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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 2001 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______ to ______.
Commission File Number: 0-20710
PEOPLESOFT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 68-0137069
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4460 HACIENDA DRIVE, PLEASANTON, CA 94588
(Address of principal executive officers) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (925) 694-3000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
CLASS OUTSTANDING AT NOVEMBER 7, 2001
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Common Stock, par value $0.01.. 302,874,931
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TABLE OF CONTENTS
PAGE
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PART I FINANCIAL INFORMATION
ITEM 1 -- Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2001 and December 31, 2000.................... 2
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2001 and
September 30, 2000.......................................... 3
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and
September 30, 2000.......................................... 4
Notes to Condensed Consolidated Financial Statement......... 5
ITEM 2 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 12
ITEM 3 -- Financial Risk Management................................... 19
PART II OTHER INFORMATION
ITEM 1 -- Legal Proceedings........................................... 30
ITEM 2 -- Changes in Securities and Use of Proceeds................... 30
ITEM 3 -- Defaults upon Senior Securities............................. 30
ITEM 4 -- Submission of Matters to a Vote of Security Holders......... 30
ITEM 5 -- Other Information........................................... 30
ITEM 6 -- Exhibits and Reports on Form 8 - K.......................... 31
SIGNATURES.................................................. 32
1
PART I -- FINANCIAL INFORMATION
ITEM 1 -- FINANCIAL STATEMENTS
PEOPLESOFT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
-------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2001 2000
(UNAUDITED)
-------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents ............................... $ 389,979 $ 646,605
Short-term investments .................................. 1,031,443 354,074
Accounts receivable, net ................................ 354,110 449,036
Income taxes receivable ................................. 6,888 31,652
Deferred tax assets ..................................... 95,505 59,214
Other current assets .................................... 84,650 75,350
-----------------------------
Total current assets ................................ 1,962,575 1,615,931
Property and equipment, at cost .............................. 503,790 443,629
Less accumulated depreciation and amortization ...... (287,921) (234,443)
-----------------------------
215,869 209,186
Investments .................................................. 93,856 95,650
Non-current deferred tax assets .............................. 20,910 19,121
Capitalized software, less accumulated amortization .......... 18,131 7,369
Other assets ................................................. 51,341 37,893
-----------------------------
Total assets ........................................ $ 2,362,682 $ 1,985,150
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................ $ 35,209 $ 35,163
Accrued liabilities ..................................... 161,335 141,743
Accrued compensation and related expenses ............... 154,255 158,623
Income taxes payable .................................... 3,468 5,059
Current portion of convertible debt ..................... 57,000 --
Deferred revenues ....................................... 407,577 429,554
-----------------------------
Total current liabilities ........................... 818,844 770,142
Long-term deferred revenues .................................. 93,964 100,858
Long-term portion of convertible debt ........................ -- 68,000
Other liabilities ............................................ 20,342 21,795
Commitments and contingencies (see notes)
Stockholders' equity:
Common stock ............................................ 3,033 2,880
Additional paid-in capital .............................. 1,116,051 813,551
Treasury stock .......................................... (35,040) (15,000)
Retained earnings ....................................... 359,444 225,660
Accumulated other comprehensive loss .................... (13,956) (2,736)
-----------------------------
Total stockholders' equity .......................... 1,429,532 1,024,355
-----------------------------
Total liabilities and stockholders' equity .......... $ 2,362,682 $ 1,985,150
=================================================================================================
See accompanying notes to condensed consolidated financial statements.
2
PEOPLESOFT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
-------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
-------------------------------------------------------------------------------------------------------------------
REVENUES:
License fees ................................ $ 151,763 $ 131,520 $ 471,346 $ 331,588
Services .................................... 333,463 274,619 989,748 817,634
Development and other services .............. 24,127 36,981 83,999 89,471
-----------------------------------------------------------
Total revenues ......................... 509,353 443,120 1,545,093 1,238,693
COSTS AND EXPENSES:
Cost of license fees ........................ 12,022 8,485 46,523 26,746
Cost of services ............................ 169,108 152,825 526,864 445,547
Cost of development and other services....... 21,842 33,566 76,202 81,307
Sales and marketing expense ................. 126,009 116,617 383,629 315,206
Product development expense ................. 70,939 76,714 223,812 240,850
General and administrative expense .......... 40,940 29,143 116,484 78,579
Product exit charges ........................ -- 35,923 -- 35,923
Restructuring, merger and other charges ..... 750 -- 12 --
-----------------------------------------------------------
Total costs and expenses ............... 441,610 453,273 1,373,526 1,224,158
-----------------------------------------------------------
Operating income (loss) .......................... 67,743 (10,153) 171,567 14,535
Other income, net ................................ 7,751 130,094 29,810 155,958
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Income before provision for income taxes ......... 75,494 119,941 201,377 170,493
Provision for income taxes ....................... 25,149 51,209 67,593 69,028
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Net income ....................................... $ 50,345 $ 68,732 $ 133,784 $ 101,465
===================================================================================================================
Basic income per share ........................... $ 0.17 $ 0.24 $ 0.45 $ 0.37
Shares used in basic per share computation ....... 302,153 281,438 296,036 277,690
===================================================================================================================
Diluted income per share ......................... $ 0.16 $ 0.23 $ 0.42 $ 0.35
Shares used in diluted per share computation ..... 322,323 304,895 322,199 291,723
===================================================================================================================
See accompanying notes to condensed consolidated financial statements.
3
PEOPLESOFT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 2000
---------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income ................................................................. $ 133,784 $ 101,465
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization .......................................... 73,783 59,806
Provision for doubtful accounts ........................................ 15,863 271
Benefit for deferred income taxes ...................................... (22,621) (43,220)
Gains on sales of investments and disposition of property and
equipment, net ....................................................... (3,116) (131,962)
Non-cash stock compensation ............................................ 2,131 --
Product exit charges ................................................... -- 35,923
Restructuring, merger and other non-cash items ......................... 12 (1,334)
Changes in operating assets and liabilities:
Accounts receivable ................................................... 75,910 (81,921)
Cash received from sales of accounts receivable ....................... -- 47,735
Accounts payable and accrued liabilities .............................. 7,399 (1,433)
Accrued compensation and related expenses ............................. (2,547) 3,915
Income taxes receivable, net .......................................... 23,582 49,225
Tax benefits from exercise of stock options ........................... 68,394 27,453
Deferred revenues ..................................................... (27,223) 3,456
Other current and noncurrent assets and liabilities ................... (13,721) (39,511)
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Net cash provided by operating activities .............................. 331,630 29,868
INVESTING ACTIVITIES:
Purchase of available-for-sale investments ................................. (5,776,371) (951,475)
Proceeds from maturities and sales of available-for-sale investments ....... 5,100,079 792,809
Proceeds from maturities of held-to-maturity investments ................... -- 46,610
Purchase of property and equipment ......................................... (69,907) (60,199)
Disposition of property and equipment ...................................... -- 378
Proceeds from sale of acquired software .................................... -- 5,878
Additions to capitalized software .......................................... -- (2,124)
Acquisitions, net of cash acquired ......................................... (26,388) (7,941)
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Net cash used in investing activities .................................. (772,587) (176,064)
FINANCING ACTIVITIES:
Net proceeds from sale of common stock and exercise of stock options ....... 215,359 122,046
Purchase of treasury stock ................................................. (20,040) --
Repurchase of long-term debt ............................................... (10,542) --
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Net cash provided by financing activities .............................. 184,777 122,046
Effect of foreign exchange rate changes on cash and cash equivalents ....... (446) (2,988)
---------------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents .................................. (256,626) (27,138)
Cash and cash equivalents at beginning of period ........................... 646,605 414,019
---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period ................................. $ 389,979 $ 386,881
===============================================================================================================
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest .................................................... $ 3,187 $ 2,789
Cash paid for income taxes, net of refunds ................................ $ 460 $ 27,323
===============================================================================================================
See accompanying notes to condensed consolidated financial statements.
4
PEOPLESOFT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The information for the three and nine months ended September 30, 2001 and
September 30, 2000, is unaudited, but includes all adjustments (consisting only
of normal, recurring adjustments) that the Company's management believes to be
necessary for the fair presentation of the financial position, results of
operations, and changes in cash flows for the periods presented. The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
periods. Despite management's best effort to establish good faith estimates and
assumptions, and to manage the achievement of the same, actual results may
differ. Certain prior period amounts have been reclassified to conform to the
current period presentation.
The accompanying interim condensed consolidated financial statements should
be read in conjunction with the financial statements and related notes included
in the Company's Annual Report to Stockholders on Form 10-K for the year ended
December 31, 2000 (as amended by Form 10-K/A). Certain information and footnote
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to the Securities and Exchange Commission rules and
regulations. Interim results of operations for the three and nine months ended
September 30, 2001 are not necessarily indicative of operating results or
performance levels that can be expected for the full fiscal year.
2. PER SHARE DATA
Basic income per share is computed by dividing net income by the weighted
average number of common shares outstanding during the period. Diluted income
per share is computed by dividing net income by the sum of weighted average
number of common shares outstanding and dilutive common equivalent shares
outstanding during the period. Common equivalent shares consist of the shares
issuable upon the exercise of stock options, warrants, convertible subordinated
notes and from withholdings associated with our employee stock purchase plan,
using the treasury stock method.
The following table sets forth the computation of basic and diluted income
per share.
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THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(In thousands, except per share amounts) 2001 2000 2001 2000
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NUMERATOR:
Net income ............................................ $ 50,345 $ 68,732 $133,784 $101,465
DENOMINATOR:
Denominator for basic income per share -
Weighted average shares outstanding ............... 302,153 281,438 296,036 277,690
Employee stock options and other ....................... 20,170 23,457 26,163 14,033
--------------------------------------------------
Denominator for diluted income per share -
Adjusted weighted average shares outstanding
assuming exercise of common equivalent shares ..... 322,323 304,895 322,199 291,723
=====================================================================================================================
Basic income per share ...................................... $ 0.17 $ 0.24 $ 0.45 $ 0.37
=====================================================================================================================
Diluted income per share .................................... $ 0.16 $ 0.23 $ 0.42 $ 0.35
=====================================================================================================================
Approximately 12.0 million shares of weighted average common stock
equivalents at prices ranging from $35.20 to $49.23 and 12.0 million shares of
weighted average common stock equivalents at prices ranging from $35.85 to
$49.23 were excluded from the computation of diluted earnings per share for the
three and nine months ended September 30, 2001 because the options' exercise
prices were greater than the average market price of the common shares during
the period.
5
3. FINANCIAL INSTRUMENTS
Derivative financial instruments are utilized by the Company to reduce
foreign currency exchange and interest rate risks. The Company has established
policies and procedures for risk assessment and for the approval, reporting and
monitoring of derivative financial instruments. The Company does not hold any
derivative financial instruments for trading or speculative purposes. Derivative
transactions are restricted to those intended for hedging purposes.
Change in Accounting
Effective January 1, 2001, the Company adopted the Financial Accounting
Standards Board Statement No. 133, as amended, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are required to
be recorded on the balance sheet at fair value. If the derivative is designated
as a fair value hedge, the changes in the fair value of the derivative and of
the hedged item attributable to the hedged risk are recognized in earnings. If
the derivative is designated as a cash flow hedge, the effective portions of
changes in the fair value of the derivative are recorded in "Accumulated other
comprehensive loss." The cumulative effect of the accounting change to adopt
SFAS 133, as amended, as of January 1, 2001 resulted in the Company recognizing
a $2.6 million unrealized loss (net of tax) in "Accumulated other comprehensive
loss."
