at Covalent Technologies, Inc., a vertical software company, as Vice President of Finance of Stellar Systems, Inc. a security software and hardware company, and as Corporate Controller of Shugart Corporation, a subsidiary of Xerox. She holds a B.A. degree in English Literature and an M.B.A. degree from Santa Clara University.
ITEM 2.
ITEM 2. PROPERTIES.
We are headquartered in San Mateo, California, where we lease approximately 22,000 square feet of office space under a lease expiring on June 30, 2002. We have an engineering staff facility in San Diego, where we lease approximately 6,000 square feet of office space under a lease expiring on August 31, 2004. We also maintain sales offices in various U.S. states, the United Kingdom, Germany, Hong Kong and Shanghai. We believe that our existing facilities are adequate to meet our current and foreseeable requirements or that suitable additional or substitute space will be available as needed.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
We are not currently subject to any material legal proceedings. We may, however, from time to time become a party to various legal proceedings that arise in the ordinary course of business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK. Our Common Stock has been traded on the Nasdaq National Market under the symbol PRSW since the effective date of our initial public offering on June 24, 1999. Prior to the initial public offering, no public market existed for our Common Stock. The price per share reflected in the table below represents the range of low and high closing sale prices for our Common Stock as reported in the Nasdaq National Market for the periods indicated.
We had 177 stockholders of record as of February 28, 2001, including several holders who are nominees for an undetermined number of beneficial owners.
DIVIDEND POLICY. We have never paid dividends on our common stock or preferred stock. We currently intend to retain any future earnings to fund the development of our business. Therefore, we do not currently anticipate declaring or paying dividends in the foreseeable future. In addition, our line of credit agreement prohibits us from paying dividends.
USE OF PROCEEDS FROM SALES OF REGISTERED SECURITIES. Our registration statement on Form S-1, SEC File No. 333-76867, for our initial public offering of common stock became effective on June 24, 1999. We registered and sold an aggregate of 3,450,000 shares of common stock under the registration statement at a per share price of $11.00. Our underwriters were BancBoston Robertson Stephens, U.S. Bancorp Piper Jaffray, and Soundview Technology Group. Offering proceeds, net of aggregate underwriting commissions and discounts of $2.7 million and other offering transaction expenses of $1.1 million, were $34.1 million. None of the underwriting commissions and discounts or other offering transaction expenses were direct or indirect payments to our directors, officers, or holders of 10% or more of our stock. From June 24, 1999 through December 31, 2000, we have used the net offering proceeds as follows:
Each of the above amounts represents our best estimate of our use of the net proceeds. None of the net offering proceeds were paid directly or indirectly to our directors, officers, or holders of 10% or more of our stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations," which are included elsewhere in this report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 2000, 1999 and 1998, and the consolidated balance sheet data at December 31, 2000, and 1999, are derived from audited consolidated financial statements included elsewhere in this report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 1997 and 1996, and the consolidated balance sheet data as of December 31, 1998, 1997 and 1996 are derived from audited financial statements not included in this report on Form 10-K.
- --------------- (1) Basic net loss per common share excludes dilution and is computed by dividing net loss by the weighted average number of common shares outstanding for the period (excluding shares subject to repurchase). Diluted net loss per common share was the same as basic net loss per common share for all periods presented since the effect of any potentially dilutive securities is excluded as they are anti-dilutive because of the Company's net losses.
(2) Upon the initial public offering, all outstanding shares of convertible preferred stock were converted into an equal number of shares of common stock. The pro forma basic and diluted net loss per share calculation includes the weighted average number of shares of outstanding convertible preferred stock as if they were outstanding shares of common stock.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements as of December 31, 2000 and 1999
and for each of the years ended December 31, 2000, 1999 and 1998, included elsewhere in this annual report on Form 10-K. In addition, this Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this annual report on Form 10-K contain forward-looking statements that involve risks and uncertainties. Words such as "anticipates," "believes, "plans," "expects," "future," "intends," and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed or forecasted. Factors that might cause such differences include, but are not limited to, those discussed in the section entitled "Additional Factors That May Affect Future Results" and those appearing elsewhere in this annual report on Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements.
OVERVIEW
Persistence is a leading provider of transactional application servers and dynamic Web content acceleration servers -- software that processes transactions between users and back-end computer systems in electronic commerce systems. We were incorporated and began operations in 1991. Our first products incorporated patented object-to-relational mapping and caching technologies, which have since become the foundation for our PowerTier product family. From 1992 to 1996, we introduced a variety of enhancements to these products, including a patented data transformation technology for mapping objects to database tables, and caching capabilities.
In 1996, we developed our PowerTier transactional application server, which integrates all of the previously released Persistence products with new shared transactional caching technologies, which enable multiple users to simultaneously access the same cached data. We first shipped our PowerTier for C++ transactional application server in 1997. Sales of PowerTier for C++ accounted for the majority of our revenues in 1997, 1998, and 1999, during which years we added a professional services staff to enable our customers to implement PowerTier more rapidly. We were one of the first companies to adopt and implement the EJB specification. In 1998, we introduced PowerTier for EJB, which customers have frequently purchased together with PowerTier for C++. Our most recent version of PowerTier for EJB is currently in use by several major customers and was commercially released in March 2000. We currently plan to continue to focus product development efforts on enhancements to both the PowerTier for C++ and the PowerTier for EJB products.
Our revenues, which consist of software license revenues and service revenues, totaled $25.3 million in 2000, $14.4 million in 1999, and $10.2 million in 1998. License revenues consist of licenses of our software products, which generally are priced based on the number of users or servers. Service revenues consist of professional services consulting, customer support and training. Because we only commenced selling application servers in 1997, we have a limited operating history in the application server market. We expect that, as a percentage of total revenues, sales of PowerTier for EJB transaction servers will increase and sales of PowerTier for C++ will decrease in the future.
We market our software and services primarily through our direct sales organizations in the United States, the United Kingdom, Germany, Hong Kong and Shanghai. Revenues from licenses and services to customers outside the United States were $7.2 million in 2000, $4.1 million in 1999 and $2.9 million in 1998 which represented approximately 28% of total revenues in each of these years. Our future success will depend, in part, on our successful development of international markets for our products.
Historically, we have received a substantial portion of our revenues from product sales to a limited number of customers. Sales of products to our top five customers accounted for 40% of total revenues in 2000, 35% of total revenues in 1999, and 55% of total revenues in 1998. In addition, the identity of our top five customers has changed from year to year. In the future, it is likely that a relatively few large customers could continue to account for a relatively large proportion of our revenues.
To date, we have sold our products primarily through our direct sales force, and we will need to continue to hire sales people, in particular those with expertise in channel sales, in order to meet our sales goals. In addition, our ability to achieve significant revenue growth will depend in large part on our success in establishing and leveraging relationships with OEM partners and other resellers.
We recognize revenues in accordance with the American Institute of Certified Public Accountants Statement of Position 97-2, "Software Revenue Recognition," as amended by Statements of Position 98-4 and 98-9. Future implementation guidance relating to these standards or any future standards may result in unanticipated changes in our revenue recognition practices, and these changes could affect our future revenues and earnings. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulleting ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 provided guidance on the recognition, presentation and disclosure of revenue in the financial statements. SAB No. 101 outlines basic criteria that must be met to recognized revenue and provides guidance for disclosure related to revenue recognition policies. The Company was required to implement SAB No. 101 in the fourth quarter of the year ended December 31, 2000. The provisions of SAB No. 101 did not have a material impact on the Company's consolidated financial position or results of operations.
We recognize license revenues upon shipment of the software if collection of the resulting receivable is probable, an executed agreement has been signed, the fee is fixed or determinable and vendor-specific objective evidence exists to allocate a portion of the total fee to any undelivered elements of the arrangement. Undelivered elements in these arrangements typically consist of services. For sales made through distributors, revenue is recognized upon shipment. Distributors have no right of return. We recognize revenues from customer training, support and consulting services as the services are performed. We generally recognize support revenues ratably over the term of the support contract. If support or professional services are included in an arrangement that includes a license agreement, amounts related to support or professional services are allocated based on vendor-specific objective evidence. Vendor-specific objective evidence for support and professional services is based on the price when such elements are sold separately, or, when not sold separately, the price established by management having the relevant authority to make such decision. Arrangements that require significant modification or customization of software are recognized under the percentage of completion method.
Since inception, we have incurred substantial research and development costs and have invested heavily in the expansion of our sales, marketing and professional services organizations to build an infrastructure to support our long-term growth strategy. The number of our employees increased from 127 as of December 31, 1999 to 152 as of December 31, 2000, representing an increase of 20%. We have incurred net losses in each quarter since 1996 and, as of December 31, 2000, had an accumulated deficit of $40.8 million. We are currently targeting that sales and marketing expenses, research and development expenses, and general and administrative expenses, will remain relatively flat during 2001. We expect to incur net losses during 2001, and potentially thereafter.
We believe that period-to-period comparisons of our operating results are not meaningful and should not be relied upon as indicative of future performance. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in early stages of development, particularly companies in new and rapidly evolving markets. We may not achieve or maintain profitability in the future. Our success depends significantly upon broad market acceptance of our PowerTier for EJB application server. Because Sun Microsystems controls the EJB standard, we need to maintain a good working relationship with them to develop future versions of PowerTier for EJB, as well as additional products using the EJB standard. Our performance will also depend on the level of capital spending in our target market of customers and on the growth and widespread adoption of the market for business-to-business electronic commerce over the Internet.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2000 AND 1999
Revenues
Our revenues were $25.3 million for 2000 and $14.4 million for 1999 representing an increase of 75%. International revenues were $7.2 million for 2000 and $4.1 million for 1999, representing an increase of 76%. For 2000, sales to Salomon Smith Barney accounted for 16% of total revenues and sales to our top five customers accounted for 40% of total revenues. For 1999, sales of products and services to Cisco (a stockholder) accounted for 13% of our total revenues, and sales of products and services to our top five customers accounted for 35% of total revenues.
