EXHIBIT 13.1
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C - A T S S O F T W A R E I N C.
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1 9 9 7
A N N U A L R E P O R T
SELECTED CONSOLIDATED FINANCIAL DATA
The statement of operations data set forth below for the three years
ended December 31, 1995 through 1997 and the balance sheet data at December
31, 1997 and 1996, are derived from, and are qualified by reference to, the
audited financial statements and should be read in conjunction with the
Consolidated Financial Statements and the Notes to the Consolidated Financial
Statements ("Notes"). Information for years ended December 31, 1993, 1994 and
1995 are derived from previously filed financial statements.
YEAR ENDED DECEMBER 31,
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1993 1994 1995 1996 1997
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenue:
License revenue $ 14,103 $17,342 $20,359 $19,322 $17,250
Service and other Revenue 200 1,120 1,939 823 1,204
------- ------- ------- ------- -------
Total revenues 14,303 18,462 22,298 20,145 18,454
------- ------- ------- ------- -------
Costs and expenses:
Cost of revenues 20 556 1,174 272 310
Research and development 2,452 3,117 3,582 6,166 6,723
Sales and marketing 6,965 8,551 10,273 11,084 11,386
General and administrative 1,958 2,533 2,838 2,617 2,991
Acquired in-process research
and development -- -- -- 7,066 585
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Total costs and expenses 11,395 14,757 17,867 27,205 21,995
------- ------- ------- ------- -------
Operating income (loss) 2,908 3,705 4,431 (7,060) (3,541)
Interest income 174 269 931 863 960
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Income (loss) before provision for income
taxes 3,082 3,974 5,362 (6,197) (2,581)
Provision for income taxes 1,602 1,391 1,877 0 0
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Net income (loss) $ 1,480 $ 2,583 $ 3,485 $ (6,197) $ (2,581)
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Net income (loss) per share - basic $ .33 $ .52 $ .64 $ (0.95) $ (0.38)
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Net income (loss) per share - diluted $ .34 $ .52 $ .57 $ (0.95) $ (0.38)
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Weighted average common share outstanding:
4,389 4,915 5,541 6,528 6,744
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------- ------- ------- ------- -------
diluted 4,416 4,942 6,062 6,528 6,744
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------- ------- ------- ------- -------
DECEMBER 31,
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1993 1994 1995 1996 1997
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(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments $8,585 $9,964 $26,701 $22,129 $20,153
Working capital 997 3,920 21,564 19,846 17,175
Total assets 15,321 18,906 38,500 32,999 30,640
Total stockholders' equity 2,094 5,002 22,892 21,911 19,684
(1) See Note 2 of Notes to Consolidated Financial Statements for an
explanation of the determination of the number of shares used in
computing per share amounts.
2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THE RESULTS ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT
OF CERTAIN FACTORS SET FORTH IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND ELSEWHERE IN THIS REPORT.
OVERVIEW
C-ATS Software Inc. (the "Company" or "C-ATS") was organized in 1988 as a
successor to a partnership formed in 1986. The Company's first product,
SWAPWARE-Registered Trademark-, was released in 1986. The Company has since
introduced additional products such as OPTIONS, FUTURES AND BONDS, MARKET
DATA, RISK MANAGER and OPERATIONS MANAGER. In late 1994, the Company
introduced C-ATALYST, an enhanced version of its product family which
includes multiple front, middle, and back office modules for capital markets,
derivatives trading, and risk management. These products serve the
established market for derivatives risk management and the emerging market
for enterprise-wide risk management. During February 1996, the Company
acquired the assets of LOR/Xxxxx Xxxx Associates, Inc. ("LOR/Xxxxx Xxxx" or
"LORGB") and developed and released an enhanced version of XXXXX-Registered
Trademark-, which extends the Company's offerings for Enterprise-wide risk
management solutions. While the Company was profitable on an annual basis
from 1992 through 1995, R&D expenses associated with the acquisition of
LOR/Xxxxx Xxxx resulted in a net loss for 1996. In 1997, the Company
acquired the rights to the software technology of International Risk Control,
Inc. ("International Risk Control") providing the Company with technology for
trading and risk management of foreign currency derivatives. This
acquisition and continued investment in R&D, Sales, Marketing, and
Administration resulted in a net loss in 1997. The Company's revenues are
derived primarily from annual renewable license fees. International revenues
accounted for 83%, 80% and 80% of total revenues in 1997, 1996 and 1995,
respectively.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
revenues represented by certain line items in the Company's Consolidated
Statements of Operations:
PERCENT OF TOTAL REVENUE
YEAR ENDED DECEMBER 31,
1995 1996 1997
---- ---- ----
Revenues:
License revenue 91% 96% 93%
Service and other revenue; 9 4 7
---- ---- ----
Total revenues 100 100 100
---- ---- ----
Costs and expenses:
Cost of revenues 5 1 2
Research and development 16 31 36
Sales and marketing 46 55 62
General and administrative 13 13 16
Acquired in-process research and development -- 35 3
---- ---- ----
Total costs and expenses 80 135 119
---- ---- ----
Operating income (loss) 20 (35) (19)
Interest income 4 4 5
---- ---- ----
Income (loss) before provision for income taxes 24 (31) (14)
Provision for income taxes 8 0 0
---- ---- ----
Net income (loss) 16% (31)% (14)%
---- ---- ----
---- ---- ----
3
LICENSE AND SERVICE REVENUE
Total revenues were $18.5 million in 1997, down 8% from $20.1 million
in revenues in 1996 and 17% from the $22.3 million in 1995. The Company's
revenues are derived primarily from annual renewable license fees. These fees
are non-refundable, are typically payable in full at the beginning of the
annual term and are recognized pro-rata over the term of the license. The
annual renewable license fee includes rights to use the Company's software
products, updates to the products, if any, product installation, initial
client training, documentation and software support services for one year. In
addition to its annual licenses, the Company makes available its services on
a contract basis to assist clients with services beyond those included in its
licenses. These services typically include additional client training and
assisting clients in their generation of client-specific reports, data base
integration and system optimization. In the fall of 1997, the Company formed
a new division, the C-ATS Consulting Group, to provide consulting services
and assist clients in implementing risk management solutions. These services
include implementation planning, integration assistance (including
implementation tools) and project management expertise. Revenues from such
projects are included in service and other revenues. They are recognized
when delivered or based upon the percentage-of-completion method and are
typically affected by the commencement or completion of significant services
projects.
License revenue decreased to $17.3 million in 1997 from $19.3 million in
1996 and $20.4 million in 1995. License revenue decreased in both 1997 and
1996 as a result of the decisions of some clients to not renew annual
licenses. Such decisions are attributable to numerous factors, but
principally are the result of consolidations within the banking industry and
the election of several customers to utilize in-house developed programs.