Forward Foreign Exchange Contracts
The Company has a foreign exchange hedging program designed to mitigate the
potential for future adverse impact on intercompany balances due to changes in
foreign currency exchange rates. The program uses forward foreign exchange
contracts as the vehicle for hedging significant intercompany balances. The
Company uses two multinational banks for substantially all of these contracts.
The Company has not designated the derivatives used in the foreign exchange
hedging program as cash flow or fair value hedges under SFAS 133, as amended. In
general, these contracts have terms of three months or less. The contracts are
recorded on the balance sheet at fair value. Changes in fair value of the
contracts and the intercompany balances being hedged are included in "Other
income, net." To the extent these contracts do not completely hedge the
intercompany balances, the net impact is recognized in "Other income, net." The
foreign currency hedging program is managed in accordance with a corporate
policy approved by the Company's Board of Directors.
During the three months ended September 30, 2001 and 2000 the Company
recorded net losses of $1.9 million and $0.4 million from these settled
contracts and underlying foreign currency exposures. During the nine months
ended September 30, 2001 and September 30, 2000 the Company recorded a net loss
of $2.7 million and a net gain of $2.0 million from these settled contracts and
underlying foreign currency exposures. At September 30, 2001, the Company had
outstanding forward exchange contracts to exchange U.S. dollars for Euros ($8.6
million), Swiss francs ($3.2 million), South African rand ($3.1 million),
British pounds ($2.0 million), Japanese yen ($1.2 million), Swedish krona ($1.1
million), New Zealand dollars ($0.9 million), and Canadian dollars ($0.6
million). At September 30, 2001, the Company had outstanding forward exchange
contracts to exchange Australian dollars ($9.0 million), Singapore dollars ($3.7
million), Hong Kong dollars ($2.2 million), and Chilean pesos ($0.6 million) for
U.S. dollars. Each of these contracts had maturity dates of October 31, 2001 and
a book value that approximated fair value at September 30, 2001. Both the cost
and the fair value of these forward exchange contracts were not material at
September 30, 2001.
Interest Rate Swap Transactions
The Company has entered into interest rate swap transactions to manage its
exposure to interest rate changes on facility lease obligations. The swaps
involve the exchange of variable for fixed interest rate payments without
exchanging the notional principal amount. The swaps have an aggregate notional
amount of $175 million and mature at various dates in 2003, consistent with the
maturity dates of the facility leases. Under these agreements, the Company
receives a variable interest rate based on the 3 month LIBOR set on the last day
of the previous quarter and pays a weighted average fixed interest rate of
6.80%. These swaps are
6
considered to be hedges against changes in the amount of future cash flows. The
Company recorded in "Accumulated other comprehensive loss" a $6.7 million
unrealized loss as of September 30, 2001 in connection with these interest rates
swaps. Derivative losses included in "Accumulated other comprehensive loss" of
$7.3 million are estimated to be reclassified into earnings during the next
twelve months based upon a 12 month forward LIBOR rate.
Concentrations of Credit Risk
The Company believes it does not have a concentration of credit or operating
risk in any one investment, industry or geographic region within or outside of
the United States.
4. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, were as follows:
--------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(In thousands) 2001 2000 2001 2000
--------------------------------------------------------------------------------------------------------------------
Net income .......................................... $ 50,345 $ 68,732 $ 133,784 $ 101,465
Other comprehensive income (loss):
Net change in unrealized gain/loss on
available-for-sale investments .............. (416) (57,790) (1,098) (142,824)
Foreign currency translation .................... 5,394 (1,296) (3,384) (2,985)
Interest rate swap transactions:
Cumulative effect of accounting change ...... -- -- (2,648) --
Net unrealized loss on cash flow hedges ..... (3,306) -- (5,542) --
Reclassification adjustment for earnings
recognized during the period .............. 840 -- 1,452 --
====================================================================================================================
Comprehensive income (loss) ....................... $ 52,857 $ 9,646 $ 122,564 $ (44,344)
====================================================================================================================
5. RESTRUCTURING AND EXIT RESERVES
The following table sets forth the Company's restructuring reserves as of
September 30, 2001, which are included in "Accrued liabilities."
---------------------------------------------------------------------------------------------
(In thousands) LEASES OTHER TOTAL
---------------------------------------------------------------------------------------------
Balance December 31, 2000 ....................... $ 4,520 $ 5,884 $ 10,404
Cash payments ................................ (1,010) -- (1,010)
Adjustments to reflect current estimates ..... -- (5,064) (5,064)
---------------------------------------------------------------------------------------------
Balance September 30, 2001 ...................... $ 3,510 $ 820 $ 4,330
=============================================================================================
6. COMMITMENTS AND CONTINGENCIES
Beginning on January 29, 1999, a series of class action lawsuits was filed in
the United States District Court for the Northern District of California against
the Company and certain of its officers and directors, alleging violations of
Section 10(b) of the Securities Exchange Act of 1934. The actions were
consolidated in June 1999 under the name of the lead case Suttovia v. Duffield,
et al., C 99-0472.
The Consolidated Complaint, which purported to bring claims on behalf of all
purchasers of PeopleSoft common stock during the period April 22, 1997 to
January 28, 1999, alleged that PeopleSoft misrepresented, inter alia, the degree
of market acceptance of its products, the technical capabilities of its
products, the success of certain acquisitions it had made, and the anticipated
financial performance of the Company in fiscal 1999.
7
On February 16, 2001, PeopleSoft agreed to a tentative settlement of the
litigation resulting in the dismissal of all claims against the defendants in
exchange for a payment of $15.0 million, all of which will be funded by the
Company's Directors and Officers Liability Insurance. The Company executed a
final Stipulation of Settlement on April 20, 2001, and on August 24, 2001, the
District Court entered a judgment approving the settlement and dismissing the
litigation with prejudice. An insurance receivable and a settlement accrual of
$15.0 million has been included in "Other current assets" and "Accrued
liabilities," respectively, in the accompanying condensed consolidated balance
sheets.
Beginning on July 6, 1999, a series of securities class action lawsuits was
filed alleging that Vantive and certain current and former directors and
officers violated Section 10(b) of the Securities Exchange Act and Rule 10b-5
promulgated thereunder. Plaintiffs filed a First Consolidated Amended Complaint
on November 15, 1999. The First Consolidated Amended Complaint added to the
previous complaints, among other things, allegations of accounting
improprieties. The Company filed a motion to strike and a motion to dismiss the
First Consolidated Amended Complaint with prejudice. The motion was granted on
March 21, 2000. On June 19, 2000, plaintiffs filed an appeal from the district
court's ruling in the Ninth Circuit Court of Appeal. A hearing was held on July
11, 2001, before the Ninth Circuit Court of Appeal, and a ruling is expected in
due course. The Company believes the complaints are without merit and intends to
continue to vigorously defend the action. However, there can be no assurance
that if there is an unfavorable resolution of the appeal, there would not be a
potential material adverse impact on the Company's future financial position,
results of operations or cash flows.
On November 5, 1996, a case was filed in the California Superior Court for
the County of Alameda (Yarborough v. Peoplesoft, Inc., Case No. 775405-2) by a
former employee of the Company whose employment was terminated in November 1995.
The complaint alleged causes of action for wrongful discharge, retaliation, age
discrimination and harassment. The Company has filed a cross complaint based
upon plaintiff's violation of Penal Code section 632 and the wrongful taking of
proprietary information from the Company. The cross complaint filed by the
Company has not yet been heard. The trial on the action has been trifurcated on
the issues of liability, damages and the Company's cross complaint. On September
18, 2001, following a jury trial on liability and damages, the Court entered
judgment on a verdict in favor of the plaintiff in the amount of $5.4 million.
The Company is considering an appeal and intends to vigorously prosecute the
trial on the cross-complaint.
The Company is party to various legal disputes and proceedings arising from
the ordinary course of general business activities. In the opinion of
management, resolution of these matters is not expected to have a material
adverse impact on the overall financial position, results of the operations or
cash flows of the Company. However, depending on the amount and the timing, an
unfavorable resolution of some or all of these matters could materially affect
the Company's future results of operations or cash flows in a particular period.
7. COMMON STOCK REPURCHASE PROGRAM
In August 2000, the Board of Directors authorized the repurchase of shares of
the Company's common stock, at management's discretion, of up to $100.0 million.
Shares repurchased under the stock repurchase program are used to offset the
dilutive effect of the Company's stock option and stock purchase plans. The
Company's repurchases of shares of common stock are recorded as treasury stock
and result in a reduction of stockholders' equity. As of September 30, 2001, a
total of 1,189,000 shares were repurchased for a total of $35.0 million.
8. SEGMENT INFORMATION
Statement of Financial Accounting No. 131, "Disclosures about Segments of an
Enterprise and Related Information," ("SFAS 131") establishes standards for the
way in which public companies disclose certain information about operating
segments in the Company's financial reports. Based on the criteria of SFAS 131,
the Company identified its chief executive officer ("CEO") as the chief
operating decision maker. The Company's CEO evaluates revenue performance based
on two segments: North America, which includes operations in the U.S. and
Canada, and International, which includes operations in all other geographic
regions. Data for the two segments is presented below. Employee headcount and
operating costs are managed by functional area, rather than by revenue segments,
and are only reviewed by the CEO on a
8
company-wide basis. In addition, the Company does not account for or report to
the CEO the assets or capital expenditures by any segment other than the
segments disclosed below.
The following table presents a summary of operating information and certain
quarter-end balance sheet information by operating segment for the three and
nine months ended September 30, 2001 and September 30, 2000:
-----------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(In thousands) 2001 2000 2001 2000
-----------------------------------------------------------------------------------------------------
REVENUES FROM UNAFFILIATED
CUSTOMERS:
North America ................ $ 392,677 $ 344,511 $ 1,192,006 $ 973,272
International ................ 116,676 98,609 353,087 265,421
-----------------------------------------------------------------------------------------------------
Consolidated ................. $ 509,353 $ 443,120 $ 1,545,093 $ 1,238,693
=====================================================================================================
OPERATING INCOME (LOSS):
North America ................ $ 50,394 $ (33,783) $ 111,029 $ (44,893)
International ................ 17,349 23,630 60,538 59,428
-----------------------------------------------------------------------------------------------------
Consolidated ................. $ 67,743 $ (10,153) $ 171,567 $ 14,535
=====================================================================================================
IDENTIFIABLE ASSETS:
North America ................ $ 2,074,929 $ 1,613,573
International ................ 287,753 228,778
-----------------------------------------------------------------------------------------------------
Consolidated ................. $ 2,362,682 $ 1,842,351
=====================================================================================================
Revenues from the Europe/Middle-East/Africa region represented 13% and 12% of
total revenues for the three months ended September 30, 2001 and September 30,
2000. Revenues from the Europe/Middle-East/Africa region represented 13% and 12%
of total revenues for the nine months ended September 30, 2001 and September 30,
2000. No other international region had revenues equal to or greater than 10% of
total revenues for the three or nine months ended September 30, 2001 or
September 30, 2000. Revenues originated in each individual foreign country were
less than 5% of total revenues for the three months ended September 30, 2001 and
September 30, 2000.