License Revenues. License revenues were $17.7 million for 2000 and $10.9 million for 1999, representing an increase of 62%. License revenues represented 70% of total revenues for 2000 and 75% of total revenues for 1999. The increase in software license revenues was primarily due to an increase in sales of our PowerTier for EJB application server and the increased size and productivity of our sales team.
Service Revenues. Our service revenues were $7.6 million for 2000 and $3.6 million for 1999, representing an increase of 114%. The increase in service revenues was primarily due to an increase in customer support fees related to increased sales of our PowerTier platform and a doubling of our professional services fees. Service revenues represented 30% of total revenues for 2000 and 25% of total revenues for 1999.
Cost of Revenues
Cost of License Revenues. Cost of license revenues consists of packaging, documentation and associated shipping costs. Our cost of license revenues was $304,000 for 2000 and $170,000 for 1999. As a percentage of license revenues, cost of license revenues remained flat at 2% for each of 2000 and 1999.
Cost of Service Revenues. Cost of service revenues consists of personnel and other costs related to professional services, technical support and training. Our cost of service revenues was $3.6 million for 2000 and $2.6 million for 1999, representing an increase of 36%. This increase was primarily due to: increased staffing of $106,000; increased travel expenses of $436,000; increased occupancy costs of $250,000; and increased prospect seminars of $217,000. As a percentage of service revenues, cost of service revenues were 47% for 2000 and 74% for 1999. This decrease was due to our support staff's ability to support an increased installed base without as substantial an increase in headcount, and greater utilization of our professional services staff. Cost of service revenues as a percentage of service revenues may vary between periods due to our use of third party professional services.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, travel and entertainment, and promotional expenses. Our sales and marketing expenses were $22.8 million for 2000 and $14.1 million for 1999, representing an increase of 62%. This increase was primarily due to our investment in our sales and marketing infrastructure, which included: an increase of $1.6 million to compensate, recruit and hire sales people and sales engineers; an increase in sales commissions of $2.4 million; an increase in advertising and promotional events of $1.7 million; an increase travel expenses of $1.1 million; and additional sales office and occupancy costs of $1.7 million. Sales and marketing expenses represented 90% of total revenues for 2000 and 97% of total revenues for 1999. We presently are targeting that 2001 sales and marketing expense levels will remain relatively flat as compared with 2000 expense levels.
Research and Development. Research and development expenses consist primarily of salaries and benefits for software developers, product managers and quality assurance personnel and payments to outside software developers. Our research and development expenses were $8.1 million for 2000 and $6.4 million for 1999, representing an increase of 28%. This increase was primarily related to: an increase in employee software developers and related personnel for product development of $1.1 million, and increased occupancy costs of $771,000. Research and development expenses for 1999 also include a one-time $303,000 compensation
charge associated with the issuance of common stock to an investor at a price which was less than the deemed fair value for accounting purposes. Research and development expenses represented 32% of total revenues for 2000 and 44% of total revenues for 1999. We presently are targeting that 2001 research and development expense levels will remain relatively flat as compared with 2000 expense levels.
General and Administrative. General and administrative expenses consist primarily of salaries, benefits and related costs for our finance, administrative and general management personnel. Our general and administrative expenses were $5.4 million for 2000 and $2.8 million for 1999, representing an increase of 93%. This increase was primarily the result of: the hiring of additional finance and administrative personnel of $1.2 million, additional professional services of $1.3 million, including corporate and patent prosecution legal costs; increased depreciation of $696,000; and an increase in bad debt reserves of $448,000 due to increasing sales levels. This increase was primarily offset by a decrease in occupancy costs of $1.2 million. General and administrative expenses represented 21% of total revenues for 2000 and 20% of total revenues for 1999. We presently are targeting that 2001 general and administrative expense levels will remain relatively flat as compared with 2000 expense levels.
Amortization of Purchased Intangibles. Amortization of purchased intangibles was $2.9 million for 2000 and $576,000 for 1999. The increase in amortization was due to the increased level of purchased intangibles, primarily resulting from our acquisition of additional purchased technology during 2000.
Interest and Other Income (Expense). Interest and other income (expense) consists primarily of earnings on our cash, cash equivalents and short-term investment balances, offset by interest expense related to obligations under capital leases and other borrowings, and, in 2000, various miscellaneous state and foreign taxes, and other expenses. Interest and other income (expense) was $1.1 million for 2000 and $859,000 for 1999, representing an increase of 32%. We expect that interest and other income (expense) will decrease as we continue to use our net proceeds from our initial public offering.
Stock-Based Compensation. Some options granted and common stock issued during the years ended December 31, 2000, 1999, 1998 and 1997 have been considered to be compensatory, as the estimated fair value for accounting purposes was greater than the stock price as determined by the board of directors on the date of grant or issuance. Total deferred stock compensation associated with equity transactions as of December 31, 2000 was $592,000, net of amortization. Deferred stock compensation is being amortized ratably over the vesting periods of these securities. Amortization expense was $416,000 in 2000 and $971,000 in 1999. We expect to record amortization expense related to these securities of approximately $332,000 in 2001.
Provision for Income Taxes. Since inception, we have incurred net operating losses for federal and state tax purposes and have not recognized any tax provision or benefit.
As of December 31, 2000, we had $34.0 million of federal and $7.8 million of state net operating loss carryforwards available to offset future taxable income. The federal net operating loss carryforwards expire through 2020, while the state net operating loss carryforwards expire through 2005. The net operating loss carryforwards for state tax purposes are substantially less than for federal tax purposes, primarily because only 50% of state net operating loss carryforwards can be utilized to offset future state taxable income. The Tax Reform Act of 1986 limits the use of net operating loss carryforwards in situations where changes occur in the stock ownership of a company. If we should be acquired or otherwise have an ownership change, as defined in the Tax Reform Act of 1986, our utilization of these carryforwards could be restricted.
As of December 31, 2000, the Company also had research and development tax credit carryforwards of $980,000 and $766,000 available to offset future federal and state income taxes, respectively. The federal credit carryforward expires in 2015, while the state credit carryforward has no expiration.
We have placed a full valuation allowance against our net deferred tax assets due to the uncertainty surrounding the realization of these assets. We evaluate on a quarterly basis the recoverability of the net deferred tax assets and the level of the valuation allowance. If and when we determine that it is more likely than not that the deferred tax assets are realizable, the valuation allowance will be reduced.
YEARS ENDED DECEMBER 31, 1999 AND 1998
REVENUES
Our revenues were $14.4 million for 1999 and $10.2 million for 1998, representing an increase of 42%. International revenues were $4.1 million for 1999 and $2.9 million for 1998, representing an increase of 41%. In 1999, sales of products to Cisco (a stockholder) accounted for 13% of total revenues, and sales of products to our top five customers represented 35% of total revenues. In 1998, sales of software licenses to Cisco accounted for 14% of total revenues, and sales of software licenses to Instinet accounted for 17% of total revenues. Sales of products to our top five customers represented 55% of total revenues in 1998.
License Revenues. License revenues were $10.9 million for 1999 and $7.5 million for 1998, representing an increase of 46%. License revenues represented 75% of total revenues for the 1999 and 74% of total revenues for 1998. The increase in software license revenues was primarily due to sales of our then new PowerTier for EJB application server and the increased size and productivity of our sales team.
Service Revenues. Our service revenues were $3.6 million for 1999 and $2.7 million for 1998, representing an increase of 32%. The increase in service revenues was primarily due to an increase in customer support fees related to increased sales of our PowerTier platform. Service revenues represented 25% of total revenues for 1999 and 26% of total revenues 1998.
COST OF REVENUES
Cost of License Revenues. Our cost of license revenues was $170,000 for 1999 and $239,000 for 1998. As a percentage of license revenues, cost of license revenues were 2% for 1999 and 3% for 1998. This decrease was primarily attributable to lower packaging and document distribution costs as a result of a change to electronic distribution of these materials.
Cost of Service Revenues. Our cost of service revenues was $2.6 million for 1999 and $1.4 million for 1998, representing an increase of 92%. This increase was primarily due to increased staffing in our support organization to support a greater installed base of customers. As a percentage of service revenues, cost of service revenues were 74% for 1999 and 51% for 1998.
OPERATING EXPENSES
Sales and Marketing. Our sales and marketing expenses were $14.1 million for 1999 and $7.2 million for 1998, representing an increase of 96%. This increase was primarily due to: our investment in our sales and marketing infrastructure, which included significant personnel-related costs to recruit and hire sales people and sales engineers and their compensation of $3.4 million; increased advertising and marketing costs of $1.2 million; additional sales office costs of $1.0 million; and increased travel and entertainment costs of $889,000. Sales and marketing expenses represented 97% of total revenues for 1999 and 71% of total revenues for 1998.
Research and Development. Our research and development expenses were $6.4 million for 1999 and $4.2 million for 1998, representing an increase of 50%. This increase was primarily related to: an increase in employee and consultant software developers and related personnel for product development of $1.8 million; and an increase in occupancy costs of $324,000. Research and development expenses for 1999 also include a one-time $303,000 compensation charge associated with the issuance of common stock to an investor at a price which was less than the deemed fair value for accounting purposes. Research and development expenses represented 44% of total revenues for 1999 and 42% of total revenues for 1998.
General and Administrative. Our general and administrative expenses were $2.8 million for 1999 and $1.2 million for 1998, representing an increase of 128%. This increase was primarily the result of: the hiring of additional finance and administrative personnel of $1.0 million, insurance costs and other costs associated with being a public company of $215,000; and bad-debt write-off of $467,000. Those increases were primarily offset by a decrease in occupancy costs of $345,000. General and administrative expenses represented 20% of total revenues for 1999 (16% without the bad-debt write off) and 12% of total revenues for 1998.