The Company licenses its products on a per site basis with the price per
site varying based upon the selection of products licensed, the number of
authorized users for each product at each site and the number of licensed
sites. As a result, total revenues in any year depend upon the number of new
and renewed annual licenses, the number of sites which use the Company's
products, product prices, and the number of users per site. Average revenue
per site increased by 6% in 1997, 6% in 1996 and 8% in 1995. The Company
believes the average revenue per site has increased because the Company
continues to offer new products and enhancements to existing products, and
because clients have increased the number of users licensed per site, factors
which have been partially offset by declines in unit pricing per product.
Although the Company has historically been able to offset declines in unit
pricing with increases in functionality and new product introductions, there
can be no assurance that the Company will continue to introduce new products
or enhancements to existing products or that such products when introduced
will result in increased revenue per client site.
Service and other revenue increased to $1.2 million in 1997 from $0.8
million in 1996 but decreased from $1.9 million in 1995. Service and other
revenue increased in 1997 from 1996 primarily due to the initiation of trial
projects related to the Company's release of its XXXXX products and to the
formation of the C-ATS Consulting Group. Service and other revenue decreased
in 1996 primarily due to completion in late 1995 of a $1.5 million systems
integration project that was undertaken and subcontracted by the Company in
the middle of 1994. Assuming customer acceptance of the XXXXX products, the
Company anticipates that service revenue will continue to grow in
proportion to licensing opportunities of the XXXXX products.
COST OF REVENUES
Cost of revenues includes the cost of documentation materials, royalties
and the cost of subcontracted services. Costs of revenues were $0.3 million,
$0.3 million and $1.2 million in 1997, 1996 and 1995, respectively. The
reduction in 1996 cost of revenues to $0.3 million from $1.2 million in 1995,
is attributable to reductions in the cost of subcontracted services for a
systems integration project that was completed in the fourth quarter of 1995.
4
RESEARCH AND DEVELOPMENT
Most of the Company's research and development expenditures are
personnel related. Total expenditures for research and development increased
to $6.7 million in 1997 from $6.2 million in 1996 and $3.6 million in 1995.
The increase in research and development expenditures was due primarily to
increases in expenditures for continuation and completion of purchased
in-process research ($3.4 million in 1997 and $2.8 million in 1996), a one
time charge of $0.6 million in connection with the third quarter of 1997
acquisition of rights to the software of International Risk Control and new
product development. The increase in 1996 includes the addition of
research staff from the acquired firm of LOR/Xxxxx Xxxx during the first
quarter of 1996. In connection with the LOR/Xxxxx Xxxx acquisition, the
Company recognized a one-time expense amounting to $7.1 million of in process
research and development as the technology had not yet reached technological
feasibility and does not have alternative future uses (See Note 3 of the
Notes to the Consolidated Financial Statements). The amounts of ongoing
software development costs which could have been capitalized in accordance
with Statement of Financial Accounting Standards No. 86," were immaterial
and, therefore, no software development costs have been capitalized by the
Company to date. The Company believes that significant investment for product
research and development is essential to product and technical leadership,
and the Company anticipates that it will continue to commit substantial
resources to research and development in the future. The focus of this
increased research and development spending will be to expand the platforms
upon which the Company's products operate; to integrate the acquired products
from LORGB; and to continue to enhance the features and functionality of the
company's products. The Company anticipates that research and development
expenditures will increase in dollar amount in 1998.
SALES AND MARKETING
Sales and marketing expenses consist principally of salary, commissions
and facilities related costs. Sales and marketing expenditures increased to
$11.4 million in 1997 from $11.1 million in 1996 and $10.3 million in 1995.
The increase in sales and marketing in 1997 was primarily due to increases
associated with the sales and marketing of the Company's expanded product
line in the North American market. The increase in sales and marketing
expenditures in 1996 was due to increases in personnel, commissions,
marketing communication programs and the expansion of the Company's Hong Kong
office. The Company anticipates that sales and marketing expenses will
continue to increase in dollar amount in 1998 as it expands its sales and
consulting service organization and promotes its XXXXX products.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of personnel costs
for finance, contract administration, human resources and general management,
as well as legal, accounting and auditing expenses. General and
administrative expenses increased to $3.0 million in 1997 from $2.6 million
in 1996 and $2.8 million in 1995. The increase in general and administrative
expenses in 1997 was due to additional executive staff to support the
expanding international sales and employee recruiting. The decrease in
general and administrative expenses in 1996 from 1995 was due to reduced
costs of professional services subsequent to becoming a publicly held
company. The Company anticipates that general and administrative expenses
will increase in dollar amount in 1998.
5
INTEREST INCOME
Interest income is comprised primarily of interest earned on the
Company's surplus cash and short-term investment balances, net of interest
expense. Interest income increased to $1.0 million in 1997 from $0.9 million
in 1996 and 1995. Interest income increased in 1997 due to higher investment
yields on lower average cash and short-term investment balances.
PROVISION FOR INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes," which
provides for a liability approach under which deferred income taxes are
provided based upon enacted laws and rates applicable to the periods in which
the taxes become payable. There was no provision for income taxes in 1997
and 1996 due to the Company's net operating loss position. The provision for
income taxes was 35% of income (loss) before the provision for income taxes
in 1995. The provision for income taxes takes into account the effects of
foreign income taxes and state income taxes, offset by utilization of
research and development and foreign tax credits.
As of December 31, 1997, the Company had $6.2 million of deferred tax
assets. Due to certain limitations of benefits related to tax carrybacks and
the current year net operating loss position, and the uncertainty of future
results, the Company has provided a valuation allowance of $3.6 million
related to the deferred tax asset. The Company's tax returns for 1990 through
1993 are currently being examined by the Internal Revenue Service relating to
the treatment of foreign withholding taxes on the Company's software license
revenue under tax treaties in effect during those years. Such examination may
result in adjustments to previously filed tax returns. The Company is
currently seeking competent authority relief, which, if successful, will
eliminate any potential double taxation. While the Company believes that it
has reserves sufficient to cover any actual tax liabilities as a result of
this examination, no assurance can be given that the reserves will be
adequate. See Note 6 of the Notes to Consolidated Financial Statements.
QUARTERLY INFORMATION
The following table presents unaudited quarterly financial information
for the eight quarters ended December 31, 1997. Management believes this
information has been prepared on the same basis as the audited Consolidated
Financial Statements and that all necessary adjustments (consisting only of
normal recurring adjustments) have been included to present fairly the
unaudited quarterly results. The following should be read in conjunction with
the audited Consolidated Financial Statements of the Company and the Notes
appearing elsewhere in these Consolidated Financial Statements. These
operating results are not necessarily indicative of results for any future
period.