9. BUSINESS COMBINATION
On May 31, 2001, the Company acquired the assets and assumed liabilities of
SkillsVillage, Inc., through a business combination accounted for under the
purchase method of accounting. The assets acquired included technology to
automate the process of procuring and managing contract services. The aggregate
purchase price of $31.5 million included the issuance of 398,029 shares of
common stock with a fair value of $16.1 million, the issuance of options to
SkillsVillage employees to purchase common stock with a fair value of $2.2
million, and cash payments of $13.2 million. Terms of the business combination
called for $2.4 million in cash and shares of common stock to be placed into
escrow for a period of 12 months to satisfy certain liabilities or claims. After
the term of the escrow has elapsed, escrow amounts will be accounted for as
additional purchase price and amounts remaining in the escrow account will be
distributed to former SkillsVillage shareholders.
The Company allocated the excess purchase price over the fair value of the
net tangible assets acquired to the following intangible assets: $21.7 million
to goodwill, $4.8 million to completed products and technology, $1.9 million to
in-process research and development, and $0.8 million to assembled workforce. As
of the acquisition date, the technological feasibility of the in-process
technology had not been established and had no alternative future use and the
Company expensed the $1.9 million in accordance with generally accepted
accounting principles. The capitalized intangible assets are being amortized
based on their estimated useful lives of four years.
In performing this allocation, the Company considered, among other factors,
its intentions for future use of the acquired assets and analyses of historical
financial performance and estimates of future performance of SkillsVillage's
products. The projected incremental cash flows were discounted back to their
present value using discount rates of 18% and 23% for developed and in-process
technology. These discount rates were determined after consideration of the
Company's rate of return on debt capital and equity, the weighted average return
on invested capital, and the risk associated with achieving forecasted sales.
9
Associated risks included achieving anticipated levels of market acceptance and
penetration, market growth rates and risks related to the impact of potential
changes in future target markets.
The Company's projections may ultimately prove to be incomplete or
inaccurate, and unanticipated events and circumstances may occur. Therefore, no
assurance can be given that the underlying assumptions used to forecast revenues
and costs to develop such projects will transpire as estimated.
10. TRANSACTIONS WITH MOMENTUM BUSINESS APPLICATIONS, INC.
On July 23, 2001, the Company and Momentum Business Applications, Inc.
("Momentum") entered into a Business Agreement Amendment, which amended the
terms of the Development Agreement and the Marketing Agreement. The Business
Agreement Amendment primarily decreased Pre-Release Royalty for any Momentum
Product to one percent (1%) of Net License Fees from six percent (6%) of Net
Revenues.
In conjunction with the Business Agreement Amendment, Momentum amended its
Restated Certificate of Incorporation to change the exercise price of the
Company's Purchase Option. The amendment to the Restated Certificate of
Incorporation relates specifically to the formulas to be utilized in the
determination of the Company's Purchase Option Price. The first formula was
modified to clarify the royalty base on which the multiple is calculated. The
formula is essentially fifteen times the sum of all pre-release royalties or
product payments paid by the Company to Momentum during the four quarters prior
to an exercise of the Purchase Option. The fourth formula was changed from a
flat amount of $75 million to: i) $90 million provided the option is exercised
no later than February 15, 2002, ii) $92.5 million if exercised on or between
February 16, 2002 and May 15, 2002, or iii) $95 million if exercised on or after
May 16, 2002. The timing of the expiration of the Purchase Option remains
unchanged.
The effectiveness of the Business Agreement Amendment was contingent upon
Momentum obtaining stockholder approval of the amendment to the Restated
Certificate of Incorporation. This amendment was approved at Momentum's Annual
Meeting of Stockholders on September 19, 2001.
11. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") approved for
issuance Statements of Financial Accounting Standards No. 141, "Business
Combinations," ("SFAS 141") and No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142").
SFAS 141, effective June 30, 2001, requires all business combinations
initiated after June 30, 2001 to be accounted for using the purchase method of
accounting. The pooling-of-interests method of accounting can no longer be used
for business combinations completed after June 30, 2001. The provisions of SFAS
141 are similar to prior generally accepted accounting principles ("GAAP"),
although SFAS 141 requires additional disclosures for transactions occurring
after the effective date. Under SFAS 141, the Company will continue to
immediately write off in-process research and development.
SFAS 142 eliminates the amortization of goodwill for business combinations
completed after June 30, 2001. Goodwill associated with business combinations
completed prior to July 1, 2001 will continue to be amortized through the income
statement during the second half of 2001. Effective January 1, 2002, goodwill
will no longer be amortized, but is required to be assessed on an annual basis
for impairment at the reporting unit level by applying a fair value based test.
SFAS 142 also provides additional guidance on acquired intangibles that should
be separately recognized and amortized, which may result in the recognition of
additional intangible assets as compared with prior GAAP.
Beginning in the first quarter of 2002, the Company will no longer amortize
goodwill, thereby eliminating annual goodwill amortization of approximately $8.7
million. Amortization for the nine months ended September 30, 2001 was $6.0
million. Unamortized goodwill was $30.8 million as of September 30, 2001. The
Company will complete an initial goodwill impairment assessment in 2002 to
determine if a transition impairment charge should be recognized under SFAS 142.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations," ("SFAS 143"). SFAS 143
addresses accounting and reporting for
10
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. This Statement requires that the fair value
of a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. The liability is accreted to its present value each
period while the cost is depreciated over its useful life. SFAS 143 is effective
for financial statements issued for fiscal years beginning after June 15, 2002.
The Company has not yet determined the effects SFAS 143 will have on its
financial position, results of operations or cash flows but does not anticipate
that the impact will be significant.
In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
("SFAS 144"). SFAS 144, which replaces SFAS 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," requires
long-lived assets to be measured at the lower of carrying amount or fair value
less the cost to sell. SFAS 144 also broadens disposal transactions reporting
related to discontinued operations. SFAS 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001. The
Company has not yet determined the effects SFAS 144 will have on its financial
position, results of operations or cash flows but does not anticipate that the
impact will be significant.
11
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Discussion and Analysis of Financial Condition and Results of Operations
contains descriptions of the Company's expectations regarding future trends
affecting its business. These forward-looking statements and other
forward-looking statements made elsewhere in this document are made in reliance
upon safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Future results are subject to risks and uncertainties, which could cause
actual results and performance to differ significantly from those contemplated
by the forward-looking statements. For a discussion of factors that could affect
future results, see "Factors That May Affect Future Results and Market Price of
Stock." Forward-looking statements contained throughout this Report include, but
are not limited to those identified with a footnote (1) symbol. The Company
undertakes no obligation to update the information contained in this Item 2.
RESULTS OF OPERATIONS
The following table sets forth, the percentage of dollar change period over
period and the percentage of total revenues represented by certain line items in
the Company's Condensed Consolidated Statements of Operations, for the three and
nine months ended September 30, 2001 and 2000.
-------------------------------------------------------------------------------------------------------------------------------
PERCENTAGE OF PERCENTAGE OF PERCENTAGE OF PERCENTAGE OF
DOLLAR CHANGE TOTAL REVENUES DOLLAR CHANGE TOTAL REVENUES
------------- ------------------- ------------- -------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------------------
2001/2000 2001 2000 2001/2000 2001 2000
-------------------------------------------------------------------------------------------------------------------------------
REVENUES:
License fees ................................ 15% 30% 30% 42% 31% 27%
Services .................................... 21 65 62 21 64 66
Development and other services .............. (35) 5 8 (6) 5 7
-------------------------------------------------------------------------------------------------------------------------------
Total revenues ...................... 15 100 100 25 100 100
===============================================================================================================================
COSTS AND EXPENSES:
Cost of license fees ........................ 42 2 2 74 3 2
Cost of services ............................ 11 33 34 18 34 36
Cost of development and other services ...... (35) 4 8 (6) 5 7
Sales and marketing expense ................. 8 25 26 22 25 26
Product development expense ................. (8) 14 17 (7) 14 19
General and administrative expense .......... 40 8 7 48 8 6
Product exit charges ........................ * -- 8 * -- 3
Restructuring, merger and other charges ..... * * * * * *
-------------------------------------------------------------------------------------------------------------------------------
Total costs and expenses ............ (3) 87 102 12 89 99
===============================================================================================================================
Operating income .............................. * 13 (2) 1,080 11 1
-------------------------------------------------------------------------------------------------------------------------------
Other income, net ............................. (94) 2 29 (81) 2 13
-------------------------------------------------------------------------------------------------------------------------------
Provision for income taxes .................... (51)% 5% 12% (2)% 4% 6%
===============================================================================================================================
* Not meaningful
Net income decreased $18.4 million or 27% to $50.3 million during the third
quarter of 2001 as compared to $68.7 million during the third quarter of 2000.
Diluted income per share decreased to $0.16 during the third quarter of 2001
compared to $0.23 during the third quarter of 2000. For the nine months ended
September 30, 2001, net income increased $32.3 million or 32% to $133.8 million
as compared to $101.5 million during the comparable period of 2000. For the nine
months ended September 30, 2001, diluted income per share increased to $0.42
compared to $0.35 during the comparable period of 2000.
The third quarter of 2001 included two non-recurring items; a favorable
adjustment of $2.3 million (no tax impact) to existing restructuring reserves to
reflect current estimates and a $1.9 million after-tax charge for in-process
research and development related to an acquisition of assets which was otherwise
insignificant to the Company. The third quarter of 2000 included two
non-recurring items; an after-tax gain from the sale of equity securities of
$73.9 million and after-tax product line exit costs of $28.6 million.
12
Excluding the non-recurring items, income increased $26.6 million or 113% to
$50.0 million during the third quarter of 2001 as compared to $23.4 million
during the third quarter of 2000. The nine months ended September 30, 2001
included a $4.9 million favorable adjustment to existing restructuring reserves
to reflect current estimates (no tax impact), a $1.2 million after-tax charge
for in-process research and development related to the acquisition of
SkillsVillage in the second quarter of 2001 and a $1.9 million after-tax charge
for in-process research and development related to the acquisition of assets
which was otherwise insignificant to the Company. The nine months ended
September 30, 2000 include after-tax gains from the sale of equity securities of
$79.8 million and after-tax product exit costs of $28.6 million. Excluding the
non-recurring items, income increased $81.7 million or 162% to $132.0
million for the nine months ended September 30, 2001 as compared to $50.3
million during the comparable period of 2000.
REVENUES
The Company licenses software under non-cancelable license agreements and
provides services including consulting, training, development and maintenance,
consisting of product support services and periodic updates.
Total revenues increased by 15% to $509.4 million in the third quarter of
2001 from $443.1 million in the third quarter of 2000. The increase in total
revenues during the quarter is primarily attributable to the $20.2 million
increase in revenue from license fees and the $58.8 million increase in revenue
from services, partially offset by the $12.9 million decrease in the revenue
from development and other services. For the year-to-date period, total revenues
increased by 25% to $1,545.1 million during the nine months ended September 30,
2001 from $1,238.7 million during the nine months ended September 30, 2000. The
year-to-date increase is attributable to an increase in revenue from license
fees of $139.8 million and an increase in revenue from services of $172.1
million, partially offset by a $5.5 million decrease in revenue from development
and other services.