Interest and Other Income (Expense). Interest and other income (expense) was $859,000 for 1999 and $1,000 for 1998. This increase was earned on the net proceeds received from our initial public offering of common stock on June 24, 1999.
Stock-Based Compensation. Some options granted and common stock issued during the years ended December 31, 1999, 1998 and 1997 have been considered to be compensatory, as the estimated fair value for accounting purposes was greater than the stock price as determined by the board of directors on the date of grant or issuance. Total deferred stock compensation associated with equity transactions as of December 31, 1999 was $1.2 million, net of amortization. Deferred stock compensation is being amortized ratably over the vesting periods of these securities. Amortization expense was $971,000 in 1999 and $331,000 in 1998.
Provision for Income Taxes. Since inception, we have incurred net operating losses for federal and state tax purposes and have not recognized any tax provision or benefit.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited consolidated statement of operations data for each of the twelve quarters in the three-year period ended December 31, 2000, as well as this data expressed as a percentage of our total revenues for the periods indicated. This data has been derived from our unaudited consolidated financial statements, which have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information when read in conjunction with the consolidated financial statements and notes thereto. Our quarterly results have been in the past and may in the future be subject to significant fluctuations. As a result, we believe that results of operations for interim periods should not be relied upon as any indication of the results to be expected in any future period.
Our quarterly operating results have fluctuated significantly in the past, and may continue to fluctuate in the future, as a result of a number of factors, many of which are outside our control. These factors include:
- our ability to close relatively large sales on schedule;
- delays or deferrals of customer orders or deployments;
- delays in shipment of scheduled software releases;
- demand for and market acceptance of our PowerTier products and other products we introduce, including Dynamai;
- the possible loss of sales people;
- introduction of new products or services by us or our competitors;
- annual or quarterly budget cycles of our customers;
- the level of product and price competition in the application server market;
- our lengthy sales cycle;
- our success in expanding our direct sales force and indirect distribution channels;
- the mix of direct sales versus indirect distribution channel sales;
- the mix of products and services licensed or sold;
- the mix of domestic and international sales; and
- our success in penetrating international markets and general economic conditions in these markets.
The typical sales cycle of our products is long and unpredictable, and is affected by seasonal fluctuations as a result of our customers' fiscal year budgeting cycles and slow summer purchasing patterns in Europe. We typically receive a substantial portion of our orders in the last two weeks of each quarter because our customers often delay purchases of our products to the end of the quarter to gain price concessions. Because a substantial portion of our costs are relatively fixed and based on anticipated revenues, a failure to book an expected order in a given quarter would not be offset by a corresponding reduction in costs and could adversely affect our operating results.
Our license revenues in the first quarter of 2000 were lower than those in the fourth quarter of 1999 and our license revenues in the first quarter of 1999 were lower than those in the fourth quarter of 1998. In the future, we expect this trend to continue, with the fourth quarter of each year accounting for the greatest percentage of total revenues for the year and with an absolute decline in revenues from the fourth quarter to the first quarter of the next year.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our business primarily through our initial public offering of common stock in June 1999, which totaled $34.1 million in aggregate net proceeds, and private sales of convertible preferred stock, which totaled $19.9 million in aggregate net proceeds. We have also financed our business through a loan in the principal amount of $800,000, borrowings of $533,000 under an equipment financing facility and capitalized leases. As of December 31, 2000, we had $19.5 million of cash, cash equivalents and short-term investments and $17.3 million of working capital.
Net cash used for operating activities was $11.7 million for 2000, $10.9 million for 1999 and $3.0 million in 1998. For each of 2000, 1999, and 1998, cash used for operating activities was attributable primarily to net losses and increases in accounts receivable. Those increases were primarily offset by depreciation and amortization, amortization of deferred stock compensation, accrued liabilities and deferred revenues.
Net cash used for investing activities was $108,000 for 2000, $10.0 million for 1999, and $436,000 for 1998. For each of the periods, cash used in investing activities reflected investments in property and
equipment. For 2000, cash used in investing activities also consisted of purchased intangibles offset by decreases in short-term investments. For 1999, cash used in investing activities also primarily consisted of purchases of short-term investments and purchased intangibles.
Net cash provided by financing activities was $3.6 million for 2000, $38.2 million for 1999, and $5.7 million for 1998. Cash provided by financing activities during these periods was primarily attributable to proceeds from the issuance of preferred and common stock. For 2000, cash was also provided from borrowings under an equipment financing facility, offset by repayments of loan agreements. For 1998, cash was also provided from borrowings under a term loan of $800,000 and partially offset by repayments of a capital lease obligations.
We have credit facilities with Comerica Bank. Under those credit facilities, the Company has a $5.0 million revolving line of credit facility available through October 31, 2001, an $800,000 equipment term loan, and a second equipment financing facility for an amount up to $1 million under which drawdowns are available through April 31, 2001. As of December 31, 2000 we had no borrowings outstanding under the revolving line of credit facility. As of December 31, 2000, we had a promissory note in favor of Comerica related to our first equipment term loan, under which $333,000 out of an original $800,000 was outstanding. We are required to make principal payments of $22,222 per month plus interest of 7.75% per annum on the unpaid principal balance, payable in 18 monthly installments. As of December 31, 2000 we had $533,000 outstanding under the second equipment financing facility. Under this facility, all borrowings outstanding on May 1, 2001 will automatically convert to a 30-month term loan having equal monthly payments of principal and interest. Borrowings under the equipment financing facility will bear interest at the bank's base rate plus 0.50%. The bank's credit facilities require the Company, among other things, to maintain a minimum tangible net worth of $10 million and a minimum quick ratio (current assets not including inventory less current liabilities) of 2 to 1. As of both June 30, 2000 and September 30, 2000, the Company's tangible net worth fell below the minimum tangible net worth ratio then in effect, and the bank waived both of those previous events. As of December 31, 2000, we were in compliance with our debt covenants. Borrowings under the facilities are collateralized by substantially all of the Company's assets
Although we have no material commitments for capital expenditures, we anticipate an increase, possibly substantial, in capital expenditures and lease commitments consistent with our anticipated growth in operations, infrastructure and personnel. We also may increase our capital expenditures as we expand into additional international markets.
We believe that our current cash, cash equivalents and short-term investments, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through at least 2001. If cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain a credit facility. If additional funds are raised through the issuance of debt securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the term of this debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders, and we may not be able to obtain additional financing on acceptable terms, if at all. If we are unable to obtain this additional financing, we may be required to reduce the scope of our planned product development and marketing efforts, which could harm our business.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued accounting statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires companies to record derivatives on the balance sheet as assets or liabilities measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 will be effective for us beginning in 2001. We believe the impact of adopting the standard will not be material to our financial position, results of operations or cash flows.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 provided guidance on the recognition, presentation and disclosure of revenue in the financial statements. SAB No. 101 outlines basic criteria that must be met to recognized revenue and provides guidance for disclosure related to revenue recognition policies. The Company was required to implement SAB No. 101 in the fourth quarter of the year ended December 31, 2000. The provisions of SAB No. 101 did not have a material impact on the Company's consolidated financial position or results of operations.
In March 2000, the FASB issued FASB interpretation No. 44 ("FIN No. 44"), "Accounting for Certain Transactions Involving Stock Compensation -- An Interpretation of APB Opinion No 2. 25." FIN 44, effective July 1, 2000, clarifies the application of APB No. 25 for matters including: the definition of an employee for purposes of APB No. 25; the criteria for determining whether a plan qualifies as a non-compensatory plan; the accounting consequence of various modifications to the terms of a previously fixed stock option or award; and the accounting for an exchange of stock compensation awards in a business combination. The adoption of FIN No. 44 did not have a material impact on the Company's consolidated financial position or results of operations.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
You should carefully consider the following risks in addition to the other information contained in this annual report on Form 10-K. The risks and uncertainties described below are intended to be the ones that are specific to our company or industry and that we deem to be material, but are not the only ones that we face.
WE HAVE A LIMITED OPERATING HISTORY IN THE APPLICATION SERVER MARKET.
Because we only commenced selling application servers in 1997, we have a limited operating history in the application server market. We thus face the risks, expenses and difficulties frequently encountered by companies in early stages of development, particularly companies in the rapidly changing software industry. These risks include:
- the timing and magnitude of capital expenditures by our customers and prospective customers;
- our substantial dependence for revenue from our PowerTier for C++ product, which was first introduced in 1997 and has achieved only limited market acceptance;
- our substantial dependence for revenue from our PowerTier for EJB product, which was first introduced in 1998 and has achieved only limited market acceptance;
- our need to expand our distribution capability through various sales channels, including a direct sales organization, original equipment manufacturers, third party distributors and systems integrators;
- our unproven ability to anticipate and respond to technological and competitive developments in the rapidly changing market for application servers;
- our unproven ability to compete in a highly competitive market;
- uncertainty as to the growth rate in the electronic commerce market and, in particular, the business-to-business electronic commerce market;
- our need to achieve market acceptance for our new product introductions, including Dynamai;
- our dependence on Enterprise JavaBeans, commonly known as EJB, becoming a widely accepted standard in the transactional application server market; and
- our dependence upon key personnel.
BECAUSE WE HAVE A HISTORY OF LOSSES AND NEGATIVE CASH FLOW, WE MAY NEVER BECOME OR REMAIN PROFITABLE.
Our revenues may not continue to grow, and we may not be able to achieve or maintain profitability in the future. We have incurred net losses each year since 1996. In particular, we incurred losses of $16.7 million in 2000, $11.3 million in 1999, $4.1 million in 1998 and $4.7 million in 1997. As of December 31, 2000, we had an accumulated deficit of $40.8 million. While we are currently targeting relatively flat sales and marketing, research and development, and general and administrative expenses for 2001, we will still need to increase our revenues to become profitable. Because our product market is new and evolving, we cannot accurately predict either the future growth rate, if any, or the ultimate size of the market for our products.