6
THREE MONTHS ENDED
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MAR. 31, 1996 JUNE 30, 1996 SEPT. 30, 1996 DEC. 31, 1996
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(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
License revenue $ 5,386 $ 4,939 $ 4,599 $ 4,398
Service and other revenue 308 134 304 77
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Total revenues 5,694 5,073 4,903 4,475
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Costs and expenses:
Cost of revenues 54 74 78 66
Research and development 1,224 1,567 1,692 1,683
Sales and marketing 2,669 2,761 2,959 2,695
General and administrative 710 650 645 612
Acquired in-process research and development 7,066 -- -- --
--------- ---------- ------------ -----------
Total costs and expenses 11,723 5,052 5,374 5,056
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Operating income (loss) (6,029) 21 (471) (581)
Interest income 231 240 198 194
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Income (loss) before provision for taxes (5,798) 261 (273) (387)
Provision (benefit) for income taxes 469 97 (101) (465)
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Net income (loss) $ (6,267) $ 164 $ (172) $ 78
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Net income (loss) per share - basic $ (1.00) $ $0.03 $ (0.03) $ 0. 01
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Net income (loss) per share - diluted $ (1.00) $ $0.02 $ (0.03) $ 0. 01
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Weighted average common shares outstanding -
basic 6,260 6,425 6,623 6,639
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Weighted average common shares outstanding -
diluted 6,260 6,797 6,623 6,971
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--------- ---------- ------------ -----------
MAR. 31, 1997 JUNE 30, 1997 SEPT. 30, 1997 DEC. 31, 1997
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(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
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Revenues:
License revenue $ 4,238 $ 4,302 $ 4,311 $ 4,400
Service and other revenue 254 244 350 355
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Total revenues 4,492 4,546 4,661 4,755
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Costs and expenses:
Cost of revenues 93 71 72 74
Research and development 1,583 1,643 1,904 1,592
Sales and marketing 2,602 2,821 2,931 3,031
General and administrative 693 713 829 757
Acquired in-process research and development -- -- 585 --
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Total costs and expenses 4,971 5,248 6,321 5,454
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Operating income (loss) (479) (702) (1,660) (699)
Interest income 236 233 248 242
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Income (loss) before provision for taxes (243) (469) (1,412) (457)
Provision for income taxes -- -- -- --
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Net income (loss) $ (243) $ (469) $ (1,412) $ (457)
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Net income (loss) per share - basic $ (0.04) $ (0.07) $ (0.21) $ (0. 07)
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Net income (loss) per share - diluted $ (0.04) $ (0.07) $ (0.21) $ (0. 07)
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Weighted average common shares outstanding -
basic 6,679 6,714 6,766 6,815
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Weighted average common shares outstanding -
diluted 6,679 6,714 6,766 6,815
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7
THREE MONTHS ENDED
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MAR. 31, 1996 JUNE 30, 1996 SEPT. 30, 1996 DEC. 31, 1996
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AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
License revenue 94% 97% 94% 98%
Service and other revenue 6 3 6 2
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Total revenues 100 100 100 100
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Costs and expenses:
Cost of revenues 1 1 2 1
Research and development 22 31 35 38
Sales and marketing 47 55 60 60
General and administrative 12 13 13 14
Acquired in-process research and development 124 -- -- --
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Total costs and expenses 206 100 110 113
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Operating income (loss) (106) 0 (10) (13)
Interest income 4 5 4 4
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Income (loss) before provision for taxes (102) 5 (6) (9)
Provision (benefit) for income taxes 8 2 (2) (11)
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Net income (loss) (110)% 3% (4)% 2%
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MAR. 31, 1997 JUNE 30, 1997 SEPT. 30, 1997 DEC. 31, 1997
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AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
License revenue 94% 95% 92% 93%
Service and other revenue 6 5 8 7
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Total revenues 100 100 100 100
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Costs and expenses:
Cost of revenues 2 2 2 2
Research and development 35 36 41 33
Sales and marketing 58 62 63 64
General and administrative 16 15 17 16
Acquired in-process research and
development -- -- 12 --
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Total costs and expenses 111 115 135 115
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Operating income (loss) (11) (15) (35) (15)
Interest income 5 5 5 5
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Income (loss) before provision for taxes (6) (10) (30) (10)
Provision for income taxes 0 0 0 0
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Net income (loss) (6)% (10)% (30)% (10)%
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The Company's license revenue increased in each quarter of 1997.
Incremental sales to existing clients and new license agreements offset
non-renewing licenses during the year. The Company's historical practice has
been to recognize revenue from its annually renewable license fees pro-rata
over the license term. Therefore the revenue impact from adding new customers
has been reflected over several quarters following sales consummation. The
Company began offering multi-year (typically five year) term licenses in the
fourth quarter of 1997 with optional annual maintenance. With this new
licensing model, the Company will recognize substantial revenues upon
delivery of the product. In addition, there may be additional maintenance
revenues, recognized ratably as such services are provided. The Company has
not yet entered into any such multi-year term licenses. Service and other
revenue is recognized when delivered or using the
8
percentage-of-completion method and is typically affected by the commencement
or completion of significant services projects.
Cost of revenues has been relatively minor. The Company has generally
increased operating expenses to support higher revenue levels and product
development efforts. Research and development costs were higher in 1997 as
compared to 1996 due to increases in staffing to support final development
and testing of the newest XXXXX product line release. Sales and marketing
costs were higher in 1997 as compared to 1996 due to increases in staffing of
the North American office and the development of the Company's consulting
service. General and administrative costs were higher on a dollar basis in
1997 as compared to 1996 due to hiring of executive and human resource
personnel to support the staffing needs of the expanding international sales
and marketing and customer service offices.
Although the Company's installed base of C-ATALYST customers has
stabilized in terms of number of clients and number of client sites, there
can be no assurance that the Company will continue to be able to renew its
existing client base or expand the number of clients or client sites where
the Company's products are licensed. A number of factors affect a client's
decision to license or continue to license the Company's products. These
factors include the status of a client's internal systems development
programs, competitiveness of the Company's current product offerings,
pricing, and level of satisfaction with the Company's sales, service and
support staff. From time to time in the past, the Company has experienced
delays in developing and introducing new products, which has slowed the rate
of growth. There can be no assurance that similar delays may not occur in the
future. The Company's expense levels are based, in part, on expectations of
future revenues. If revenues do not meet expectations, operating results
could be adversely affected. Net income may be disproportionately affected
by a change in revenues because only a small portion of the Company's
expenses varies with revenues.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date through cash flow from
operations and its initial public offering of stock effective March 20, 1995.
As of December 31, 1997, the Company had $20.2 million in cash, cash
equivalents and short-term investments, and no long-term debt. Short-term
investments consist principally of auction market preferred stock and
tax-preferred securities.
Net cash utilized by operating activities totaled $1.8 million in 1997,
while $1.0 million in 1996 and approximately $3.1 million was provided by
operating activities in 1995. Investing activities used net cash of
approximately $1.9 million, $3.4 million and $21.0 million in 1997, 1996 and
1995, respectively. Inclusive within these uses were the purchase of
short-term investments of approximately $20.2 million in 1995, and the
subsequent sale in 1996 of $7.4 million of these short-term investments which
were used to help fund the approximately $3.3 million cash portion of the
investment in LORGB the same year. Net cash flows provided by financing
activities were approximately $0.5 million, $0.3 million and $14.3 million in
1997, 1996 and 1995, respectively with $13.8 million of the net cash in 1995
provided by the Company's initial public offering that year. The Company
purchased approximately $0.5 million of property and equipment in 1997, and
$0.7 million in both 1996 and 1995. The Company has no other significant
capital commitments.