Revenue from license fees increased by 15% to $151.8 million in the third
quarter of 2001 from $131.5 million in the third quarter of 2000. Revenue from
license fees increased by 42% to $471.3 million during the nine months ended
September 30, 2001 from $331.6 million during the nine months ended September
30, 2000. The increase in revenue from license fees during three and nine months
ended September 30, 2001 was primarily the result of increased licensing
activity following the general availability of PeopleSoft 8.
Revenue from services increased by 21% to $333.5 million in the third quarter
of 2001 from $274.6 million in third quarter of 2000. The increase in services
revenue during the third quarter of 2001 as compared to the third quarter of
2000 primarily resulted from an increase in consulting revenue of $32.9 million,
an increase in maintenance revenue of $24.2 million and an increase in training
revenue of $1.8 million. The increase in services revenue is attributable to the
growth of the installed license base. Revenue from services as a percentage of
total revenues was 66% and 62% for the three months ended September 30, 2001 and
2000. Revenue from services increased by 21% to $989.7 million, or 64% of total
revenues, for the nine months ended September 30, 2001 from $817.6 million, or
66% of total revenues, for the nine months ended September 30, 2000. The change
in services revenue during the nine months ended September 30, 2001 compared to
the nine months ended September 30, 2000 primarily resulted from an increase in
consulting revenue of $91.7 million, an increase in maintenance revenue of $69.0
million and an increase in training revenue of $11.5 million. The increase in
services revenue is attributable to the growth of the installed license base.
Variances in the Company's license contracting activity during a given quarter
may impact its future consulting, maintenance and training service revenues
since these revenues typically follow license fee revenues. With the general
availability of PeopleSoft 8 (including PeopleSoft CRM which was released in
June 2001), the Company expects that demand from its installed base and new
customers for consulting, maintenance and training services will continue to
increase over the next several quarters.(1) However the Company cannot give
assurance that it will be successful in expanding its consulting, maintenance
and training services.
----------
(1) Forward-Looking Statement
13
Revenue from development and other services decreased to $24.1 million in the
third quarter of 2001 from $37.0 million in the third quarter of 2000. Per the
terms of the development agreement with Momentum Business Applications, Inc.
("Momentum"), the Company performs development services on behalf of Momentum.
Momentum pays one hundred and ten percent (110%) of the Company's fully burdened
costs relating to the research and development services provided by the Company.
Cost of development services decreased to $21.8 million during the third quarter
of 2001 from $33.6 million during the third quarter of 2000. Revenue from
development services decreased to $84.0 million during the nine months ended
September 30, 2001 from $89.5 million during the nine months ended September 30,
2000. Cost of development services decreased to $76.2 million during the nine
months ended September 30, 2001 from $81.3 million during the nine months ended
September 30, 2000. As of September 30, 2001, most of the initial development
projects undertaken by Momentum have been completed or are expected to be
completed in the near future. As a result, the Company expects revenues from
development and other services, and the related costs, to decrease over the next
several quarters.(1)
Revenues by Segment
At September 30, 2001, the Company is organized by geographic areas, in two
operating segments: North America, which includes operations in the U.S. and
Canada, and International, which includes operations in all other regions.
Revenues from the North America segment increased by 14% to $392.7 million,
or 77% of total revenues, during the third quarter of 2001 from $344.5 million,
or 78% of total revenues, during the third quarter of 2000. Revenues from the
North America segment increased by 22% to $1,192.0 million, or 77% of total
revenues, during the nine months ended September 30, 2001 from $973.3 million,
or 79% of total revenues during the nine months ended September 30, 2000. The
increase in revenues is primarily attributable to the general availability of
PeopleSoft 8.
Revenues from the International segment increased by 18% to $116.7 million,
or 23% of total revenues, in the third quarter of 2001 from $98.6 million, or
22% of total revenues, in the third quarter of 2000. Within the International
segment, revenues from Europe/Middle-East/Africa region represented 13% and 12%
of total revenues during the third quarters of 2001 and 2000. Revenues from the
International segment increased by 33% to $353.1 million, or 23% of total
revenues, during the nine months ended September 30, 2001 from $265.4 million,
or 21% of total revenues, during the nine months ended September 30, 2000.
Revenues from Europe/Middle-East/Africa region represented 13% and 12% of total
revenues during the nine months ended September 30, 2001 and 2000. The increase
in revenues is primarily attributable to the general availability of PeopleSoft
8.
COSTS AND EXPENSES
Cost of license fees consists principally of royalties, product warranty
costs, technology access fees for certain third-party software products and the
amortization of capitalized software costs. The Company's products are based on
a combination of internally developed technology and application products, as
well as bundled third-party products and technology. Cost of license fees
increased to $12.0 million in the third quarter of 2001 from $8.5 million in the
third quarter of 2000, representing 2% of total revenues in each of those
quarters. Cost of license fees represented 8% of license fee revenues in the
third quarter of 2001 and 6% of license fee revenues in the third quarter of
2000. The increase in the cost of license fees is primarily due to an additional
$1.0 million for product warranty costs and an additional $1.0 million in
amortization related to technology acquired subsequent to the third quarter of
2000. During the nine months ended September 30, 2001 and 2000, cost of license
fees increased to $46.5 million from $26.7 million, representing 3% and 2% of
total revenues and 10% and 8% of license revenues. The increase in the cost of
license fees is primarily attributable to an increase of $13.4 million in
royalties which relate to increased license fee revenue and an increase of $7.7
million in product warranty costs. Cost of license fees as a percentage of
license fee revenues may fluctuate from period to period due principally to the
mix of sales of royalty-bearing software products in each period and
fluctuations in revenues contrasted with certain fixed expenses such as the
amortization of capitalized software.
----------
(1) Forward-Looking Statement
14
Cost of services consists primarily of employee-related costs and the related
infrastructure costs incurred to provide installation and consulting services,
customer care center administrative support, training, and product support.
These costs increased to $169.1 million in the third quarter of 2001 from $152.8
million in the third quarter of 2000, representing 33% and 34% of total revenues
and 51% and 56% of service revenues. Cost of services for the year-to-date
period increased to $526.9 million during the nine months ended September 30,
2001 from $445.5 million during the nine months ended September 30, 2000,
representing 34% and 36% of total revenues and 53% and 54% of service revenues.
The dollar increase in cost of services during the quarter and year-to-date
periods is consistent with the increase in services revenue. With the general
availability of PeopleSoft 8, the Company expects that demand from its installed
base and new customers for consulting and training will increase over the next
several quarters and consequently, cost of services may increase in dollar
amount, and may change as a percentage of total revenues in future periods. (1)
Sales and marketing expenses increased to $126.0 million in the third quarter
of 2001 from $116.6 million in the third quarter of 2000, representing 25% and
26% of total revenues in each of those quarters. For the year-to-date period,
sales and marketing expense increased to $383.6 million for the nine months
ended September 30, 2001 from $315.2 million for the nine months ended September
30, 2000. The increase for the three and nine months ended September 30, 2001 is
primarily attributable to costs associated with growth in the sales and
marketing organizations related to increased sales force and marketing and
advertising campaigns for PeopleSoft 8 (including PeopleSoft CRM which was
released in June 2001). The Company expects sales and marketing activity related
to PeopleSoft 8 to increase in future quarters which may result in an increase
in sales and marketing expenses.(1)
Product development expenses consist of costs related to the Company's staff
of software developers and outside consultants, and the associated
infrastructure costs required to support software product development
initiatives. Product development expenses decreased to $70.9 million in the
third quarter of 2001 from $76.7 million in the third quarter of 2000,
representing 14% and 17% of total revenues in each of those quarters. For the
year-to-date period, product development expenses decreased to $223.8 million
during the nine months ended September 30, 2001 from $240.9 million for the nine
months ended September 30, 2000. The decrease in product development expenses is
primarily attributable to fewer outside contractors being required for
development initiatives. The Company's current focus in application development
is to extend its software offerings by delivering enhanced functionality and
develop a number of new applications, mostly focused on internet collaboration
and eCommerce.(1) In addition, the Company anticipates continued investment in
additional functionality across all of its software product offerings, including
global product requirements and industry specific requirements.(1) However, the
Company cannot give assurance that such development efforts will result in
products, features or functionality or that the market will accept the software
products, features or functionality developed. The Company expects that the
dollar amounts invested in product development expenses during the fourth
quarter of 2001 will be higher than amounts invested during the three months
ended September 30, 2001.(1)
General and administrative expenses increased to $40.9 million during the
third quarter of 2001 from $29.1 million during the third quarter of 2000,
representing 8% and 7% of total revenues. For the year-to-date period, general
and administrative expenses increased to $116.5 million for the nine months
ended September 30, 2001 from $78.6 million for the nine months ended September
30, 2000. The increase in the three and nine months ended September 30, 2001 is
partially due to increases in employee compensation and benefits costs, due in
part to a 15% increase in general and administrative headcount from the prior
year. The increase in the infrastructure and increased utilization of outside
consultants is partially attributable to the Company's upgrade to the
PeopleSoft 8 eBusiness applications for each major business process area.
Furthermore, the Company recorded an additional $2.6 million and $5.9 million in
non-product related litigation expense in the three and nine months ended
September 30, 2001, respectively, compared to the same periods in 2000.
PRODUCT EXIT CHARGES
----------
(1) Forward-Looking Statement
15
During the third quarter of 2000, PeopleSoft recorded non-cash pretax product
exit charges in the amount of $35.9 million related to the impairment and
write-off of the unamortized cost of capitalized software, customer list and
goodwill related to two products abandoned during the quarter.
RESTRUCTURING, MERGER AND OTHER CHARGES
The third quarter of 2001 includes two non-recurring items; a favorable
adjustment of $2.3 million (no tax impact) to existing restructuring reserves to
reflect current estimates and a $3.0 million pre-tax charge for in-process
research and development related to the acquisition of assets which was
otherwise insignificant to the Company. The nine months ended September 30, 2001
included a $4.9 million favorable adjustment to existing restructuring reserves
to reflect current estimates (no tax impact), a $3.0 million pre-tax charge for
in-process research and development related to the acquisition in the third
quarter of 2001 which was otherwise insignificant to the Company and a $1.9
million pre-tax charge for in-process research and development related to the
acquisition of SkillsVillage in the second quarter of 2001.
OTHER INCOME, NET
Other income, net, which includes interest income, interest expense and
other, decreased to $7.8 million in the third quarter of 2001 from $130.1
million in the third quarter of 2000. Other income, net, decreased to $29.8
million in the nine months ended September 30, 2001 from $156.0 million during
the comparable period in 2000. The decrease during the third quarter and
year-to-date periods was primarily the result of $120.1 million and $9.5 million
gains on the sale of corporate equity securities during the third and first
quarters of 2000.
PROVISION FOR INCOME TAXES
The Company's income tax provision decreased to $25.1 million for the third
quarter of 2001 from $51.2 million for the same period in 2000 and decreased to
$67.6 million in the nine months ended September 30, 2001 from $69.0 million for
the same period in 2000. The effective tax rate was 34.5% for the each of the
nine months ended September 30, 2001 and September 30, 2000, excluding the
impact of the in-process research and development charges and the favorable
adjustments to existing restructuring reserves during the nine months ended
September 30, 2001 and the gains on sale of marketable equity securities and the
product exit charges in 2000. The net deferred tax assets at September 30, 2001
were $116.4 million. The valuation of these net deferred tax assets is based on
historical tax provisions and expectations about future taxable income.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB") approved for
issuance Statements of Financial Accounting Standards No. 141, "Business
Combinations," ("SFAS 141") and No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142").