WE HAVE FINANCED OUR BUSINESS THROUGH THE SALE OF STOCK AND NOT THROUGH CASH GENERATED BY OUR OPERATIONS.
Since inception, we have generally had negative cash flow from operations. To date, we have financed our business primarily through sales of common stock and convertible preferred stock and not through cash generated by our operations. We expect to continue to have negative cash flow from operations.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE.
Although we believe that our current cash, cash equivalents and short-term investment balances will be sufficient to meet our anticipated operating cash needs through at least 2001, we may need to raise additional funds prior to that time. We face several risks in connection with this possible need to raise additional capital:
- the issuance of additional securities could result in:
- debt securities with rights senior to the common stock;
- dilution to existing stockholders as a result of issuing additional equity or convertible debt securities;
- debt securities with restrictive covenants that could restrict our ability to run our business as desired; or
- securities issued on disadvantageous financial terms.
- the failure to procure needed funding could result in:
- a dramatic reduction in scope in our planned product development or marketing efforts; or
- an inability to respond to competitive pressures or take advantage of market opportunities, which could adversely affect our ability to achieve profitability or positive cash flow.
THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK.
Our operating results have fluctuated significantly in the past and may fluctuate significantly in the future as a result of a variety of factors, many of which are outside our control. In particular, the fourth quarter of each year has in the past tended to account for the greatest percentage of total revenues for the year, and we have often experienced an absolute decline in revenues from the fourth quarter to the first quarter of the next year. If our future quarterly operating results are below the expectations of securities analysts or investors, the price of our common stock would likely decline. The factors that may cause fluctuations of our operating results include the following:
- our ability to close relatively large sales on schedule;
- delays or deferrals of customer orders or deployments;
- delays in shipment of scheduled software releases;
- demand for and market acceptance of our PowerTier products and other products we introduce;
- the possible loss of sales people;
- introduction of new products or services by us or our competitors;
- annual or quarterly budget cycles of our customers;
- the level of product and price competition in the application server and web content acceleration server markets;
- our lengthy sales cycle;
- our success in expanding our various sales channels, including a direct sales force and indirect distribution channels;
- the mix of direct sales versus indirect distribution channel sales;
- the mix of products and services licensed or sold;
- the mix of domestic and international sales; and
- our success in penetrating international markets and general economic conditions in these markets.
We typically receive a substantial portion of our orders in the last two weeks of each fiscal quarter because our customers often delay purchases of our products to the end of the quarter to gain price concessions. Because a substantial portion of our costs are relatively fixed and based on anticipated revenues, a failure to book an expected order in a given quarter would not be offset by a corresponding reduction in costs and could adversely affect our operating results.
OUR SALES CYCLE IS LONG, UNPREDICTABLE AND SUBJECT TO SEASONAL FLUCTUATIONS, SO IT IS DIFFICULT TO FORECAST OUR REVENUES.
Any delay in sales of our products or services could cause our quarterly revenues and operating results to fluctuate. The typical sales cycle of our products is long and unpredictable and requires both a significant capital investment decision by our customers and our education of potential customers regarding the use and benefits of our products. Our sales cycle is generally between three and nine months. A successful sales cycle typically includes presentations to both business and technical decision makers, as well as a limited pilot program to establish technical fit. Our products typically are purchased as part of a significant enhancement to a customer's information technology system. The implementation of our products involves a significant commitment of resources by prospective customers. Accordingly, a purchase decision for a potential customer typically requires the approval of several senior decision makers. Our sales cycle is affected by the business conditions of each prospective customer, as well as the overall economic climate for internet-related capital expenditures. Due to the relative importance of many of our product sales, a lost or delayed sale could adversely affect our quarterly operating results. Our sales cycle is affected by seasonal fluctuations as a result of our customers' fiscal year budgeting cycles and slow summer purchasing patterns in Europe.
WE DEPEND ON A RELATIVELY SMALL NUMBER OF SIGNIFICANT CUSTOMERS, AND THE LOSS OF ONE OR MORE OF THESE CUSTOMERS COULD RESULT IN A DECREASE IN OUR REVENUES.
Historically, we have received a substantial portion of our revenues from product sales to a limited number of customers. In 2000, sales of products and services to Salomon Smith Barney accounted for 16% of total revenues and sales to our top five customers accounted for 40% of total revenues. In 1999, sales of products and services to Cisco accounted for 13% of our total revenues, and sales of products and services to our top five customers accounted for 35% of total revenues. In 1998, sales of products and services to Cisco accounted for 14% of our total revenues, sales of products and services to Instinet accounted for 17% of our total revenues, and sales of products and services to our top five customers accounted for 55% of total revenues. In addition, the identity of our top five customers has changed from year to year. If we lose a significant customer, or fail to increase product sales to an existing customer as planned, we may not be able to replace the lost revenues with sales to other customers. In addition, because our marketing strategy is to concentrate on selling products to industry leaders, any loss of a customer could harm our reputation within
the industry and make it harder for us to sell our products to other companies in that industry. The loss of, or a reduction in sales to, one or more significant customers would likely result in a decrease in our revenues.
WE DEPEND ON THE JAVA PROGRAMMING LANGUAGE, THE ENTERPRISE JAVABEANS STANDARD AND THE EMERGING MARKET FOR DISTRIBUTED OBJECT COMPUTING, AND IF THESE TECHNOLOGIES FAIL TO GAIN ACCEPTANCE, OUR BUSINESS COULD SUFFER.
We are focusing significant marketing efforts on our PowerTier for EJB application server, which is based on three relatively new technologies, which have not been widely adopted by a large number of companies. These three technologies are a distributed object computing architecture, Sun Microsystems' Java programming language and Enterprise JavaBeans, or EJB. Distributed object computing combines the use of software modules, or objects, communicating across a computer network to software applications, such as our PowerTier application server. EJB is the Java programming standard for use in an application server. In 1998, we launched our PowerTier for EJB product, which is a transactional application server that uses Java and conforms to the EJB standard. Sun Microsystems released the EJB standard in 1998, and thus far EJB has had limited market acceptance. Since our PowerTier for EJB product depends upon the specialized EJB standard, we face a limited market compared to competitors who may offer application servers based on more widely accepted standards, including the Java programming language. We expect a substantial portion of our future revenues will come from sales of products based on the EJB standard. Thus, our success depends significantly upon broad market acceptance of distributed object computing in general, and Java application servers in particular. If EJB does not become a widespread programming standard for application servers, our revenues and business could suffer.
IF WE DO NOT DELIVER PRODUCTS THAT MEET RAPIDLY CHANGING TECHNOLOGY STANDARDS AND CUSTOMER DEMANDS, WE WILL LOSE MARKET SHARE TO OUR COMPETITORS.
The market for our products and services is characterized by rapid technological change, dynamic customer demands and frequent new product introductions and enhancements. Customer requirements for products can change rapidly as a result of innovation in software applications and hardware configurations and the emergence or adoption of new industry standards, including Internet technology standards. We may need to increase our research and development investment to maintain our technological leadership. Our future success depends on our ability to continue to enhance our current products and to continue to develop and introduce new products that keep pace with competitive product introductions and technological developments. For example, as Sun Microsystems introduces new EJB specifications, we will need to introduce new versions of PowerTier for EJB designed to support these new specifications to remain competitive. If we do not bring enhancements and new versions of our products to market in a timely manner, our market share and revenues could decrease and our reputation could suffer. If we fail to anticipate or respond adequately to changes in technology and customer needs, or if there are any significant delays in product development or introduction, our revenues and business could suffer.
BECAUSE OUR DIRECT SALES TEAM IS CURRENTLY OUR MOST CRITICAL SALES CHANNEL, ANY FAILURE TO MAINTAIN AND TRAIN THIS TEAM MAY RESULT IN LOWER REVENUES.
We must have a strong direct sales team to generate increased revenue. In the last several years, we have experienced significant turnover in our sales team, and in early 2001, we substantially reorganized our sales team. In order to meet our future sales goals, we may continue to need to hire more salespeople for both our domestic and international sales efforts. In the past, newly hired employees have required training and approximately six to nine months experience to achieve full productivity. Like many companies in the software industry, we are likely to continue to experience turnover in our sales force, and thus a number of our sales people at any given time may be relatively new and may not meet our sales goals. In addition, our recently hired employees may not become productive, and we may not be able to hire enough qualified individuals in the future.
BECAUSE OUR FUTURE REVENUE GOALS ARE BASED ON OUR DEVELOPMENT OF A STRONG SALES CHANNEL THROUGH OEM PARTNERS AND OTHER RESELLERS, ANY FAILURE TO DEVELOP THIS CHANNEL MAY RESULT IN LOWER REVENUES.
To date, we have sold our products primarily through our direct sales force, but our ability to achieve significant revenue growth in the future will depend in large part on our success in establishing and leveraging relationships with OEM partners and other resellers. It may be difficult for us to establish these relationships, and, even if we establish these relationships, we will then depend on the sales efforts of these third-parties. In addition, because these relationships are nonexclusive, these third parties may choose to sell application servers or other alternative solutions offered by our competitors, and not our products. If we fail to successfully build our third-party distribution channels or if our third party partners do not perform as expected, our business could be harmed.
BECAUSE OUR PRODUCTS ARE OFTEN INCORPORATED INTO ENTERPRISE-WIDE SYSTEM DEPLOYMENTS, ANY DELAYS IN THESE PROJECTS MAY RESULT IN LOWER REVENUES.