On February 13, 1996, C-ATS Sub, Inc. (a wholly owned subsidiary of the
Company), merged with LOR/Xxxxx Xxxx Associates, Inc. ("LORGB"), a California
Corporation, pursuant to an "Agreement and Plan of Reorganization" dated
January 30, 1996. LORGB designs, develops, and markets integrated,
organization-wide market and credit risk management software systems. As a
result of the merger, LORGB ceased to exist while C-ATS Sub, Inc. continued
as the surviving corporation. The transaction was accounted for as a
"purchase" and accordingly, the operating results of the acquired business
have been included in the consolidated statement of operations from the date
of the acquisition.
9
At the consummation of the merger, the outstanding LORGB common stock
was exchanged for an aggregate of approximately 578,651 shares of the
Company's common stock (the stock price was valued at $7.00 as of the merger
date) and approximately $3,294,000 in cash. In addition, the Company assumed
all options, representing the right to purchase approximately 167,000 shares
of the Company's common stock.
Historically, more client licenses are due for renewal in the second and
fourth quarters of each year than in the first and third quarters. Because of
the Company's pro-rata revenue recognition policy, this pattern has not had a
significant impact on quarterly revenues. However, this pattern has and will
likely continue to impact the timing of cash flows and the Company's cash and
accounts receivable balances. Any decline or delay in contract renewals could
have a material adverse effect on the Company's cash balances.
The Company believes that available funds, and the cash flow expected to
be generated from operations will be adequate to meet the Company's
anticipated working capital and capital expenditure requirements for at least
the next twelve months.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's business, financial condition and results of operations
can be impacted by a number of factors including without limitation the
following factors.
CONTINUED DEPENDENCE ON DERIVATIVES RISK MANAGEMENT PRODUCT
C-ATS has derived substantially all of its revenues from the sale of
software products and services for derivatives risk management, and its
future growth is critically dependent on increased revenues from products for
this use. The target clients for the Company's products include large banks
and financial institutions, many of whom rely on internally developed
derivative risk management systems. Their acceptance of the Company's
products depends, among other things, on the products' functionality and
performance characteristics, the ability of these clients to achieve cost
savings by using third party software, the development time and cost of
internally developed software, the willingness of these institutions to rely
on third party software for mission critical financial applications, and
their assessment of C-ATS' financial resources as well as its technical,
managerial, service and support capabilities. The Company has generally found
that the costs of switching to a new derivatives risk management system are
so substantial that clients will generally not change systems unless they
perceive a significant deficiency with their existing system.
A number of factors could adversely affect market acceptance of the
Company's products for derivatives risk management applications. First,
although the Company's products include software applications for a number of
widely traded derivatives, such as swaps, options, swaptions and futures,
they do not include software applications for many other derivative
instruments. Although applications for these derivatives can be developed
using FiCAD or may be included in the Company's future products, the absence
of applications for specific derivatives may reduce market acceptance of the
Company's products. Second, some financial institutions may require a higher
level of product customization and technical support than is customarily
provided by C-ATS. To the extent these clients cannot obtain this support
from C-ATS or third party service organizations, they may be reluctant to
use the Company's products. Finally, C-ATALYST and XXXXX have a long sales
cycle that can adversely affect sales and increase marketing costs. As a
result of these and other factors, there can be no assurance that C-ATALYST
and XXXXX will achieve significant market acceptance.
EARLY STAGE OF DEVELOPMENT OF MARKET FOR ENTERPRISE-WIDE RISK MANAGEMENT; NO
ASSURANCE OF MARKET ACCEPTANCE OF ENTERPRISE-WIDE RISK MANAGEMENT PRODUCTS
The market for enterprise-wide risk management software products is in
an early stage of development. Although many financial institutions and
organizations are exploring enterprise-wide risk
10
management, C-ATS believes that only a small number of enterprises have
actually implemented enterprise-wide risk management systems. A number of
factors will determine when and if a significant market for enterprise-wide
risk management software products develops, including regulatory actions,
client education and awareness of the need for enterprise-wide risk
management and the availability of commercially accepted enterprise-wide risk
management systems. Even if a significant market develops, there can be no
assurance that the Company's products will achieve commercial acceptance.
First, there can be no assurance that the Company's approach to
enterprise-wide risk management will be accepted in the marketplace. Although
several companies are using prior versions of the Company's products for
site-wide or enterprise-wide risk management, the newest version of XXXXX
was released for commercial sales in December 1996. This product is a
substantial enhancement of the product obtained in the acquisition of
LOR/Xxxxx Xxxx, designed for enterprise-wide market and credit risk
management. While financial institutions are potentially subject to
regulatory guidelines to implement a enterprise-wide market risk management
system, there can be no assurance that the Company's products will achieve
substantial acceptance in the marketplace.
Second, although the Company's products facilitates enterprise-wide risk
management, the process of creating a enterprise-wide risk management system
can be extremely complex and in most cases requires substantial additional
software engineering and integration in order to connect the many independent
systems in place at most institutions and to link these systems to the
Company's products. The cost of such a process is likely to far exceed the
cost of licensing the Company's products. There is no assurance that a
significant number of institutions will be willing to undertake such a large
project or to incur such costs. Third, many institutions implementing
enterprise-wide risk management will require substantial outside assistance
in software engineering. The Company intends primarily to provide standard
products and to rely on third parties to provide such assistance. Revenues
from enterprise-wide risk management products will be limited if such
third-party support is not readily available. Fourth, the development of
sophisticated enterprise-wide risk management systems will depend on the
availability of extensive transaction and counterparty data which the client
must provide for portfolios not managed with the Company's products. Lack of
access to such data may restrict an institution's ability to perform
enterprise-wide risk management.
Finally, many of the factors that affect market acceptance of the
Company's products for derivatives risk management, such as the decision to
develop software internally or rely on third-party software, also will affect
market acceptance of the Company's products for enterprise-wide risk
management. See "Factors That May Affect Future Results -- Continued
Dependence on Derivatives Risk Management Products." Failure of a significant
market for enterprise-wide risk management products to develop or, if it
does, failure of the Company's products to achieve broad market acceptance
could have a material adverse affect on the Company's business, operating
results and financial condition.
LIMITED SUPPORT, TRAINING AND CUSTOMIZATION
Some financial institutions may require a higher level of product
customization and technical support and training than the Company customarily
provides or can provide. The Company intends primarily to rely on third
parties to provide such customization and support. Additionally, the Company
has limited resources to devote to training. To the extent financial
institutions cannot obtain desired levels of customization, support and
training, they may be reluctant to use the Company's products, which could
slow market acceptance of the Company's products. This could impede the
Company's growth and could have a material adverse effect on the Company's
business, operating results and financial condition.