SFAS 141, effective June 30, 2001, requires all business combinations
initiated after June 30, 2001 to be accounted for using the purchase method of
accounting. The pooling-of-interests method of accounting can no longer be used
for business combinations completed after June 30, 2001. The provisions of SFAS
141 are similar to prior generally accepted accounting principles ("GAAP"),
although SFAS 141 requires additional disclosures for transactions occurring
after the effective date. Under SFAS 141, the Company will continue to
immediately write off in-process research and development.
SFAS 142 eliminates the amortization of goodwill for business combinations
completed after June 30, 2001. Goodwill associated with business combinations
completed prior to July 1, 2001 will continue to be amortized through the income
statement during the fourth quarter of 2001. Effective January 1, 2002, goodwill
will no longer be amortized, but is required to be assessed on an annual basis
for impairment at the reporting unit level by applying a fair value based test.
SFAS 142 also provides additional guidance on acquired intangibles that should
be separately recognized and amortized, which may result in the recognition of
additional intangible assets as compared with prior GAAP.
16
Beginning in the first quarter of 2002, the Company will no longer amortize
goodwill, thereby eliminating annual goodwill amortization of approximately $8.7
million. Amortization for the nine months ended September 30, 2001 was $6.0
million. Unamortized goodwill was $30.8 million as of September 30, 2001. The
Company will complete an initial goodwill impairment assessment in 2002 to
determine if a transition impairment charge should be recognized under SFAS 142.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations," ("SFAS 143"). SFAS 143
addresses accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. This Statement requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
The liability is accreted to its present value each period while the cost is
depreciated over its useful life. SFAS 143 is effective for financial statements
issued for fiscal years beginning after June 15, 2002. The Company has not yet
determined the effects SFAS 143 will have on its financial position, results of
operations or cash flows but does not anticipate that the impact will be
significant.
In October 2001, the FASB issued Statements of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
("SFAS 144"). SFAS 144, which replaces SFAS 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," requires
long-lived assets to be measured at the lower of carrying amount or fair value
less the cost to sell. SFAS 144 also broadens disposal transactions reporting
related to discontinued operations. SFAS 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001. The
Company has not yet determined the effects SFAS 144 will have on its financial
position, results of operations or cash flows but does not anticipate that the
impact will be significant.
BUSINESS COMBINATIONS
On May 31, 2001, the Company acquired the assets and assumed liabilities of
SkillsVillage, Inc., through a business combination accounted for under the
purchase method of accounting. The assets acquired included technology to
automate the process of procuring and managing contract services. The aggregate
purchase price of $31.5 million included the issuance of 398,029 shares of
common stock with a fair value of $16.1 million, the issuance of options to
SkillsVillage employees to purchase common stock with a fair value of $2.2
million, and cash payments of $13.2 million. Terms of the business combination
called for $2.4 million in cash and shares of common stock to be placed into
escrow for a period of 12 months to satisfy certain liabilities or claims. After
the term of the escrow has elapsed, escrow amounts will be accounted for as
additional purchase price and amounts remaining in the escrow account will be
distributed to former SkillsVillage shareholders.
The Company allocated the excess purchase price over the fair value of the
net tangible assets acquired to the following intangible assets: $21.7 million
to goodwill, $4.8 million to completed products and technology, $1.9 million to
in-process research and development, and $0.8 million to assembled workforce. As
of the acquisition date, the technological feasibility of the in-process
technology had not been established and had no alternative future use; and the
Company expensed the $1.9 million in accordance with generally accepted
accounting principles. The capitalized intangible assets are being amortized
based on their estimated useful lives of four years.
In performing this allocation, the Company considered, among other factors,
its intentions for future use of the acquired assets and analyses of historical
financial performance and estimates of future performance of SkillsVillage's
products. The projected incremental cash flows were discounted back to their
present value using discount rates of 18% and 23% for developed and in-process
technology. This discount rates were determined after consideration of the
Company's rate of return on debt capital and equity, the weighted average return
on invested capital, and risk associated with achieving forecasted sales.
Associated risks included achieving anticipated levels of market acceptance and
penetration, market growth rates and risks related to the impact of potential
changes in future target markets.
17
The Company's projections may ultimately prove to be incomplete or
inaccurate, and unanticipated events and circumstances are likely to occur.
Therefore, no assurance can be given that the underlying assumptions used to
forecast revenues and costs to develop such projects will transpire as
estimated.(1)
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2001, the Company had $1,143.7 million in working capital,
including $390.0 million in cash and cash equivalents and $1,031.4 million in
short-term investments, consisting principally of investments in
interest-bearing demand deposit accounts with various financial institutions,
tax-exempt money market funds and highly liquid debt securities of corporations,
municipalities and the U.S. Government. The Company believes that the
combination of cash and cash equivalents and short-term investment balances,
potential cash flow from operations and issuance of stock under the employee
purchase plan and stock option exercises will be sufficient to satisfy its
operating cash requirements and expected purchases of property and equipment at
least through the next twelve months.
The following table summarizes the Company's cash flows from operating,
investing and financing activities.
---------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2001 2000
(In millions)
---------------------------------------------------------------------------------
Net cash (used in) provided by:
Operating activities ................................. $ 331.6 $ 29.9
Investing activities ................................. (772.6) (176.0)
Financing activities ................................. 184.8 122.0
Effect of exchange rate changes on cash and cash
equivalents ........................................ (0.4) (3.0)
---------------------------------------------------------------------------------
Decrease in cash and cash equivalents .................. $(256.6) $(27.1)
=================================================================================
Net cash provided by operating activities was $331.6 million during the nine
months ended September 30, 2001 compared to $29.9 million during the nine months
ended September 30, 2000. This increase is due primarily to the decrease in
accounts receivable, the increase in depreciation and amortization, the decrease
in the gain on sale of investments and the increase in the tax benefits from
exercise of stock options partially offset by the increase in income taxes
receivable and the decrease in deferred revenues.
Net cash used in investing activities was $772.6 million during the nine
months ended September 30, 2001 compared to $176.0 million during the nine
months ended September 30, 2000. The Company's principal uses of cash for
investing activities during the nine months ended September 30, 2001 were
primarily for the net purchases of investments of $676.3 million and purchases
of property and equipment in the amount of $69.9 million. The Company's
principal uses of cash from investing activities during the nine months ended
September 30, 2000 were primarily for the net purchases of investments of $112.1
million and purchases of property and equipment in the amount of $60.2 million.
Net cash provided by financing activities was $184.8 million during the nine
months ended September 30, 2001 compared to $122.0 million during the nine
months ended September 30, 2000. The principal source of cash from financing
activities during the nine months ended September 30, 2001 was from proceeds due
to the exercise of common stock options by employees and the issuance of stock
under the employee stock purchase plan of $215.4 million offset by the
repurchase of common stock of $20.0 million and the repurchase of long term debt
of $10.5 million. The principal source of cash from financing activities during
the nine months ended September 30, 2000 was from proceeds due to the exercise
of common stock options by employees and the issuance of stock under the
employee stock purchase plan of $122.0 million.
----------
(1) Forward-Looking Statement
18
ITEM 3 - FINANCIAL RISK MANAGEMENT
Effective January 1, 2001, the Company adopted the Financial Accounting
Standards Board Statement No. 133, as amended, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are required to
be recorded on the balance sheet at fair value. If the derivative is designated
as a fair value hedge, the changes in the fair value of the derivative and of
the hedged item attributable to the hedged risk are recognized in earnings. If
the derivative is designated as a cash flow hedge, the effective portions of
changes in the fair value of the derivative are recorded in "Accumulated other
comprehensive loss." The cumulative effect of the accounting change to adopt
SFAS 133, as amended, as of January 1, 2001 resulted in the Company recognizing
a $2.6 million unrealized loss (net of tax) in "Accumulated other comprehensive
loss."
The Company uses derivative instruments to manage exposures to foreign
currency and interest rate risks.
FOREIGN EXCHANGE RISK
During the nine months ended September 30, 2001 and 2000, the Company's
revenues originating outside the United States were 26% of total revenues.
Revenues generated in the Europe/Middle-East/Africa region were 13% and 12% of
total revenues during the same periods. Revenues from all other geographic
regions were less than 10% of total revenues for the same periods. International
sales are made mostly from the Company's foreign sales subsidiaries in the local
countries and are typically denominated in the local currency of each country.
These subsidiaries incur most of their expenses in the local currency as well.
The Company's international business is subject to risks typical of an
international business, including, but not limited to: differing economic
conditions, changes in political climate, differing tax structures, local
regulations and restrictions, and foreign exchange rate volatility. Accordingly,
the Company's future results can be adversely impacted by changes in these or
other factors.
The Company's exposure to foreign exchange rate fluctuations arises in part
from intercompany accounts in which the cost of software, including certain
development costs, incurred in the United States is charged to the Company's
foreign sales subsidiaries. These intercompany accounts are typically
denominated in the functional currency of the foreign subsidiary in order to
centralize foreign exchange risk with the parent company in the United States.
The Company is also exposed to foreign exchange rate fluctuations as the
financial results of foreign subsidiaries are translated into U.S. dollars in
consolidation. As exchange rates vary, these results, when translated, may vary
from expectations and adversely impact overall expected profitability.
The Company has a foreign exchange hedging program designed to mitigate the
potential for future adverse impact on intercompany balances due to changes in
foreign currency exchange rates. The program uses forward foreign exchange
contracts as the vehicle for hedging significant intercompany balances. The
Company uses two multinational banks for substantially all of these contracts.
The Company has not designated the derivatives used in the foreign exchange
hedging program as cash flow or fair value hedges under SFAS 133. In general,
these contracts have terms of three months or less. These contracts are recorded
on the balance sheet at fair value. Changes in fair value of the contracts and
the intercompany balances being hedged are included in "Other income, net." To
the extent these contracts do not completely hedge the intercompany balances,
the net impact is recognized in "Other income, net." The foreign currency
hedging program is managed in accordance with a corporate policy approved by the
Company's Board of Directors.
19
At September 30, 2001, the Company had the following outstanding forward
foreign exchange contracts to exchange U.S. dollars for foreign currency:
--------------------------------------------------------------------
NOTIONAL WEIGHTED
FUNCTIONAL CURRENCY NOTIONAL AMOUNT AVERAGE EXCHANGE RATE
--------------------------------------------------------------------
Euro $ 8.6 million 0.923
Swiss francs 3.2 million 0.625
South African rand 3.1 million 0.113
British pounds 2.0 million 1.476
Japanese yen 1.2 million 0.008
Swedish krona 1.1 million 0.093
New Zealand dollars 0.9 million 0.405
Canadian dollars 0.6 million 0.636
--------------
$ 20.7 million
At September 30, 2001, the Company had the following outstanding forward
foreign exchange contracts to exchange foreign currency for U.S. dollars:
--------------------------------------------------------------------
NOTIONAL WEIGHTED
FUNCTIONAL CURRENCY NOTIONAL AMOUNT AVERAGE EXCHANGE RATE
--------------------------------------------------------------------
Australian dollars $ 9.0 million 0.490
Singapore dollars 3.7 million 0.565
Hong Kong dollars 2.2 million 0.128
Chilean pesos 0.6 million 0.001
--------------
$ 15.5 million
At September 30, 2001, each of these contracts had maturity dates of October
31, 2001 and had a book value that approximated fair value. Neither the cost nor
the fair value of these contracts was material at September 30, 2001. During the
three months ended September 30, 2001 and 2000 the Company recorded a net loss
of $1.9 million and a net loss of $0.4 million from these settled contracts and
underlying foreign currency exposures. During the nine months ended September
30, 2001 and 2000 the Company recorded a net loss of $2.7 million and a net gain
of $2.0 million from these settled contracts and the underlying foreign currency
exposures.