Because our products are often incorporated into multi-million dollar enterprise projects, we depend on the successful and timely completion of these enormous projects to fully deploy our products and achieve our revenue goals. These enterprise projects often take many years to complete and can be delayed by a variety of factors, including general or industry-specific economic downturns, our customers' budget constraints, other customer-specific delays, problems with other system components or delays caused by the systems integrators who may be managing the system deployment. If our customers cannot successfully implement large-scale deployments, or they determine for any reason that our products cannot accommodate large-scale deployments or that our products are not appropriate for widespread use, our business could suffer. In addition, if a systems integrator fails to complete a project utilizing our product for a customer in a timely manner, our revenues or business reputation could suffer.
BECAUSE WE COMPETE WITH SUN MICROSYSTEMS, WHO CONTROLS THE EJB APPLICATION SERVER STANDARD, WE FACE THE RISK THAT THEY MAY DEVELOP THIS STANDARD TO FAVOR THEIR OWN PRODUCTS.
Our success depends on achieving widespread market acceptance of our PowerTier for EJB application server. Because Sun Microsystems controls the EJB standard, we need to maintain a good working relationship with Sun Microsystems to develop future versions of PowerTier for EJB, as well as additional products using EJB, that will gain market acceptance. In March 1998, we entered into a license agreement with Sun Microsystems, pursuant to which we granted Sun Microsystems rights to manufacture and sell, by itself and not jointly with others, products under a number of our patents, and Sun Microsystems granted us rights to manufacture and sell, by ourselves and not jointly with others, products under a number of Sun Microsystems' patents. As a result, Sun Microsystems may develop and sell some competing products that would, in the absence of this license agreement, infringe our patents. Because Sun Microsystems controls the EJB standard, it could develop the EJB standard in a more proprietary way to favor a product offered by its subsidiary, iPlanet, or a third party, which could make it much harder for us to compete in the EJB application server market.
MICROSOFT HAS ESTABLISHED A COMPETING APPLICATION SERVER STANDARD, WHICH COULD DIMINISH THE MARKET POTENTIAL FOR OUR PRODUCTS IF IT GAINS WIDESPREAD ACCEPTANCE.
Microsoft has established a competing standard for distributed computing, COM, which includes an application server product. If this standard gains widespread market acceptance over the EJB or CORBA standards, on which our products are based, our business would suffer. Because of Microsoft's resources and commanding position with respect to other markets and technologies, Microsoft's entry into the application server market may cause our potential customers to delay purchasing decisions. We expect that Microsoft's presence in the application server market will increase competitive pressure in this market.
WE FACE SIGNIFICANT COMPETITION FROM COMPANIES WITH GREATER RESOURCES THAN WE HAVE AND MAY FACE ADDITIONAL COMPETITION IN THE FUTURE.
The market for our products is intensely competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. We believe that the principal competitive factors in our market are:
- performance, including scalability, integrity and availability;
- ability to provide a complete software platform;
- flexibility;
- use of standards-based technology;
- ease of integration with customers' existing enterprise systems;
- ease and speed of implementation;
- quality of support and service;
- security;
- company reputation; and
- price.
Our competitors for both PowerTier and Dynamai include both publicly and privately-held enterprises, including BEA Systems (WebLogic), Secant Technologies, IBM (WebSphere), Oracle (OAS) and i-Planet (Sun Microsystems). Many customers may not be willing to purchase our PowerTier platform because they have already invested heavily in databases and other enterprise software components offered by these competing companies. Many of these competitors have preexisting customer relationships, longer operating histories, greater financial, technical, marketing and other resources, greater name recognition and larger installed bases of customers than we do. In addition, some competitors offer products that are less complex than our PowerTier products and require less customization to implement with potential customers' existing systems. Thus, potential customers engaged in simpler business-to-business e-commerce transactions may prefer these "plug-and-play" products to our more complex offerings. Moreover, there are other very large and established companies, including Microsoft, who offer alternative solutions and are thus indirect competitors. Further, dozens of companies have already supported, or have announced their intention to support EJB, and may compete against us in the future. These competitors and potential competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we can. In addition, in the PowerTier for C++ market, many potential customers build their own custom application servers, so we effectively compete against our potential customers' internal information technology departments.
In the Dynamai market, similar dynamic Web content acceleration technology is available from a variety of sources, including but not limited to internal development, application server vendors such as Oracle, electronic commerce software vendors such as Intershop and ATG, content delivery networks such as Akamai and epicRealm, and emerging software and hardware appliance vendors such as Chutney and Cachier, who are directly targeting Dynamai's market.
IF THE MARKET FOR BUSINESS-TO-BUSINESS ELECTRONIC COMMERCE OVER THE INTERNET DOES NOT DEVELOP AS WE CURRENTLY ENVISION, OUR BUSINESS MODEL COULD FAIL AND OUR REVENUES COULD DECLINE.
Our performance and future success will depend on the growth and widespread adoption of the market for business-to-business electronic commerce over the Internet. If business-to-business electronic commerce does not develop in the manner currently envisioned, our business could be harmed. Moreover, critical issues concerning the commercial use of the Internet, including security, cost, accessibility and quality of network service, remain unresolved and may negatively affect the growth of the Internet as a platform for conducting business-to-business electronic commerce. In addition, the Internet could lose its viability due to delays in the
development or adoption of new standards and protocols to handle increased activity or due to increased government regulation and taxation of Internet commerce.
OUR FAILURE TO MANAGE OUR RESOURCES COULD IMPAIR OUR BUSINESS.
Achieving our planned revenue growth and other financial objectives will place significant demands on our management and other resources. Our ability to manage our resources effectively will require us to continue to develop and improve our operational, financial and other internal systems and controls, as well as our business development capabilities, and to train, motivate and manage our employees. If we are unable to manage our resources effectively, we may not be able to retain key personnel and the quality of our services and products may suffer.
OUR BUSINESS COULD SUFFER IF WE CANNOT ATTRACT AND RETAIN THE SERVICES OF KEY EMPLOYEES.
Our future success depends on the ability of our management to operate effectively, both individually and as a group. We are substantially dependent upon the continued service of our existing executive personnel, especially Christopher T. Keene, our Chief Executive Officer and Chairman of the Board. We do not have a key person life insurance policy covering Mr. Keene or any other officer or key employee. Our success will depend in large part upon our ability to attract and retain highly-skilled employees, particularly sales personnel and software engineers. There is significant competition for skilled employees, especially for people who have experience in both the software and Internet industries. We have experienced significant turnover among sales personnel in recent years, which makes retention more challenging. If we are not successful in attracting and retaining these skilled employees, our sales and product development efforts would suffer. In addition, if one or more of our key employees resigns to join a competitor or to form a competing company, the loss of that employee and any resulting loss of existing or potential customers to a competitor could harm our business. If we lose any key personnel, we may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by those former employees.
OUR SOFTWARE PRODUCTS MAY CONTAIN DEFECTS OR ERRORS, AND SHIPMENTS OF OUR SOFTWARE MAY BE DELAYED.
Complex software products often contain errors or defects, particularly when first introduced or when new versions or enhancements are released. Our products have in the past contained and may in the future contain errors and defects, which may be serious or difficult to correct and which may cause delays in subsequent product releases. Delays in shipment of scheduled software releases or serious defects or errors could result in lost revenues or a delay in market acceptance, which could have a material adverse effect on our revenues and reputation.
WE MAY BE SUED BY OUR CUSTOMERS FOR PRODUCT LIABILITY CLAIMS AS A RESULT OF FAILURES IN THEIR CRITICAL BUSINESS SYSTEMS.
Because our customers use our products for important business applications, errors, defects or other performance problems could result in financial or other damages to our customers. They could pursue claims for damages, which, if successful, could result in our having to make substantial payments. Although our purchase agreements typically contain provisions designed to limit our exposure to product liability claims, existing or future laws or unfavorable judicial decisions could negate these limitation of liability provisions. A product liability claim brought against us, even if meritless, would likely be time consuming and costly for us to litigate or settle.
A SIGNIFICANT PORTION OF OUR REVENUES IS DERIVED FROM INTERNATIONAL SALES, WHICH COULD DECLINE AS A RESULT OF LEGAL, BUSINESS AND ECONOMIC RISKS SPECIFIC TO INTERNATIONAL OPERATIONS.
Our future success will depend, in part, on our successful development of international markets for our products. Approximately 28% of our revenues came from sales of products and services outside of the United States during each of 2000, 1999, and 1998. We expect international revenues to continue to represent a significant portion of our total revenues. To date, almost all of our international revenues have resulted from
our direct sales efforts. In international markets, however, we expect that we will depend more heavily on third party distributors to sell our products in the future. The success of our international strategy will depend on our ability to develop and maintain productive relationships with these third parties. The failure to develop key international markets for our products could cause a reduction in our revenues. Additional risks related to our international expansion and operation include:
- difficulties of staffing and managing foreign operations;
- our dependence on the sales efforts of our third party distributors;
- longer payment cycles typically associated with international sales;
- tariffs and other trade barriers;
- failure to comply with a wide variety of complex foreign laws and changing regulations;
- exposure to political instability and economic downturns;
- failure to localize our products for foreign markets;
- restrictions on the export of technologies;
- potentially adverse tax consequences;
- reduced protection of intellectual property rights in some countries; and
- currency fluctuations.
We sell products outside the United States in U.S. dollars. We do not currently engage in any hedging transactions to reduce our exposure to currency fluctuations as a result of our foreign operations. We are not currently ISO 9000 compliant, nor are we attempting to meet all foreign technical standards that may apply to our products. Our failure to develop our international sales channel as planned could cause a decline in our revenues.
IF WE DO NOT PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR COMPETITIVE POSITION MAY BE IMPAIRED.
Our success depends on our ability to protect our proprietary rights to the technologies used in our products, and yet the measures we are taking to protect these rights may not be adequate. If we are not adequately protected, our competitors could use the intellectual property that we have developed to enhance their products, which could harm our business. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure and other contractual restrictions to protect our proprietary technology, but these legal means afford only limited protection. Unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States. We have in the past brought lawsuits to protect our intellectual property rights. Further litigation may be necessary to enforce our intellectual property rights, which could result in substantial costs and diversion of management attention and resources.