11
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS
The Company's quarterly operating results may fluctuate substantially as
a result of a variety of factors including the volume and timing of license
renewals by existing clients, license agreements with new clients, the timing
and market acceptance of new products or technological advances by the
Company or its competitors, price levels, and unexpected expenses. The
Company's expense levels are based, in part, on expectations of future
revenues. If revenues in a particular quarter do not meet expectations,
operating results could be adversely affected. The Company expects that its
operating results will fluctuate in the future as a result of these and other
factors. Additionally, the Company has accrued a reserve for tax liabilities
in connection with an Internal Revenue Service examination. There can be no
assurance that such reserve will be adequate to cover all potential
liabilities. Results of past quarters should not be relied on as an
indication of future results. See Note 6 of the Notes to Consolidated
Financial Statements.
DEPENDENCE ON RENEWABLE LICENSES; SIGNIFICANT POTENTIAL PRICE COMPETITION
The Company's revenues are derived primarily from annual renewable
license fees. These fees are non-refundable, typically paid in full at the
beginning of the annual term and recognized as revenue pro-rata over the term
of license. The Company has been successful to date in negotiating renewable
licenses. Beginning in the fourth quarter of 1997, the Company began offering
multi-year term licenses. The Company believes this choice will be favorably
received by its clients. Many of the Company's competitors offer multi-year
licenses. Although no clients have as yet selected the multi-year term
license in 1997, the Company expects some clients will do so in 1998. A
multi-year term license may result in larger fluctuations in revenues than
the Company has historically experienced as multi-year term license revenue
will be recognized at the time of delivery and completion of customer
commitment and there will be no future license revenue amortization. A
significant decline in the percentage of clients who renew their license or
the failure of the Company to continue to enter into renewable or limited
term licenses would have a material adverse effect on the business, operating
results and financial condition of the Company.
Because the software industry is intensely competitive, software
products have often experienced price erosion. As is typical in the industry,
the Company's fixed costs as a percentage of revenues are high, and
significant price erosion could have a material adverse effect on the
Company's business, operating results and financial condition. Although to
date any price decline in unit prices of the Company's products has been
offset by the introduction of new or enhanced products, there can be no
assurance that significant price erosion will not occur in the future.
DEPENDENCE ON INTERNATIONAL OPERATIONS AND SALES
Clients outside the United States accounted for approximately 83%, 80%
and 80% of the Company's revenues in 1997, 1996 and 1995, respectively. The
Company anticipates that its revenues for the next several years will also
substantially derive from international sales. The Company markets and
licenses its products outside the United States through its international
branch offices and subsidiaries. The Company has offices in Tokyo, London,
and Hong Kong as well as the United States, and the Company has licensed
clients in 19 countries. International sales and operations may be limited or
disrupted by the imposition of government controls, export license
requirements, political instability, trade restrictions, changes in tariffs
and exchange rates, difficulties in staffing, coordinating communications,
managing international operations and other factors. The Company normally
prices its products in U.S. dollars, but it incurs expenses in local
currencies for its overseas operations.
The Company attempts to reduce its exposure to exchange rate
fluctuations by purchasing foreign currencies every several months in amounts
equal to the operating expenses estimated to be payable in such currencies
during the next one to three months. As of December 31, 1997, the Company
held cumulative
12
foreign currencies available in the amount of approximately $280,000 to fund
future expected operating expenses. However, no assurance can be given that
this strategy will be sufficient to offset any dramatic declines in the value
of the U.S. dollar. Regulatory compliance requirements differ among foreign
countries and are also different from those established in the United States,
and any inability to obtain necessary foreign regulatory approvals on a
timely basis could have an adverse effect on the Company's international
sales, and thereby on its business, financial condition and results of
operations. Additionally, the Company's business, financial condition and
international operating results may be adversely affected by fluctuations in
currency exchange rates as well as increases in duty rates, difficulties in
obtaining export licenses, ability to maintain or increase prices and
competition.
DEPENDENCE ON KEY PERSONNEL; SUBSTANTIAL EXECUTIVE COMPENSATION
The Company's success depends to a significant extent upon the
contributions of its executive officers, and key sales, marketing, technical
service and engineering personnel. None of the Company's personnel are
subject to a noncompetition agreement or other long-term employment contract
with the Company. Further, in order to attract and retain its executive
officers, the Company has in the past paid to its executive officers
substantial compensation and bonuses. In addition, the Company's future
success will depend significantly on its continuing ability to attract and
retain highly qualified technical, sales and marketing personnel. Because the
Company's business requires that many of these personnel have specialized
knowledge of advanced computer programming and financial theory, and because
the pool of such qualified personnel is extremely limited, competition for
such personnel is intense, particularly among the Company's clients who have
substantially greater financial resources than the Company. Failure to
attract and retain such personnel could have a material adverse affect on the
Company's business, operating results and financial condition.
NEW MANAGEMENT RESPONSIBILITIES; GROWTH
Many of the Company's executive officers have joined the Company in the
last twenty- four months. Although each of the new executives brings
significant prior experience to the Company, some are new to the Company's
specific business segment. In addition, future growth will require increased
personnel, expanded information systems and additional financial and
administrative control procedures, particularly because the Company has
significant international operations. There can be no assurance that the
Company would be able to attract and retain additional qualified personnel or
successfully manage expanding operations, including an increasing number of
client relationships and geographically dispersed locations or maintain
adequate managerial, financial and operating systems and controls
DEPENDENCE ON DIRECT SALES FORCE; ABSENCE OF INDIRECT SALES CHANNELS.
C-ATS currently distributes its products exclusively through its direct
sales force. As is typical of many companies, the Company has experienced
turnover of its sales force in the past, and there can be no assurance that
the Company will be able to attract and retain adequate sales and marketing
personnel. During 1997, the Company began evaluation of indirect distribution
channels such as distributors, value-added resellers and systems integrators.
The Company has selected two such organizations to work with and to expand
access to its markets. During 1997 these efforts did not generate material
revenues. The Company may expand such efforts in 1998, however, there can be
no assurances that these channels will provide effective sales and marketing
support for the Company. Failure to increase the Company's direct sales force
or establish effective indirect sales channels could have a material adverse
effect on the Company's business, operating results or financial condition.
13
DEPENDENCE ON FINANCIAL INDUSTRY; CHANGE IN DERIVATIVES AND RISK MANAGEMENT
MARKET, AND REGULATORY ENVIRONMENT
Substantially all of the Company's current clients are domestic and
international financial institutions. An economic downturn in the commercial
and investment banking industries or in the level of derivatives trading
could have a material adverse effect on the Company's business, operating
results and financial condition. Any adverse change in the derivatives market
affecting demand for the Company's products, whether by regulation,
consolidation within the financial industry, negative publicity or otherwise,
could have a material adverse effect on the Company's business, operating
results and financial condition.