In addition to hedging existing transactional exposures, the Company's
foreign exchange management policy allows for the hedging of anticipated
transactions, and exposure resulting from the translation of foreign subsidiary
financial results into U.S. dollars. Such hedges can only be undertaken to the
extent that the exposures are highly certain, reasonably estimable, and
significant in amount. No such hedges have been undertaken through September 30,
2001.
INTEREST RATE RISK
Investments in Debt Securities
The Company invests its cash in a variety of financial instruments,
consisting principally of investments in interest-bearing demand deposit
accounts with financial institutions, tax-exempt money market funds and highly
liquid debt and equity securities of corporations, municipalities and the U.S.
Government. These investments are denominated in U.S. dollars. Cash balances in
foreign currencies overseas are operating balances and are only invested in
short-term time deposits of local operating banks.
The Company classifies debt and marketable equity securities based on
management's intention on the date of purchase and reevaluates such designation
as of each balance sheet date. Debt securities which management has the intent
and ability to hold to maturity are classified as held-to-maturity and reported
at amortized cost. All other debt and equity securities are classified as
available-for-sale and carried at fair value with net unrealized gains and
losses included in "Accumulated other comprehensive loss," net of tax.
Investments in both fixed rate and floating rate interest earning instruments
carry a degree of interest rate risk. Fixed rate securities may have their fair
market value adversely impacted due to a rise in interest rates, while floating
rate securities may produce less income than expected if interest rates fall.
Due in part to these factors, the Company's future investment income may fall
short of expectations due to changes in
20
interest rates or the Company may suffer losses in principal if forced to sell
securities which have declined in market value due to changes in interest
rates.(1)
The Company's investments are made in accordance with an investment policy
approved by the Board of Directors. At September 30, 2001, the average maturity
of the Company's investment securities was approximately two months. All
investment securities had maturities of less than eighteen months. The following
table presents certain information about the investments held by the Company at
September 30, 2001 that are sensitive to changes in interest rates. These
investments are not leveraged and are held for purposes other than trading. The
Company believes its investment securities, comprised of highly liquid debt
securities of corporations, municipalities, and the U.S. Government, are similar
enough to aggregate. Due to the Company's anticipated tax rate, it is
advantageous for the Company to invest largely in tax-advantaged securities. The
average interest rates shown below reflect a weighted average rate for both
taxable and tax-exempt investments. At September 30, 2001, the Company invested
heavily in tax--exempt investments which reduced the weighted average interest
rate.
--------------------------------------------------------------------------------------------------
AS OF SEPTEMBER 30, 2001 EXPECTED MATURITY
-------------------------
(In millions) ONE YEAR MORE THAN PRINCIPAL FAIR
OR LESS ONE YEAR AMOUNT VALUE
--------------------------------------------------------------------------------------------------
Available-for-sale securities ...... $ 1,133.6 $ 93.3 $ 1,226.9 $ 1,227.8
Weighted average interest rate ..... 2.61% 3.80%
==================================================================================================
Interest Rate Swap Transactions
In June 2000, the Company entered into interest rate swap transactions to
manage its exposure to interest rate changes on facility lease obligations. The
swaps involve the exchange of fixed and variable interest rate payments without
exchanging the notional principal amount. The swaps have an aggregate notional
amount of $175 million and mature at various dates in 2003, consistent with the
maturity dates of the facility leases. Under these agreements, the Company
receives a variable rate based on the 3 month LIBOR set on the last day of the
previous quarter and pays a weighted average fixed rate of 6.80%. These swaps
are considered to be hedges against changes in amount of future cash flows. The
$6.7 million unrealized loss as of September 30, 2001 resulted in a $6.7 million
increase in "Accumulated other comprehensive loss" from December 31, 2000.
Derivative losses included in "Accumulated other comprehensive loss" of $7.3
million are estimated to be reclassified into earnings during the next twelve
months based upon a 12 month forward LIBOR rate.
EQUITY SECURITIES RISK
Convertible Subordinated Notes
In August 1997, the Company issued an aggregate of $69 million in convertible
subordinated notes, due August 2002. These notes bear interest at a rate of
4.75% per annum and are convertible into the Company's common stock at the
investor's option at any time at a conversion price equal to $50.82 per share.
The Company has repurchased $12.0 million of convertible subordinated notes as
of September 30, 2001. Based on the traded yield to maturity, the approximate
fair market value of the convertible subordinated notes was $54.7 million and
$66.5 million as of September 30, 2001 and December 31, 2000.
----------
(1) Forward-Looking Statement
21
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
The Company has identified certain forward-looking statements in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere in this Form 10-Q with a footnote (1) symbol. The
Company may also make other forward-looking statements from time to time, both
written and oral. The actual results may differ materially from those projected
in any such forward-looking statements due to a number of factors, including
those set forth below and elsewhere in this Form 10-Q.
The Company operates in a dynamic and rapidly changing environment that
involves numerous risks and uncertainties. The following section describes some,
but not all, of these risks and uncertainties that we believe may adversely
affect the Company's business, financial condition or results of operations.
This section should be read in conjunction with the unaudited Condensed
Consolidated Financial Statements and Notes thereto and Management's Discussion
and Analysis of Financial Condition and Results of Operations included in this
report on Form 10-Q and Management's Discussion and Analysis of Financial
Condition and Results of Operations for the year ended December 31, 2000
contained in the Company's Annual Report to Stockholders on Form 10-K (as
amended by Form 10-K/A).
CHANGES IN GENERAL GLOBAL ECONOMIC, POLITICAL AND MARKET CONDITIONS COULD CAUSE
DECREASES IN DEMAND FOR OUR SOFTWARE AND RELATED SERVICES WHICH COULD NEGATIVELY
AFFECT OUR REVENUE AND OPERATING RESULTS AND THE MARKET PRICE OF OUR STOCK.
Our revenue and profitability depends on the overall demand for our software
and related services. A downturn in the global economy and financial markets
could result in a delay or cancellation of customer purchases. Some of our
competitors have recently announced that economic conditions have negatively
impacted their financial results. Recent developments associated with the
terrorist attacks on the United States have resulted in economic, political and
other uncertainties, which could adversely affect our revenue growth and
operating results. If demand for our software and related services decreases,
our revenues may decrease and our operating results would be adversely affected.
A reduction in revenues may also cause our stock price to fall.
OUR QUARTERLY OPERATING RESULTS ARE DIFFICULT TO PREDICT AND MAY FLUCTUATE
SUBSTANTIALLY, WHICH MAY ADVERSELY AFFECT OUR BUSINESS AND OUR STOCK'S MARKET
PRICE.
Our revenues and results of operations are difficult to predict and may
fluctuate substantially from quarter to quarter. These fluctuations can
adversely affect our business and the market price of our stock. License
revenues in any quarter depend substantially upon the amount of contracts signed
and our ability to recognize revenues under our revenue recognition policy. Our
contracting activity is difficult to forecast for a variety of reasons,
including the following:
- a significant portion of our license agreements are typically
completed within the last few weeks of the quarter;
- our sales cycle is relatively long and varies as a result of
expanding our product line and broadening our software product
applications to cover a customer's overall business;
- the size of license transactions can vary significantly;
- the possibility that economic downturns are characterized by
decreased product demand, price erosion, technological shifts, work
slowdowns and layoffs may substantially reduce contracting activity;
- customers may unexpectedly postpone or cancel anticipated system
replacement or new system evaluations due to changes in their
strategic priorities, project objectives, budgetary constraints or
company management;
- customer evaluations and purchasing processes vary significantly from
company to company, and a customer's internal approval and
expenditure authorization process can be difficult and time
consuming, even after selection of a vendor;
- changes in our competitors and our own pricing policies and discount
plans may affect customer purchasing patterns; and
22
- the number, timing and significance of our competitors' and our own
software product enhancements and new software product announcements
may affect purchase decisions.
In addition, our expense levels, operating costs and hiring plans are based on
projections of future revenues and are relatively fixed. If our actual revenues
fall below expectations, our net income is likely to be disproportionately
adversely affected.
WE MAY BE REQUIRED TO DEFER RECOGNITION OF LICENSE REVENUE FOR A SIGNIFICANT
PERIOD OF TIME AFTER ENTERING INTO A LICENSE AGREEMENT, WHICH COULD NEGATIVELY
IMPACT OUR FINANCIAL RESULTS.
We may have to delay recognizing license revenue for a significant
period of time after entering into a license agreement for a variety of types of
transactions, including:
- transactions that include both currently deliverable software
products and software products that are under development or contain
other undeliverable elements;
- transactions where the customer demands services that include
significant modifications, customizations or complex interfaces that
could delay product delivery or acceptance;
- transactions that involve acceptance criteria that may preclude
revenue recognition or if there are identified product-related
issues, such as performance issues; and
- transactions that involve payment terms or fees that depend upon
contingencies.
Because of the factors listed above and other specific requirements under
GAAP for software revenue recognition, we must have very precise terms in our
license agreements to recognize revenue when we initially deliver software or
perform services. Although we have a standard form of license agreement that
meets the criteria for current revenue recognition on delivered elements, we
negotiate and revise these terms and conditions in some transactions.
Negotiation of mutually acceptable terms and conditions can extend the sales
cycle, and sometimes we do not obtain terms and conditions that permit revenue
recognition at the time of delivery or even as work on the project is completed.
Our inability to recognize revenue as expected could negatively impact our
financial results.
ANY REDUCTION IN OUR CONTRACTING ACTIVITY IS LIKELY TO RESULT IN REDUCED
SERVICES REVENUES IN FUTURE PERIODS.
Variances or slowdowns in prior quarter contracting activity may impact
our consulting, training and maintenance service revenues since these revenues
typically follow license fee revenues. Our ability to maintain or increase
service revenue primarily depends on our ability to increase the number of our
licensing agreements.
OUR FUTURE REVENUE IS SUBSTANTIALLY DEPENDENT UPON OUR INSTALLED CUSTOMER BASE
CONTINUING TO LICENSE OUR PRODUCTS AND RENEW OUR SERVICE AGREEMENTS.
We have traditionally depended on our installed customer base for
additional future revenue from services and licenses of other products. Also, if
our customers fail to renew their maintenance agreements, our revenue could
decrease. The maintenance agreements are generally renewable annually at the
option of the customers and there are no mandatory payment obligations or
obligations to license additional software. Therefore, current customers may not
necessarily generate significant maintenance revenue in future periods. In
addition, customers may not necessarily purchase additional products or
services. Our services revenue and maintenance revenue also depend upon the use
of these services by our installed customer base. Any downturn in software
license revenue could result in lower services and maintenance revenue in future
quarters.