WE MAY BE SUED FOR PATENT INFRINGEMENT.
The software industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement and the violation of other intellectual property rights. As the number of competitors in the application server and web content acceleration server markets grow and the functionality of products in different market segments overlaps, the possibility of an intellectual property claim against us increases. For example, we may inadvertently infringe a patent of which we are unaware. In addition, because patent applications can take many years to issue, there may be a patent application now pending of which we are unaware, which will cause us to be infringing when it is issued in the future. To address these patent infringement or other intellectual property claims, we may have to enter into royalty or licensing agreements on disadvantageous commercial terms. Alternatively, we may be unable to obtain a necessary license. A successful claim against us, and our failure to license the infringed or similar technology,
would harm our business. In addition, any infringement or other intellectual property claims, with or without merit, which are brought against us could be time consuming and expensive to litigate or settle and could divert management attention from administering our core business.
FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE.
If our current stockholders sell substantial amounts of common stock, including shares issued upon the exercise of outstanding options and warrants, in the public market, the market price of our common stock could fall. In addition, these sales of common stock could impede our ability to raise funds at an advantageous price through the sale of securities. As of December 31, 2000, we had 19.9 million shares of common stock outstanding. Virtually all of our shares, other than shares held by affiliates, are freely tradeable. In addition, shares held by affiliates are tradeable, subject to the volume and other restrictions of Rule 144.
OUR STOCK PRICE HAS BEEN, AND MAY CONTINUE TO BE, VOLATILE.
Our common stock has only been available in the public market since June 24, 1999. An active public market for our common stock has not completely developed. To date, the market price of our common stock has been highly volatile and may rise or fall in the future as a result of many factors, such as:
- variations in our quarterly results;
- announcements of technological innovations by us or our competitors;
- introductions of new products by us or our competitors;
- acquisitions or strategic alliances by us or our competitors;
- hiring or departure of key personnel;
- the gain or loss of a significant customer or order;
- changes in estimates of our financial performance or changes in recommendations by securities analysts;
- market conditions and expectations regarding capital spending in the software industry and in our customers' industries; and
- adoption of new accounting standards affecting the software industry.
The market prices of the common stock of many companies in the software and Internet industries have experienced extreme price and volume fluctuations, which has often been unrelated to these companies' operating performance. In the past, securities class action litigation has often been brought against a company after a period of volatility in the market price of its stock. We may in the future be a target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources, which could harm our business.
OUR EXECUTIVE OFFICERS AND DIRECTORS OWN A LARGE PERCENTAGE OF OUR VOTING STOCK AND COULD EXERT SIGNIFICANT INFLUENCE OVER MATTERS REQUIRING STOCKHOLDER APPROVAL.
As of February 28, 2001, executive officers and directors, and entities affiliated with them, owned approximately 28% of our outstanding common stock. Accordingly, these stockholders may, as a practical matter, continue to control the election of a majority of the directors and the determination of all corporate actions. This concentration of voting control could have the effect of delaying or preventing a merger or other change in control, even if it would benefit our other stockholders.
THE ANTITAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND UNDER DELAWARE LAW COULD DISCOURAGE A TAKEOVER.
Provisions in our certificate of incorporation, bylaws and Delaware law may discourage, delay or prevent a merger or other change in control that a stockholder may consider favorable. These provisions may also discourage proxy contests or make it more difficult for stockholders to take corporate action. These provisions include the following:
- establishing a classified board in which only a portion of the total board members will be elected at each annual meeting;
- authorizing the board to issue preferred stock;
- prohibiting cumulative voting in the election of directors;
- limiting the persons who may call special meetings of stockholders;
- prohibiting stockholder action by written consent; and
- establishing advance notice requirements for nominations for election of the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.
WE MAY ENGAGE IN FUTURE ACQUISITIONS THAT COULD DISRUPT OUR BUSINESS AND DILUTE OUR STOCKHOLDERS.
As part of our business strategy, we expect to review acquisition prospects that we believe would be advantageous to the development of our business. For example, we have acquired object request broker technology and servlet engine technology. While we have no current agreements or negotiations underway with respect to any major acquisitions, we may make acquisitions of businesses, products or technologies in the future. If we make any acquisitions, we could take any or all of the following actions, any of which could materially and adversely affect our financial results and the price of our common stock:
- issue equity securities that would dilute existing stockholders' percentage ownership;
- incur substantial debt;
- assume contingent liabilities; or
- take substantial charges in connection with the amortization of goodwill and other intangible assets.
Acquisitions also entail numerous risks, including:
- difficulties in assimilating acquired operations, products and personnel with our pre-existing business;
- unanticipated costs;
- diversion of management's attention from other business concerns;
- adverse effects on existing business relationships with suppliers and customers;
- risks of entering markets in which we have limited or no prior experience; and
- potential loss of key employees from either our preexisting business or the acquired organization.
We may not be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future, and our failure to do so could harm our business.
WE HAVE NOT DESIGNATED ANY SPECIFIC USE FOR THE NET PROCEEDS OF THE COMPANY'S INITIAL PUBLIC OFFERING OF COMMON STOCK, AND THUS MAY USE THE REMAINING NET PROCEEDS TO FUND OPERATING LOSSES, FOR ACQUISITIONS OR FOR OTHER CORPORATE PURPOSES.
We have not designated any specific use for the net proceeds of our initial public offering of common stock. As a result, our management and board of directors has broad discretion in spending the remaining net proceeds of that offering. We currently expect to use the remaining net proceeds primarily for working capital and general corporate purposes, funding product development and funding our sales and marketing organization. In addition, we may use a portion of the remaining net proceeds for further development of our product lines through acquisitions of products, technologies and businesses.
ITEM 7A.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Sensitivity. Our operating results are sensitive to changes in the general level of U.S. interest rates, particularly because most of our cash equivalents are invested in short-term debt instruments. If market interest rates were to change immediately and uniformly by ten percent from levels at December 31, 2000, the fair value of our cash equivalents would change by approximately $80,000.
Foreign Currency Fluctuations. We have not had any significant transactions in foreign currencies, nor did we have any significant balances that are due or payable in foreign currencies at December 31, 2000. Therefore, a hypothetical ten percent change in foreign currency rates would have an insignificant impact on our financial position or results of operations. We do not hedge any of our foreign currency exposure.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 14(a) for an index to the consolidated financial statements and supplementary data that are attached hereto.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
PART III
The Company's Proxy Statement for its 2001 Annual Meeting of Stockholders, when filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, will be incorporated by reference in this Form 10-K pursuant to General Instruction G(3) of Form 10-K and will provide the information required under Part III (Items 10-13), except for the information with respect to the Company's executive officers, which is included in "Item 1. Business -- Executive Officers."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
(1) Financial Statements and Report of Deloitte & Touche LLP (pages through):
Audited Consolidated Financial Statements:
Independent Auditors' Report
Consolidated Balance Sheets at December 31, 2000 and 1999
Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998
Notes to Consolidated Financial Statements
(2) Financial Statement Schedule (pages S-1 through S-3)
Audited Consolidated Financial Statement Schedule:
Independent Auditors' Report
Schedule II -- Consolidated Schedule of Valuation and Qualifying Accounts for the years ended December 31, 2000, 1999 and 1998
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the consolidated financial statements or notes thereto.
(3) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
EXHIBIT INDEX
- --------------- * Incorporated herein by reference to the exhibit filed with the Company's Registration Statement on Form S-1 (Commission File No. 333-76867)
+ Confidential treatment requested as to portions of this exhibit.
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K for the fiscal year ended December 31, 2000 to be signed on its behalf by the undersigned, thereunto duly authorized.
PERSISTENCE SOFTWARE, INC.
By: /s/ CHRISTOPHER T. KEENE ------------------------------------ Christopher T. Keene Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
By: /s/ CHRISTINE RUSSELL ------------------------------------ Christine Russell Chief Financial Officer (Principal Financial and Accounting Officer)
Date: April 2, 2001
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Christine Russell his attorney-in-fact, with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
PERSISTENCE SOFTWARE, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Persistence Software, Inc.:
We have audited the accompanying consolidated balance sheets of Persistence Software, Inc. and subsidiary (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
San Jose, California January 30, 2001 (February 28, 2001 as to the table in Note 4)
PERSISTENCE SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PAR VALUE AMOUNTS)
ASSETS
See notes to consolidated financial statements.
PERSISTENCE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
See notes to consolidated financial statements.
PERSISTENCE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
See notes to consolidated financial statements.
PERSISTENCE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See notes to consolidated financial statements.
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business -- Persistence is a leading provider of transaction application servers and dynamic Web content acceleration servers -- software that processes transactions between users and back-end computer systems in electronic commerce systems. Persistence's PowerTier application server software caches corporate application data to speed business transactions, while the Company's Dynamai application-aware software is designed to cache dynamic Web content to speed Internet transactions.
Principles of Consolidation -- The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All intercompany transactions and balances have been eliminated in consolidation.
Cash Equivalents -- The Company considers all highly liquid debt instruments purchased with remaining maturities of less than three months to be cash equivalents.
Short-term Investments -- Short-term investments consist primarily of highly liquid debt instruments purchased with remaining maturity dates of greater than 90 days but less than 12 months. Management determines the classification of debt and equity securities at the time of purchase and reevaluates the classification at each balance sheet date. Debt securities are classified as available-for-sale when the Company generally has the ability and intent to hold such securities to maturity, but, in certain circumstances, may potentially dispose of such securities prior to their maturity. Securities available-for-sale are reported at fair value with unrealized gains and losses reported as a separate component of stockholders' equity. All available- for-sale securities are classified as current assets. At December 31, 2000 and 1999, short-term investments consisted of corporate debt securities (commercial paper) and U.S. government debt securities with maturities of less than one year.