Derivative instruments have been involved in a number of well-publicized
financial losses, including those involving Barings Bank and Orange County of
California. Such losses have led to increasing governmental scrutiny and
potential regulation of derivatives markets generally. Current legislative
and regulatory measures reportedly being considered include additional
reporting requirements pertaining to the current values of and risks
associated with derivatives positions, and regulation of the mathematical
models used to measure such values and risks. The Company believes that
regulations which impose requirements of increased management controls or
increased reporting may increase the demand for the Company's products.
However, some legislators have questioned whether certain types of
derivatives trading should be prohibited. Prohibitions on trading activities
could reduce the size of the Company's markets.
COMPETITION
The market for financial risk management software is intensely
competitive and is characterized by rapid technological change and frequent
introduction of new products and features. The Company competes generally on
the basis of product features and functions, product architecture, price, the
speed and accuracy of the product processing capability, client service, the
availability of sufficiently trained technical staff, and the vendor
financial stability. In order to maintain or improve its position in this
industry, the Company must continue to enhance its current products and
develop new products in a timely fashion. There can be no assurance that the
Company will succeed in this effort.
A major source of competition for the Company's products are
applications that are internally developed by the financial institutions
which are its potential clients, as well as institutions that are current
clients. Even those financial institutions, including the Company's clients,
that use the Company's products or other third-party software for some
applications usually use internally developed software for the same or
related applications. Many of these organizations have substantial internal
development resources with the capability to develop specific products for
their needs. Many of these organizations also value the ability to control
the source code for their software systems. The Company does not typically
make its source code available. There can be no assurance that the Company
will successfully market its products to these organizations.
There are a significant number of independent commercial competitors for
the Company's products. Some of these competitors, including SunGard Data
Systems Inc., Infinity, Inc., and ACT Group plc., are larger than the
Company and have longer operating histories and significantly greater
financial, technical, sales and marketing and other resources, greater name
recognition and a larger installed client base.
TECHNOLOGICAL CHANGE
The financial risk management software industry is characterized by rapid
technological advances, changes in client requirements and preferences, and
frequent new product introductions and enhancements. Historically, the Company
has released product enhancements at intervals of one to three years. The
Company's future success will depend, in significant part, upon its ability to
enhance its current products and to
14
develop and market new products on a timely basis that keep pace with
technological developments, respond to evolving client requirements and
achieve market acceptance. In particular, the Company believes it must
continue to respond quickly to users' needs for additional functionality and
to advances in hardware and software platforms. Any failure by the Company to
anticipate or respond adequately to technological developments and client
requirements, or any significant delays or excessive costs in product
development or introduction, could have a material adverse effect on the
Company's operating results and financial condition. Because of the
complexity of the Company's products, from time to time development efforts
have taken longer than expected, causing delays in the release of new
products and product enhancements, and this may occur again in the future.
Any such delays could have a material adverse effect on the Company's
business, operating results or financial condition. There can be no assurance
that the Company will be successful in developing and marketing new products
or product enhancements on a timely basis or that the Company will not
experience significant delays or excessive costs in the future that could
have a material adverse effect on the Company's operating results and
financial condition.
Because the Company has limited resources, the Company must restrict its
product development efforts and its porting efforts to a relatively small
number of products and operating platforms. There can be no assurance that
these efforts will be successful or, even if they are successful, that any
resulting products or operating platforms will achieve market acceptance.
Additionally, the Company offers standardized products designed for use
worldwide. These products do not include general ledger systems or certain
other product features tailored for specific regional markets or industry
segments. The failure to include these features may adversely affect market
acceptance of the Company's products. Furthermore, there can be no assurance
that the cost of research and development efforts required to keep pace with
technological changes will not have an adverse effect on the Company's
business, operating results or financial condition.
New software products often contain undetected defects, or "bugs," that
can adversely affect the performance of the product or otherwise disrupt a
user's operations. If the Company's products contain material defects, client
acceptance of such products could be adversely affected. Further, the Company
could be subject to liability claims (for which it may not carry adequate
insurance) that could have a material adverse effect on the Company's
operating results and financial condition.
LIMITED INTELLECTUAL PROPERTY PROTECTION
The Company's ability to compete effectively depends in large part on
its ability to develop and maintain proprietary aspects of its technology.
The Company relies on a combination of trade secret, copyright and trademark
law, nondisclosure agreements and various measures including physical and
logical access controls, to protect its proprietary rights in its software
products. Despite these precautions it may be possible for unauthorized third
parties to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Moreover, the laws of
some foreign countries do not protect the Company's proprietary rights in its
products to the same extent as do the laws of the United States. In addition,
some aspects of the Company's products are not subject to intellectual
property protection.
There can be no assurance that others may not independently develop the
same or similar technology or otherwise obtain access to the Company's
proprietary technology. In addition, the Company cannot be certain that
others will not independently develop substantially equivalent or superseding
proprietary technology, or that an equivalent product will not be marketed in
competition with the Company's products, thereby substantially reducing the
value of the Company's proprietary rights. There can be no assurance that any
confidentiality agreements between the Company and its employees will provide
adequate protection for the Company's proprietary information in the event of
any unauthorized use or disclosure of such proprietary information.
15
While the Company is not currently engaged in any intellectual property
litigation or proceedings, there can be no assurance that the Company will
not become involved in such proceedings. An adverse outcome in litigation or
similar adversarial proceedings could subject the Company to significant
liabilities to third parties, require disputed rights to be licensed from
others or require the Company to cease the marketing or use of certain
products, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company may be
required to obtain licenses to patents or proprietary rights of others, and
there can be no assurance that any licenses required under any patents or
proprietary rights would be made available on terms acceptable to the
Company, if at all. In January 1995, the Company received a letter claiming
infringement of trademark with regard to its use of the C-atalyst name in the
United Kingdom; however, although the Company does not believe that the
outcome of the claim will have a material adverse effect on its business,
there can be no assurance as to how the matter will be resolved.
YEAR 2000 COMPLIANCE
The Company believes that all of its most current versions of its
products will not cease to perform nor generate incorrect or ambiguous data
or results due to a change in date on or after January 1, 2000, and will
calculate any information dependent on such dates in the same manner, and
with the same functionality, data integrity and performance, as such product
do on or before December 31, 1999 (collectively, "Year 2000 Compliance").
Year 2000 Compliance issues may arise with respect to any modifications made
to the product by a party other than the Company or from a combination or
use of the Company's products with any other software programs or hardware
device not provided by the Company and therefore may result in unforeseen
Year 2000 Compliance problems for some of the Company's customers which may
have an adverse effect on the Company.
Additionally, like any company with a computing infrastructure and
utilizing business-application software programs written over many years, the
Company's internal operations may be subject to year 2000 Compliance issues.
The Company has been implementing enterprise wide information systems which
support a majority of the Company's world-wide operations. These systems are
considered to currently be Year 2000 Compliant. Based solely due to a change
in date to or after January 1, 2000 thereon, the Company believes that its
internal operations will not be materially adversely impacted.