OVERALL INCREASES IN SERVICES REVENUES AS A PERCENTAGE OF TOTAL REVENUES COULD
ADVERSELY AFFECT OUR OPERATING RESULTS BECAUSE OUR SERVICES REVENUES BRING LOWER
GROSS MARGINS THAN OUR LICENSE REVENUES.
Because service revenues have lower gross margins than license revenues, an
increase in the percentage of total revenue represented by service revenues
could have a detrimental impact on our overall
23
gross margins and could adversely affect operating results. In addition, we
subcontract certain consulting services to third parties which generally carry
lower gross margins than our service business overall. As a result, if service
revenues increase as a percentage of total revenue and the services provided by
third-party consultants increase, our gross margins will be lower.
IF ACCOUNTING INTERPRETATIONS RELATING TO REVENUE RECOGNITION CHANGE, OUR
REPORTED REVENUES COULD DECLINE OR WE COULD BE FORCED TO MAKE CHANGES IN OUR
BUSINESS PRACTICES.
Over the past several years, the American Institute of Certified Public
Accountants issued Statement of Position, or SOP 97-2, "Software Revenue
Recognition," and SOP 98-9, "Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions." These standards address
software revenue recognition matters primarily from a conceptual level and do
not include specific implementation guidance. In addition, in December 1999, the
Securities and Exchange Commission staff issued Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements," ("SAB 101"), which explains
how the SEC staff believes existing revenue recognition rules should be applied
or analogized to for transactions not addressed by existing rules. We believe
that we are currently in compliance with SOP 97-2, SOP 98-9 and SAB 101.
The accounting profession continues to discuss certain provisions of SOP
97-2 and SAB 101 with the objective of providing additional guidance and/or
interpretations. These discussions and the issuance of interpretations, once
finalized, could lead to unanticipated changes in our current revenue accounting
practices, which could cause us to recognize lower revenues. As a result, we may
need to change our business practices significantly in order to continue to
maximize recognition of our license revenues. These changes may extend sales
cycles, increase administrative costs and otherwise adversely affect our
business.
OUR MARGINS MAY BE REDUCED IF WE NEED TO LOWER PRICES OR OFFER OTHER FAVORABLE
TERMS ON OUR PRODUCTS AND SERVICES TO MEET COMPETITIVE PRESSURES IN OUR
INDUSTRY.
We compete with a variety of software vendors, including internet
application vendors in the enterprise application software market segment,
vendors in the manufacturing software application market segment, vendors in the
CRM application market segment, providers of human resource management system
software products, providers of financial management systems software products,
and numerous small firms that offer products with new or advanced features. Some
of our competitors may have advantages over us due to their significant
worldwide presence, longer operating and product development history, and
substantially greater financial, technical and marketing resources. At least one
competitor has a larger installed base than us. In addition, Oracle Corporation
is a competitor whose relational database management system underlies a
significant portion of our installed applications.
If competitors offer more favorable payment terms and/or more favorable
contractual implementation terms or guarantees, we may need to lower prices or
offer other favorable terms in order to compete successfully. Such changes could
reduce margins and adversely affect our results of operations.
IF OUR INTERNATIONAL BUSINESS GROWS, WE WILL BECOME INCREASINGLY SUBJECT TO
CURRENCY RISKS AND OTHER COSTS AND CONTINGENCIES THAT COULD ADVERSELY AFFECT OUR
RESULTS.
We continue to invest in an effort to enhance our international
operations. The global reach of our business could cause us to be subject to
unexpected, uncontrollable and rapidly changing events and circumstances in
addition to those experienced in United States locations. The following factors,
among others, present risks that could have an adverse impact on our business
and earnings:
- conducting business in currencies other than United States dollars
subjects us to currency controls and fluctuations in currency
exchange rates;
- we may be unable to hedge the currency risk in some transactions
because of uncertainty or the inability to reasonably estimate our
foreign exchange exposure, particularly in Europe;
- increased cost and development time required to adapt our products to
local markets;
24
- lack of experience in a particular geographic market;
- legal, regulatory, social, political, labor or economic conditions in
a specific country or region, including loss or modification of
exemptions for taxes and tariffs, and import and export license
requirements and trade restrictions; and
- operating costs in many countries are higher than in the United
States.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO ATTRACT QUALIFIED EMPLOYEES IN A
HIGHLY COMPETITIVE LABOR MARKET.
We believe that our future success will depend upon our ability to
attract, train and retain highly skilled technical, managerial, sales and
marketing personnel. If we do not attract, train, retain and effectively manage
our employees, our costs may increase, development and sales efforts may be
hindered and our customer service may be degraded. Although we invest
significant resources in recruiting and retaining employees, there is intense
competition for personnel in the software industry. At times, we have had
difficulty locating enough highly qualified candidates in desired geographic
locations, or with required industry-specific expertise. Industry-wide use of
non-compete agreements by our competitors further decreases the pool of
available sales and technical personnel.
THE LOSS OF KEY EMPLOYEES COULD HAVE AN ADVERSE EFFECT ON OUR OPERATIONS AND
STOCK PRICE.
We believe that there are certain key employees within the organization,
primarily in the senior management team, who are necessary for us meet our
short-term objectives. Due to the competitive employment nature of the software
industry, there is a risk that we will not be able to retain these key
employees. The loss of one or more key employees could adversely affect our
continued growth. In addition, uncertainty created by turnover of key employees
could cause fluctuations in our stock price and further turnover of our
employees.
IF WE FAIL TO CONTINUALLY IMPROVE OUR SOFTWARE PRODUCTS AND INTRODUCE NEW
PRODUCTS OR SERVICE OFFERINGS, OUR COMPETITIVE POSITION COULD ERODE AND OUR
BUSINESS AND STOCK PRICE MAY SUFFER.
The market for our software products is characterized by rapid
technological change, evolving industry standards, changes in customer
requirements and frequent new product introductions and enhancements. The market
for business application software has been and continues to be intensely
competitive, which requires that we constantly improve our existing products and
create new products. Our future success will depend in part upon our ability to:
- continue to enhance and expand our core applications;
- continue to provide enterprise and customer relationship management
applications or service offerings;
- continue to successfully integrate third-party products;
- enter new markets; and
- develop new products or improve our existing products to keep pace
with technological developments, including developments related to
the internet, satisfy increasingly sophisticated customer
requirements and achieve market acceptance.
We may not be able to enhance existing products or develop and introduce
new products in a timely manner. In addition, to the extent that we use third
parties to do some or all of the product development work, we may be affected by
their non-performance.
Our software products can be licensed for use with a variety of popular
industry standard relational database management systems. There may be future or
existing relational database management system platforms that achieve popularity
within the business application marketplace and on which we may desire to offer
our applications. These future or existing relational database management system
products may or may not be architecturally compatible with our software product
design. We may not be able to
25
develop software products on additional platforms with the specifications and
within the time frame necessary for market success.
In addition, the effort and expense of developing, testing and
maintaining software product lines will increase with the increasing number of
possible combinations of:
- vendor hardware platforms;
- operating systems and updated versions;
- our application software products and updated versions; and
- relational database management system platforms and updated versions.
Developing consistent software product performance characteristics
across all of these combinations could place a significant strain on our
resources and software product release schedules.
AS OUR SOFTWARE OFFERINGS INCREASE IN SCOPE AND COMPLEXITY, OUR NEED TO AVOID
AND CORRECT UNDETECTED ERRORS MAY INCREASE OUR COSTS AND SLOW THE INTRODUCTION
OF NEW PRODUCTS AND WE MAY BECOME SUBJECT TO PRODUCT LIABILITY AND WARRANTY
CLAIMS WHICH COULD BE COSTLY TO RESOLVE AND RESULT IN NEGATIVE PUBLICITY.
Our software programs, like all software programs generally, may contain
a number of undetected errors despite internal and third parties' testing. This
may result in increased costs to correct such errors and reduced acceptance of
our software products in the marketplace.
Product software errors could subject us to product liability and/or
warranty claims. Although our agreements contain provisions designed to limit
our exposure to potential liability claims, these provisions could be
invalidated by unfavorable judicial decisions or by federal, state, local or
foreign laws or regulations. If a claim against us was successful, we might be
required to incur significant expense and pay substantial damages. Even if we
were to prevail, the accompanying publicity could adversely impact the demand
for our products.
IF WE LOSE ACCESS TO CRITICAL THIRD-PARTY SOFTWARE OR TECHNOLOGY, OUR COSTS
COULD INCREASE AND THE INTRODUCTION OF NEW PRODUCTS AND PRODUCT ENHANCEMENTS
COULD BE DELAYED, THUS HURTING OUR COMPETITIVE POSITION.
We license numerous critical software products technology from third
parties, some of whom are also competitors, and incorporate some of their
products into our own software products. If any of the third-party software
vendors were to change their product offerings or terminate our licenses, we
might need to seek alternative vendors and incur additional internal or external
development costs to ensure continued performance of our products. Such
alternatives may not be available on attractive terms, or may not be as widely
accepted or as effective as the software provided by our existing vendors. In
addition, if the cost of licensing any of these third-party software products or
other technology significantly increases, our gross margin levels could
significantly decrease.
IF WE FAIL TO MAKE OUR PRODUCTS COMPATIBLE WITH AND SUPPORT CURRENT OR FUTURE
CLIENT INTERFACES DESIGNED BY THIRD PARTIES, OUR FINANCIAL RESULTS MAY SUFFER.
With PeopleSoft 8, use of a web browser as the user interface replaces
the traditional desktop access through networked Microsoft Windows-based
personal computers. Web browser access via the internet or an intranet involves
numerous risks inherent in using the internet, including security, availability
and reliability. There is a risk that customers will not be willing or able to
implement internet-based applications. We may wish to offer our applications on
future or existing user interfaces that achieve popularity within the business
application marketplace. These future or existing user interfaces may or may not
be architecturally compatible with our current software product design. We may
not be able to support new user interfaces and achieve market acceptance of new
user interfaces that we do support and failure to do so may result in lower
revenues.
26
WE ARE DEPENDENT ON RELATIONSHIPS WITH THIRD-PARTY SYSTEMS INTEGRATORS FOR THE
MARKETING AND DEPLOYMENT OF OUR PRODUCTS, AND ANY DISRUPTION OF THESE
RELATIONSHIPS COULD DAMAGE OUR BUSINESS.
We build and maintain strong working relationships with businesses that
we believe play an important role in the successful marketing of our software
products. Our current and potential customers often rely on third-party system
integrators to develop, deploy and manage client/server applications. We believe
that our relationships with these companies enhance our marketing and sales
efforts. However, these companies, most of which have significantly greater
financial and marketing resources than us, may start, or in some cases increase,
the marketing of competitive business application software, or may otherwise
discontinue their relationships with, or support of, us. Furthermore, if our
partners are unable to recruit and adequately train a sufficient number of
consulting personnel to support the implementation of our software products, we
may lose customers. In addition, integrators who generate consulting fees from
customers by providing implementation services may be less likely to recommend
our software application architecture if these products are more difficult to
install and maintain than competitors' similar product offerings.
OUR RELATIONSHIP WITH MOMENTUM BUSINESS APPLICATIONS HAS REDUCED OUR CONTROL
OVER IMPORTANT RESEARCH AND DEVELOPMENT PROJECTS AND CREATES OTHER RISKS.
We face a number of risks as a result of our relationship with Momentum.