Short-term investments include the following available-for-sale securities at December 31, 1999 (in thousands):
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
Short-term investments include the following available-for-sale securities at December 31, 2000 (in thousands):
Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over estimated useful lives of three years. Leasehold improvements are amortized over the shorter of the lease term or their useful life.
Purchased intangibles are stated at cost. Amortization is computed using the straight-line method over the estimated useful lives of two to three years.
Impairment of Long-Lived Assets and Long-Lived Assets To Be Disposed Of -- The Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets or intangibles may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Software Development Costs -- Costs for the development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized in accordance with Statement of Financial Accounting Standards (SFAS) No. 86, Computer Software To Be Sold, Leased or Otherwise Marketed. Because the Company believes its current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no costs have been capitalized to date.
Notes Receivable from Stockholders -- The notes receivable from stockholders were issued in exchange for common stock, bear interest at 5.93% per annum, and are due in December 2001. The notes are full-recourse.
Revenue Recognition -- Revenue consists primarily of fees for licenses of the Company's software products, maintenance and customer support.
License Revenue -- Revenue from software licenses is recognized upon shipment of the software if collection of the resulting receivable is probable, an executed agreement has been signed, the fee is fixed or determinable and vendor-specific objective evidence exists to allocate a portion of the total fee to any undelivered elements of the arrangement. Such undelivered elements in these arrangements typically consist of services. For sales made through distributors, revenue is recognized upon shipment. Distributors have no right of return.
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
Service Revenue -- Revenue from customer training, support and consulting services is recognized as the services are performed. Support revenue is recognized ratably over the term of the support contract. If support or professional services are included in an arrangement that includes a license agreement, amounts related to support or professional services are allocated based on vendor-specific objective evidence. Vendor-specific objective evidence for support and professional services is based on the price when such elements are sold separately, or, when not sold separately, the price established by management having the relevant authority. Arrangements which require significant modification or customization of software are recognized under the percentage of completion method.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 provided guidance on the recognition, presentation and disclosure of revenue in the financial statements. SAB No. 101 outlines basic criteria that must be met to recognized revenue and provides guidance for disclosure related to revenue recognition policies. The Company was required to implement SAB No. 101 in the fourth quarter of the year ended December 31, 2000. The provisions of SAB No. 101 did not have a material impact on the Company's consolidated financial position or results of operations.
Income Taxes -- Income taxes are provided using an asset and liability approach which requires recognition of deferred tax liabilities and assets, net of valuation allowances, for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities and net operating loss and tax credit carryforwards.
Foreign Currency Transactions -- The functional currency of the Company's foreign subsidiary is the British Pound Sterling. Accordingly, all monetary assets and liabilities are translated at the current exchange rate at the end of the year, nonmonetary assets and liabilities are translated at historical rates and net sales and expenses are translated at average exchange rates in effect during the period. Translation gains and losses, which are included in balance sheet and in other comprehensive income (loss) in the accompanying consolidated statements of changes in stockholders' equity, have not been significant.
Stock Compensation -- The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, no accounting recognition is given to employee stock options granted with an exercise price equal to fair market value of the underlying stock on the grant date. Upon exercise, the net proceeds and any related tax benefit are credited to stockholders' equity.
In March 2000, the FASB issued FASB interpretation No. 44 ("FIN No. 44"), "Accounting for Certain Transactions Involving Stock Compensation -- An Interpretation of APB Opinion No. 25." FIN 44, effective July 1, 2000, clarifies the application of APB No. 25 for matters including: the definition of an employee for purposes of APB No. 25; the criteria for determining whether a plan qualifies as a non-compensatory plan; the accounting consequence of various modifications to the terms of a previously fixed stock option or award; and the accounting for an exchange of stock compensation awards in a business combination. The adoption of FIN No. 44 did not have a material impact on the Company's consolidated financial position or results of operations.
Net Loss per Common Share -- Basic net loss per common share excludes dilution and is computed by dividing net loss by the weighted average number of common shares outstanding for the period (excluding shares subject to repurchase). Diluted net loss per common share was the same as basic net loss per common share for all periods presented. This result is due to the exclusion of all potentially dilutive securities, which are actually anti-dilutive because of the Company's net losses.
Concentration of Credit Risk -- Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments, and trade
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
receivables. The risk associated with cash and cash equivalents and short-term investments is mitigated by using only high-quality financial institutions and investing in high-grade debt securities The Company primarily sells its products to companies in the United States and Europe. The Company does not require collateral or other security to support accounts receivable. To reduce credit risk, management performs ongoing credit evaluations of its customers' financial condition. The Company maintains allowances for potential credit losses.
Financial Instruments -- The Company's financial instruments include cash and equivalents, short-term investments, notes receivable from stockholders and long-term debt. At December 31, 2000 and 1999, the fair value of these financial instruments approximated their financial statement carrying amounts, because the financial instruments are either short-term or reflect interest rates consistent with market rates.
Significant Estimates -- The preparation of financial statements in conformity with accounting principle as generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Certain Risks and Uncertainties -- The Company operates in the software industry, and accordingly, can be affected by a variety of factors. For example, management of the Company believes that changes in any of the following areas could have a significant negative effect on the Company in terms of its future financial position, results of operations and cash flows: ability to obtain additional financing; regulatory changes; fundamental changes in the technology underlying software products; market acceptance of the Company's products under development; development of sales channels; loss of significant customers; adverse changes in international market conditions; litigation or other claims against the Company; the hiring, training and retention of key employees; successful and timely completion of product development efforts; and new product introductions by competitors.
We have incurred net losses each year since 1996 including losses of $16.7 million in 2000, $11.3 million in 1999, and $4.1 million in 1998. As of December 31, 2000, we had an accumulated deficit of $40.8 million. We believe our cash and cash equivalents and short-term investments of $19.4 million are sufficient to meet our anticipated cash needs for working capital and capital expenditures through at least 2001. If cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to raise additional financing or reduce the scope of our planned product development and marketing efforts.
Comprehensive Income -- The Company had no comprehensive income items, other than net loss for the year ended December 31, 1998, a $10,000 unrealized loss in the market value of short-term investments for 1999, and a $10,000 unrealized gain in the market value of short term investments along with a $46,000 cumulative translation adjustment for 2000.
Segments of an Enterprise -- The Company currently operates in one reportable segment and the chief operating decision maker is the Company's Chief Executive Officer.
Other Recently Issued Accounting Standards -- In June 1998, the Financial Relations Accounting Board ("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement requires companies to record derivatives on the balance sheet as assets or liabilities measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 will be effective for the Company's fiscal year ending December 31, 2001. We have completed our evaluation of the impact of adopting SFAS No. 133 and believe that the impact of adopting the standard will not be material to our financial position, results of operations or cash flows.
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
Reclassifications -- Certain reclassifications have been made to the prior year financial statement presentations to conform to the current year presentation.
2. PROPERTY AND EQUIPMENT
Property and equipment consist of:
3. LONG-TERM OBLIGATIONS
Long-term obligations consist of:
In November 2000, the Company renewed its credit facilities with a bank. Under the renewed facilities, the Company continues to have available a $5 million revolving line of credit facility available through October 31, 2001 and a new $1 million equipment financing facility under which drawdowns are available through April 31, 2001 in addition to its outstanding $800,000 equipment term loan.
As of December 31, 2000, the Company had no borrowings outstanding under its renewed $5 million line of credit facility. Under this facility, any outstanding borrowings will bear interest at either the bank's base rate (9.5% as of December 31, 2000) or LIBOR plus 2.0 basis points for a maximum of two LIBOR advances in $1 million minimum increments having 30, 60, or 90 day maturities.
As of December 31, 2000, the Company had $533,000 outstanding under its new $1 million equipment financing facility with the bank. Under this facility, all borrowings outstanding on May 1, 2001 will automatically convert to a 30-month term loan having equal monthly payments of principal and interest. Borrowings under the equipment financing facility will bear interest at the bank's base rate plus 0.50%.
As of December 31, 2000, the Company had $333,000 outstanding under its $800,000 equipment term loan, which bears interest at 7.75%. The Company is required to make equal principal payments of $22,000 per month plus interest on the unpaid balance, payable in monthly installments through March 2002.
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
The bank's renewed credit facilities require the Company, among other things, to maintain a minimum tangible net worth of $10 million and a minimum quick ratio (current assets not including inventory less current liabilities) of 2 to 1. As of both June 30, 2000 and September 30, 2000, the Company's tangible net worth fell below the minimum tangible net worth ratio then in effect, and the bank waived both of those previous events. As of December 31, 2000, the Company was in compliance with its debt covenants. Borrowings under the facilities are collateralized by substantially all of the Company's assets.
Other long-term obligations represent uncollaterialized non-interest-bearing amounts payable for the acquisition of various purchased intangibles that are generally due within two years.
As of December 31, 2000, annual maturities under the equipment financing facility, the existing equipment term loan, and the other long-term obligations are as follows:
4. LEASE COMMITMENTS
Equipment with a net book value of $71,000 and nil at December 31, 2000 and 1999, respectively, (net of accumulated amortization of $694,000 and $692,000) has been leased under capital leases.
The Company leases its principal facility under a noncancelable operating lease expiring on June 30, 2002. Rent expense was approximately $965,000, $953,000 and $337,000 in 2000, 1999 and 1998, respectively.
Future minimum payments under the Company's leases at December 31, 2000(a) are:
- --------------- (a) The operating lease payment schedule above represents future minimum payments for each of the years presented based on information available as of February 28, 2001 as a result of the renegotiations of certain operating leases by the Company between January 1, 2001 and February 28, 2001.