FUTURE ACQUISITIONS
Future acquisitions by the Company may result in potentially dilutive
issuances of equity securities, the incurrence of additional debt and
amortization expenses related to goodwill and other intangible assets, which
could adversely affect the Company's profitability. For example, the Company
acquired LOR/Xxxxx Xxxx Associates, Inc. on February 13, 1996. In addition,
acquisitions involve numerous risks, including difficulties in the
assimilation of the operations, products and personnel of the acquired
company, the diversion of management's attention from other business
concerns, risks of entering markets in which the Company has little or no
direct prior experience, and the potential loss of key employees of the
acquired company. The Company has, from time to time, engaged in discussions
with a number of parties to acquire products complementary to its existing
products, and may in the future pursue acquisitions of complementary
products, technologies or businesses. While there are currently no
commitments or agreements with respect to any acquisition, in the event that
such an acquisition does occur, there can be no assurance as to the effect
thereof on the Company's business, operating results or financial condition.
16
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To C-ATS Software Inc.:
We have audited the accompanying consolidated balance sheets of C-ATS
Software Inc. (a Delaware corporation) and subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of C-ATS
Software Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 1997 in conformity with generally accepted
accounting principles.
XXXXXX XXXXXXXX LLP
San Jose, California
January 23, 1998
17
C-ATS SOFTWARE INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
------------------------
ASSETS 1997 1996
--------- ---------
CURRENT ASSETS:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . $ 3,707 $ 7,041
Short-term investments. . . . . . . . . . . . . . . . . . . . . . . 16,446 15,088
Accounts receivable, net of accounts receivable allowance
of $242 and $100 in 1997 and 1996, respectively . . . . . . . . . 5,100 4,558
Prepaid expenses. . . . . . . . . . . . . . . . . . . . . . . . . . 271 457
Income tax refund receivable - current. . . . . . . . . . . . . . . --- 1,670
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . 2,607 2,120
--------- ---------
Total current assets . . . . . . . . . . . . . . . . . . . . . . 28,131 30,934
--------- ---------
PROPERTY AND EQUIPMENT:
Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,809 2,754
Leasehold improvements. . . . . . . . . . . . . . . . . . . . . . . 125 134
Furniture and fixtures. . . . . . . . . . . . . . . . . . . . . . . 403 457
3,337 3,345
Less- Accumulated depreciation and amortization . . . . . . . . . . (2,486) (2,367)
--------- ---------
Net Property and equipment . . . . . . . . . . . . . . . . . . 851 978
--------- ---------
Purchase software, at cost. . . . . . . . . . . . . . . . . . . . . . 1,516 1,464
Less- Accumulated amortization. . . . . . . . . . . . . . . . . . . (879) (660)
--------- ---------
Net purchased software . . . . . . . . . . . . . . . . . . . . . 637 804
--------- ---------
Income tax refund receivable - long term. . . . . . . . . . . . . . . 686 ---
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335 283
--------- ---------
$30,640 $32,999
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . $ 390 $ 573
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . 674 720
Accrued compensation. . . . . . . . . . . . . . . . . . . . . . . . 1,604 1,217
Accrued taxes payable . . . . . . . . . . . . . . . . . . . . . . . 281 37
Deferred revenue. . . . . . . . . . . . . . . . . . . . . . . . . . 8,007 8,541
--------- ---------
Total current liabilities. . . . . . . . . . . . . . . . . . . . 10,956 11,088
--------- ---------
COMMITMENTS (see Note 4)
STOCKHOLDERS' EQUITY:
Preferred stock, 5,000,000 shares authorized , no par value . . . . --- ---
Common stock, $.001 par value
Authorized 40,000,000 shares
Outstanding 6,817,744 shares in 1997 and 6,639,587 shares in 1996 7 7
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . 23,282 22,758
Accumulated translation adjustment. . . . . . . . . . . . . . . . . 228 398
Retained earnings (deficit) . . . . . . . . . . . . . . . . . . . . (3,833) (1,252)
--------- ---------
Total stockholders' equity. . . . . . . . . . . . . . . . . . . . 19,684 21,911
--------- ---------
$ 30,640 $ 32,999
--------- ---------
--------- ---------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL
PART OF THESE CONSOLIDATED BALANCE SHEETS.
18
C-ATS SOFTWARE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
--------- --------- ----------
REVENUES:
License revenue. . . . . . . . . . . . . . . . . . . . . . . . $ 17,250 $ 19,322 $ 20,359
Service and other revenue. . . . . . . . . . . . . . . . . . . 1,204 823 1,939
--------- --------- ----------
Total revenues. . . . . . . . . . . . . . . . . . . . . . . 18,454 20,145 22,298
--------- --------- ----------
COSTS AND EXPENSES:
Cost of revenues . . . . . . . . . . . . . . . . . . . . . . . 310 272 1,174
Research and development . . . . . . . . . . . . . . . . . . . 6,723 6,166 3,582
Sales and marketing. . . . . . . . . . . . . . . . . . . . . . 11,386 11,084 10,273
General and administrative . . . . . . . . . . . . . . . . . . 2,991 2,617 2,838
Acquired in-process research and development . . . . . . . . . 585 7,066 --
--------- --------- ----------
Total costs and expenses. . . . . . . . . . . . . . . . . . 21,995 27,205 17,867
--------- --------- ----------
Operating income (loss) . . . . . . . . . . . . . . . . . . (3,541) (7,060) 4,431
INTEREST INCOME. . . . . . . . . . . . . . . . . . . . . . . . . 960 863 931
--------- --------- ----------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES. . . . . . . . . (2,581) (6,197) 5,362
PROVISION FOR INCOME TAXES . . . . . . . . . . . . . . . . . . 0 0 1,877
--------- --------- ----------
NET INCOME (LOSS). . . . . . . . . . . . . . . . . . . . . . . . $ (2,581) $ (6,197) $ 3,485
--------- --------- ----------
--------- --------- ----------
NET INCOME (LOSS) PER SHARE
BASIC. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.38) $ (0.95) $ 0.64
--------- --------- ----------
--------- --------- ----------
DILUTED. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.38) $ (0.95) $ 0.57
--------- --------- ----------
--------- --------- ----------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
BASIC. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,744 6,528 5,441
--------- --------- ----------
--------- --------- ----------
DILUTED. . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,744 6,528 6,062
--------- --------- ----------
--------- --------- ----------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL
PART OF THESE CONSOLIDATED STATEMENTS.