These risks include:
- in order to obtain funding for a development project, we must agree
with Momentum on project selection, budgets, timetables and
specifications for each project, and Momentum has oversight
responsibilities for the actual product development;
- if we choose to acquire Momentum, we could face restrictions on the
amount and timing of our utilization of, or could lose, the tax
benefits associated with the research and development expenditures on
the projects Momentum pursues; and
- if we choose to acquire Momentum, we will likely be required to
record significant accounting charges relating to the acquisition of
in-process research and development and the amortization of
intangible assets, which would decrease earnings.
WE MAY BE REQUIRED TO UNDERTAKE A COSTLY REDESIGN OF OUR PRODUCTS IF THIRD-PARTY
SOFTWARE DEVELOPMENT TOOLS BECOME AN INDUSTRY STANDARD.
Our software products include a suite of proprietary software
development tools, known as PeopleTools, which are fundamental to the effective
use of our software products. While no industry standard exists for software
development tools, several companies have focused on providing software
development tools and each of them is attempting to establish its software
development tools as the accepted industry standard. We may not be able to
respond appropriately or rapidly to the emergence of an industry standard or
might be compelled to abandon or modify PeopleTools if a software product other
than PeopleTools becomes the clearly established and widely accepted industry
standard. In addition, we may be forced to redesign our software products to
operate with such third party's software development tools, or face the
potential sales obstacle of marketing a proprietary software product against
other vendors' software products that incorporate a standardized software
development toolset.
WE MAY BE UNABLE TO ACHIEVE THE BENEFITS WE ANTICIPATE FROM JOINT SOFTWARE
DEVELOPMENT OR MARKETING ARRANGEMENTS WITH OUR BUSINESS PARTNERS.
We enter into various development or joint business arrangements to
develop new software products or extensions to our existing software products.
We may distribute ourselves or jointly sell with our business partners an
integrated software product and pay a royalty to the business partner based on
end-user license fees under these joint business arrangements. While we intend
to develop business applications that are integrated with our software products,
these software products may in fact not be integrated or brought to market or
the market may reject the integrated enterprise solution. As a result, we may
not achieve the revenues that we anticipated at the time we entered into the
joint business arrangement.
OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS MAY OFFER ONLY LIMITED
PROTECTION. OUR PRODUCTS MAY INFRINGE ON THIRD-PARTY INTELLECTUAL PROPERTY
RIGHTS, WHICH COULD RESULT IN MATERIAL COSTS.
We consider certain aspects of the way we conduct our internal
operations, and our software and documentation to be proprietary, and rely on a
combination of contract, patent, copyright, trademark and
27
trade secret laws and other measures to protect this information. Pending patent
applications may not result in issued patents and, even if issued, the patents
may not provide any meaningful competitive advantage. We also rely on
contractual restrictions in our agreements with customers, employees and others
to protect our intellectual property rights. However, there can be no assurances
that these agreements will not be breached, that we have adequate remedies for
any breach or that our trade secrets will not otherwise become known. Moreover,
the laws of certain countries do not protect proprietary intellectual property
rights as effectively as do the laws of the United States.
Through an escrow arrangement, we have granted many of our customers a
contingent future right to use our source code solely for internal maintenance
services. If our source code is accessed through the escrow, the likelihood of
misappropriation or other misuse of our intellectual property may increase.
Finally, the laws of some countries in which our software products are or may be
licensed do not protect our software products and intellectual property rights
to the same extent as the laws of the United States. Defending our rights could
be costly.
Our competitors may independently develop technologies that are
substantially equivalent or superior to our technology. Third parties may assert
infringement claims against us more aggressively in the future, especially in
light of recent developments in patent law expanding the scope of patents on
software. These assertions could result in the need to enter into royalty
arrangements, and could result in costly and time-consuming litigation,
including damage awards.
ACQUISITIONS PRESENT MANY RISKS, AND WE MAY BE UNABLE TO ACHIEVE THE FINANCIAL
AND STRATEGIC GOALS INTENDED AT THE TIME OF ANY ACQUISITION.
We may from time to time acquire or invest in complementary companies,
products or technologies, and enter into joint ventures and strategic alliances
with other companies. The risks we commonly encounter in such transactions
include:
- we may have difficulty assimilating the operations and personnel of
the acquired company;
- we may have difficulty effectively integrating the acquired
technologies or products with our current products and technologies;
- our ongoing business may be disrupted by transition and integration
issues;
- we may not be able to retain key technical and managerial personnel
from the acquired entity;
- we may be unable to achieve the financial and strategic goals for the
acquired and combined businesses;
- we may have difficulty in maintaining controls, procedures and
policies during the transition and integration;
- our relationships with partner companies or third-party providers of
technology or products could be adversely affected;
- potential impairment of relationships with employees and customers;
- our due diligence process may fail to identify significant issues
with product quality, product architecture, legal contingencies, and
product development among other things; and
- we may be required to take significant product exit charges if
products acquired in business combinations are unsuccessful.
THE INTRODUCTION OF THE EURO CREATES UNCERTAINTY THAT COULD ADVERSELY AFFECT OUR
SALES.
PeopleSoft 8 contains European Monetary Union, or EMU, functionality
that allows for dual currency reporting and information management. However,
since the Euro will not be the sole legally required currency in any of the
member nations until 2002, it is possible that all issues related to conversion
to EMU have not surfaced yet, and may not have been adequately addressed. In
addition, our products may be used with third-party products that may or may not
be EMU compliant. Although we continue to take steps to address the impact, if
any, of EMU compliance for such third-party products, failure of any critical
28
technology components to operate properly under EMU may adversely affect our
sales or require us to incur unanticipated expenses to remedy any problems.
POWER OUTAGES IN CALIFORNIA MAY ADVERSELY AFFECT US.
We have significant operations in the state of California and are
dependent on a continuous power supply. A California energy crisis could
substantially disrupt our operations and increase our expenses. California has
implemented, and may in the future continue to implement, rolling blackouts
throughout the state. If blackouts interrupt our power supply, we may be
temporarily unable to continue operations at our California facilities. Any such
interruption in our ability to continue operations at our facilities could delay
the development of our products and disrupt communications with customers or
other third parties on whom we rely, such as system integrators. Future
interruptions could damage our reputation and could result in lost revenue,
either of which could substantially harm our business and results of operations.
Furthermore, if energy prices were to increase, our operating expenses will
likely increase which could have a negative effect on operating results.
TERRORIST ACTIVITY MAY INTERFERE WITH OUR ABILITY TO CONDUCT BUSINESS.
Recent terrorist attacks on the United States present a potential threat
to communication systems, information technology and security, damage to
buildings and their contents and injury to or death of key employees. We may
need to take steps to increase security and add necessary protections against
terrorist threats. This may require significant capital expenditure or
adjustment or change of business practices which could result in loss of focus
and distraction to our employees. Moreover, an actual or perceived increase in
risk of travel due to further terrorist acts may reduce our ability to
demonstrate products, meet with prospective customers and provide professional
services and training which may adversely affect our ability to close sales and
meet projected forecasts. Although built to structural standards, our facilities
are physically vulnerable to a terrorist attack. Significant structural damage
to our facilities could cause a disruption of our information systems and loss
of financial data and certain customer data, which could adversely impact our
business operations.
OUR STOCK PRICE HAS BEEN AND MAY REMAIN VOLATILE, WHICH EXPOSES US TO THE RISK
OF SECURITIES LITIGATION.
The trading price of our common stock has in the past and may in the
future be subject to wide fluctuations in response to factors such as the
following:
- revenue or results of operations in any quarter failing to meet the
expectations, published or otherwise, of the investment community;
- announcements of technological innovations by us or our competitors;
- acquisitions of new products or significant customers by us or our
competitors;
- developments with respect to our patents, copyrights or other
proprietary rights of or our competitors;
- changes in recommendations or financial estimates by securities
analysts;
- rumors or dissemination of false and/or unofficial information;
- changes in management;
- conditions and trends in the software industry;
- announcement of acquisitions or other significant transactions by us
or our competitors;
- adoption of new accounting standards affecting the software industry;
and
- general market conditions, including geopolitical events.
Fluctuations in the price of our common stock may expose us to the risk
of securities class action lawsuits. Defending against such lawsuits could
result in substantial costs and divert management's
29
attention and resources. In addition, any settlement or adverse determination of
these lawsuits could subject us to significant liabilities.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On February 16, 2001, PeopleSoft agreed to a tentative settlement of the
litigation (Suttovia v. Duffield, et al), which will result in the dismissal
of all claims against the defendants in exchange for a payment of $15.0
million, all of which will be funded by the Company's Directors and Officers
Liability Insurance. The Company executed a final Stipulation of Settlement
on April 20, 2001, and on August 24, 2001, the District Court entered a
judgment approving the settlement and dismissing the litigation with
prejudice. An insurance receivable and a settlement accrual of $15.0 million
has been included in "Other current assets" and "Accrued liabilities,"
respectively, in the accompanying condensed consolidated balance sheets.
On February 16, 2001, the defendants in a shareholder derivative suit
(Marble v. Duffield, et al.) agreed to a settlement, pursuant to which
certain limited corporate therapeutics will be offered, and in exchange for
which all claims will be dismissed with prejudice. The attorneys' fees for
plaintiffs' counsel will be paid out of the $15.0 million settlement fund
established for settlement of the related class action litigation. On July
26, 2001, the Superior Court entered a judgement approving the settlement of
the derivative suit, and dismissing the litigation with prejudice.
On June 19, 2000, plaintiffs in the Vantive securities class action
lawsuits filed an appeal from the district court's ruling in the Ninth
Circuit Court of Appeal. A hearing was held on July 11, 2001, before the
Ninth Circuit Court of Appeal, and a ruling is expected to be handed down in
due course. The Company believes the complaints are without merit and
intends to continue to vigorously defend the action.
On November 5, 1996, a case was filed in the California Superior Court
for the County of Alameda (Yarborough v. PeopleSoft, Inc., Case No.
775405-2) by a former employee of the Company whose employment was
terminated in November 1995. The complaint alleges causes of action for
wrongful discharge, retaliation, age discrimination and harassment. The
Company has filed a cross complaint based upon plaintiff's violation of
Penal Code section 632 and the plaintiff taking of proprietary information
from the Company. The cross complaint filed by the Company has not yet been
heard. The trial on the action has been trifurcated on the issues of
liability, damages and the Company's cross complaint. On September 18, 2001,
following a jury trial on liability and damages, the Court entered judgment
on a verdict in favor of the plaintiff in the amount of $5.4 million. The
Company is considering an appeal and intends to vigorously prosecute the
trial on the cross-complaint.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
30
Item 6. Exhibits and Reports on Form 8 - K
a) Exhibits
10.45 Amendment to the Development and Marketing Agreements
between Momentum and PeopleSoft, dated as of July 23, 2001,
made by and between Momentum Business Applications, Inc. and
PeopleSoft, Inc.
b) Reports on Form 8 - K
There were no Reports on Form 8-K filed during the three months
ended September 30, 2001.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: November 9, 2001
PEOPLESOFT, INC.
By: /s/ Kevin T. Parker
----------------------------------------------
Kevin T. Parker
Sr. Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
32
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
10.45 Amendment to the Development and Marketing Agreements
between Momentum and PeopleSoft, dated as of July 23, 2001,
made by and between Momentum Business Applications, Inc. and
PeopleSoft, Inc.