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
5. STOCKHOLDERS' EQUITY
Convertible Preferred Stock
With the closing of the initial public offering of common stock in June 1999, all shares of the Company's outstanding convertible preferred stock were converted to common stock on a share for share basis.
Common Stock
In February 1999, the Company entered into an agreement with a customer and Series D preferred stockholder, whereby such customer was to perform development work to achieve certain performance improvements related to the Company's PowerTier product. In connection with this agreement, the Company allowed such customer to purchase 90,300 shares of common stock at $1.65 per share in February 1999, which was less than the deemed fair value for accounting purposes. The Company has recorded a research and development expense of $303,000 in 1999 for the difference between the deemed fair value and the stock price of $1.65 per share.
1994 Stock Purchase Plan
Under the 1994 Stock Purchase Plan (the Plan), the Company could sell common stock to employees of the Company at the fair market value as determined by the Board of Directors. Sales are to be made pursuant to restricted stock purchase agreements containing provisions established by the Board. No shares were issued under the Plan in 2000, 1999 and 1998. The Company has the right to repurchase these shares at the original issuance price upon termination of employment; this right expires ratably over four years. During 2000, 1999 and 1998, the Company repurchased 5,782, 10,084 and 23,081 shares, respectively, at prices ranging from $0.06 to $0.23 per share. At December 31, 2000, no shares were subject to repurchase and no shares were available for future grant.
1997 Stock Plan
As of December 31, 2000, the Company has reserved 5,609,652 shares of common stock for issuance, at the discretion of the Board of Directors, to officers, directors, employees and consultants pursuant to its 1997 Stock Plan. This reserved amount was increased automatically on January 1, 2001 under the provisions of the Plan by 840,000 shares to 6,449,652 shares reserved. The Plan also provides for an automatic annual increase on the first day of 2002, 2003, 2004 and 2005 equal to the lesser of 840,000 shares, 4.9% of the outstanding common stock on the last day of the immediately preceding fiscal year, or such lesser number as determined by the Board of Directors.
At December 31, 2000, 796,487 shares have been issued at $0.23 per share pursuant to restricted stock purchase agreements in which the Company has a right to repurchase these shares at original issuance price upon termination of employment; this right expires ratably over four years. At December 31, 2000, 184,167 shares were subject to repurchase. No shares were repurchased in 1999, 1998 or 1997.
At December 31, 2000 4,138,158 shares are reserved for exercise of issued and outstanding options, and 285,406 shares are available for future grant. The shares available for future grant automatically increased by 840,000 shares on January 1, 2001 to 1,125,406 shares.
Options granted under the 1997 Stock Plan generally vest over four years and expire ten years from the date of grant. Certain options were issued to a director in his capacity as a consultant in 1998 (See Note 8).
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
Additional information with respect to options under the 1997 Stock Plan is as follows:
Additional information regarding options outstanding as of December 31, 2000 is as follows:
1999 Directors' Stock Option Plan
The Company's 1999 Directors' Stock Option Plan (the "Directors' Plan") became effective upon the closing of the Company's initial public offering in June 1999. Under the Directors' Plan, a total of 500,000 shares of common stock have been reserved for the grant of nonstatutory stock options to nonemployee directors of the Company. Options granted under the Director's Plan shall be immediately vested and expire in five years from the date of grant. No options were granted under the Director's Plan during 1999. During 2000, 44,000 options were granted under the Director's Plan at exercise prices ranging from $9.75 to $22.50 and all were outstanding at December 31, 2000.
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
1999 Employee Stock Purchase Plan
The Company's 1999 Employee Stock Purchase Plan (the "ESPP") became effective upon the closing of the Company's initial public offering in June 1999. Under the ESPP, eligible employees may purchase common stock through payroll deductions, which may not exceed 20% of any employee's compensation, nor more than 2,500 shares in any one purchase period. A total of 600,000 shares of common stock has been reserved for issuance under the ESPP. The ESPP allows for an automatic annual increase on the first day of 2000, 2001, 2002, 2003 and 2004 equal to the lessor of 250,000 shares or 1% of outstanding common stock on the last day of the immediately preceding fiscal year. As of December 31, 1999, no shares were issued under the ESPP. During 2000, 104,077 shares were issued under the ESPP at prices ranging from $9.35 to $14.56 per share and aggregate proceeds of $1,037,000.
Deferred Stock Compensation
In connection with grants of certain stock options and issuance of common stock in 2000, 1999, and, the Company recorded $85,000 (terminations of $283,000), $45,000 (terminations of $90,000), and $2,266,000, respectively, for the difference between the estimated fair value and the stock price as determined by the Board of Directors on the date of grant/issuance. This amount is being amortized to expense over the vesting period of the related stock/stock options (generally four years). Amortization of deferred stock compensation for the years ended December 31, 2000, 1999 and 1998 was $416,000, $971,000 and $331,000, respectively.
Stock-Based Compensation
SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure of pro forma net loss had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions for options outstanding under the 1997 Stock Plan: expected life, 24 months following vesting; risk free interest rate, 5.1% in 2000, 5.4% in 1999 and 5.5% in 1998; volatility of 124% for 2000, 50% for 1999 after the Company's June 1999 initial public offering of common stock and none before that date, and none during 1998; and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the awards granted in 1997 and after had been amortized to expense over the vesting period of the awards, pro forma net loss (net of amortization of deferred compensation expense already recorded for the years ended December 31, 2000, 1999 and 1998, as discussed above) would have been approximately $27.0 million ($1.40 per basic and diluted share) in 2000, $13.0 million ($0.99 per basic and diluted share) in 1999 and $4.4 million ($0.63 per basic and diluted share) in 1998.
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
6. NET LOSS PER SHARE
The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per share (in thousands):
For the above mentioned periods, the Company had securities outstanding which could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net loss per share in the periods presented, as their effect would have been anti-dilutive. Such outstanding securities consist of the following:
7. INCOME TAXES
The Company's deferred income tax assets are comprised of the following at December 31:
Deferred income taxes reflect the tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as net operating loss and tax credit carryforwards. Due to the uncertainty surrounding the realization of the
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
benefits of its favorable tax attributes in future tax returns, as of December 31, 2000 and 1999, the Company has fully reserved its net deferred tax assets of approximately $16.7 million and $11.1 million, respectively.
The Company's effective rate differs from the expected benefit at the federal statutory tax rate at December 31 as follows:
Substantially all of the Company's loss from operations for all periods presented is generated from domestic operations.
At December 31, 2000, the Company has net operating loss (NOL) carryforwards of approximately $34.0 million and $7.8 million for federal and state income tax purposes, respectively. The federal NOL carryforwards expire through 2020, while the state NOL carryforwards expire through 2005. The net operating loss carryforwards available for state tax purposes are substantially less than for federal tax purposes, primarily because only 50% of state net operating losses can be utilized to offset future state taxable income.
At December 31, 2000, the Company also has research and development credit carryforwards of approximately $980,000 and $788,000 available to offset future federal and state income taxes, respectively. The federal credit carryforward expires in 2015, while the state credit carryforward has no expiration.
The extent to which the loss and credit carryforwards can be used to offset future taxable income and tax liabilities, respectively, may be limited, depending on the extent of ownership changes within any three-year period.
8. RELATED PARTY TRANSACTIONS
During 1998, the Company recognized revenue of $168,000 and $1,450,000 from a Series B and a Series C preferred stockholder, respectively. At December 31, 1998, the Company had deferred revenue of $30,000 and $642,000 with the same Series B and Series C preferred stockholders, respectively. All of the deferred revenue was recognized in 1999. At December 31, 1998, the Company had accounts receivable of $101,000 from the Series B preferred stockholder.
During 1999, the Company paid $69,000 to a director for consulting services. During 1998, the Company paid $18,000 to a director for consulting services, and in 1998 paid $20,500 to another director for consulting services. In July 1998, the Company granted a fully vested option to purchase up to 3,572 shares of common stock at $0.50 per share to a director in connection with consulting services rendered. Compensation expense of $9,000 was recorded for the difference between the exercise price and the deemed fair market value of the common stock on the date of grant.
During 2000, the Company had insignificant transactions with related parties.
See also Note 9 for information about significant revenues from common stockholders.
PERSISTENCE SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
9. SEGMENT INFORMATION, OPERATIONS BY GEOGRAPHIC AREA AND SIGNIFICANT CUSTOMERS
The Company is engaged in the development and marketing of transactional application server software products and operates in one reportable segment under SFAS 131.
Geographic Information
- --------------- (1) Revenues are broken out geographically by the ship-to location of the customer.
Significant Customers
During 2000, one customer accounted for 16% of the Company's total revenues. During 1999, one customer (a common stockholder) accounted for 13% of the Company's total revenues. During 1998, one customer (a common stockholder) accounted for 14% of total revenues. Additionally, during 1998, another customer (also a common stockholder) accounted for 17% of total revenues.
At December 31, 2000, one customer accounted for 19% of accounts receivable, and another customer accounted for 18% of accounts receivable. At December 31, 1999, one customer accounted for 11% of accounts receivable.
10. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) tax-deferred savings plan, whereby eligible employees may contribute a percentage of their eligible compensation (presently from 1% to 20% up to the maximum allowed under IRS rules). Company contributions are discretionary; no such Company contributions have been made since inception of this plan.
PERSISTENCE SOFTWARE, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the consolidated financial statements or notes thereto.
S-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Persistence Software, Inc.:
We have audited the consolidated financial statements of Persistence Software, Inc. and subsidiary (the "Company") as of December 31, 2000 and 1999, and for each of the three years in the period ended December 31, 2000, and have issued our report thereon dated January 30, 2001, (February 28, 2001 as to the table in Note 4). Our audits also included the consolidated financial statement schedule of the Company listed in the Index at Item 14(a)(2). This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
San Jose, California January 30, 2001
S-2
SCHEDULE II
PERSISTENCE SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
S-3