19
C-ATS SOFTWARE INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Common Common Additional Accumulated Retained
Stock Stock Paid-in Translation Earnings
Shares Amount Capital Adjustment (Deficit) Total
--------- --------- ---------- ------------ --------- ----------
BALANCE, DECEMBER 31, 1994 . . . . . . . . . . . . . . 4,212,499 $ 4 $ 3,899 $ 222 $ 877 $ 5,002
Exercise of stock options for cash at
$0.10 to $5.00 per share. . . . . . . . . . . . . . 268,159 -- 290 -- -- 290
Exercise of warrants at $3.10 per share. . . . . . . . 67,744 -- 210 -- -- 210
Issuance of common stock in initial public
offering for cash at $12.00 per share, net of
offering costs of $1,792. . . . . . . . . . . . . . 1,300,000 2 13,806 -- -- 13,808
Foreign currency translation adjustment. . . . . . . . -- -- -- 97 -- 97
Net income . . . . . . . . . . . . . . . . . . . . . . -- -- -- -- 3,485 3,485
--------- --------- ------- ---------- --------- --------
BALANCE, DECEMBER 31, 1995 . . . . . . . . . . . . . . 5,848,402 6 18,205 319 4,362 22,892
Tax benefit related to employee stock options. . . . . -- -- -- -- 583 583
Stock issued for LORGB acquisition . . . . . . . . . . 578,651 1 4,206 -- -- 4,207
Exercise of stock options for cash at
$0.10 to $8.00 per share. . . . . . . . . . . . . . 178,472 -- 156 -- -- 156
Issuance of common stock from ESPP for cash at
$5.10 to $6.06 per share. . . . . . . . . . . . . . 34,062 -- 191 -- -- 191
Foreign currency translation adjustment. . . . . . . . -- -- -- 79 -- 79
Net (loss). . . . . . . . . . . . . . . . . . . . . . -- -- -- -- (6,197) (6,197)
--------- --------- ------- ---------- --------- --------
BALANCE, DECEMBER 31, 1996 . . . . . . . . . . . . . . 6,639,587 7 22,758 398 (1,252) 21,911
Exercise of stock options for cash at
$0.10 to $4.69 per share. . . . . . . . . . . . . . 137,290 -- 372 -- -- 372
Issuance of common stock from ESPP for cash at
$3.72 to $3.88 per share. . . . . . . . . . . . . . 40,867 -- 152 -- -- 152
Foreign currency translation adjustment. . . . . . . . -- -- -- (170) -- (170)
Net (loss). . . . . . . . . . . . . . . . . . . . . . -- -- -- -- (2,581) (2,581)
--------- --------- ------- ---------- --------- --------
BALANCE, DECEMBER 31, 1997 . . . . . . . . . . . . . . 6,817,744 $ 7 $23,282 $ 228 $ (3,833) $ 19,684
--------- --------- ------- ---------- --------- --------
--------- --------- ------- ---------- --------- --------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL
PART OF THESE CONSOLIDATED STATEMENTS.
20
C-ATS SOFTWARE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Year Ended December 31,
-------------------------------------
1997 1996 1995
------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (2,581) $ (6,197) $ 3,485
Adjustments to reconcile net income (loss) to net cash provided (used) by
operating activities-
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . 832 919 582
Acquired in-process research and development. . . . . . . . . . . . . -- 7,066 --
Change in assets and liabilities-
(Increase) decrease in accounts receivable. . . . . . . . . . . . . (542) 2,595 (2,072)
(Increase) decrease in prepaid expenses . . . . . . . . . . . . . . 186 556 (34)
(Increase) decrease in deferred tax asset and income tax refunds. . 497 (902) (473)
(Increase) decrease in other assets . . . . . . . . . . . . . . . . (52) 35 (127)
Increase (decrease) in accounts payable . . . . . . . . . . . . . . (183) (520) 731
Increase (decrease) in accrued liabilities and accrued compensation 319 (241) 339
Increase (decrease) in accrued taxes payable. . . . . . . . . . . . 244 (1,604) (42)
Increase (decrease) in deferred revenue . . . . . . . . . . . . . . (534) (2,738) 676
------- ------- -------
Net cash provided (used) by operating activities. . . . . . . . . (1,814) (1,031) 3,065
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available-for-sale short-term investments. . . . . . . . . . (28,079) (15,479) (20,227)
Proceeds from sales and maturities of available-for-sale
short-term investments. . . . . . . . . . . . . . . . . . . . . . . 26,721 22,893 --
Investment in acquisition of LORGB . . . . . . . . . . . . . . . . . . . -- (3,294) --
Purchases of property and equipment. . . . . . . . . . . . . . . . . . . (516) (673) (733)
------- ------- -------
Net cash used by investing activities . . . . . . . . . . . . . . (1,874) (3,447) (20,960)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock . . . . . . . . . . . . . . . . . 524 347 16,100
Common stock offering costs. . . . . . . . . . . . . . . . . . . . . . . -- -- (1,792)
------- ------- -------
Net cash provided by financing activities . . . . . . . . . . . . 524 347 14,308
------- ------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (170) 79 97
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . . . . . . . . . . . (3,334) 2,842 (3,490)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD . . . . . . . . . . . . . 7,041 4,199 7,689
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD . . . . . . . . . . . . . . . . $ 3,707 $ 7,041 $ 4,199
------- ------- -------
------- ------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes . . . . . . . . . . . . . . . . . . . . . . . $ 761 $ 818 $ 1,417
------- ------- -------
------- ------- -------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL
PART OF THESE CONSOLIDATED STATEMENTS.
21
C-ATS SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. NATURE OF OPERATIONS:
C-ATS Software Inc. (the "Company") was organized in 1988 as a successor
to a partnership formed in 1986. The Company develops and markets
client/server software for financial risk management. The majority of the
Company's current clients are domestic and international financial
institutions. On March 20, 1995, the Company completed an initial public
offering of 1,300,000 shares of common stock at $12.00 per share. Total
proceeds to the Company (net of offering costs) were $13.8 million.
On February 13, 1996, C-ATS Sub, Inc. (a wholly owned subsidiary of the
Company), merged with LOR/Xxxxx Xxxx Associates, Inc. ("LORGB"), a California
Corporation, pursuant to an "Agreement and Plan of Reorganization" dated
January 30, 1996. LORGB designs, develops, and markets integrated,
organization-wide market and credit risk management software systems. As a
result of the merger, LORGB, Inc. ceased to exist while C-ATS Sub continued
as the surviving corporation. The transaction was accounted for as a
"purchase." Accordingly, the operating results of the acquired business have
been included in the consolidated statement of operations from the date of
the acquisition (See Note 3).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF FINANCIAL STATEMENT PRESENTATION
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during reporting
periods. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company licenses its products to end users under annual license
agreements which include rights to maintenance support services and product
upgrades. Accordingly, license revenues are recognized ratably over twelve
months. In addition, the Company provides training and consulting services
to its clients. Revenue from such services is generally recognized as the
services are performed.
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs incurred after
technological feasibility has been demonstrated. To date, amounts that could
have been capitalized have been immaterial and, therefore, no software
development costs have been capitalized.
22
NET INCOME (LOSS) PER SHARE
In 1997, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 128 "Earnings per Share" ("SFAS No. 128"). SFAS No. 128 requires
companies to complete net income or loss per share under two different
methods, "basic" and "diluted". "Basic" net income or loss per share for
each period is calculated by dividing the net income or loss by the weighted
average shares of common stock outstanding during the period. Diluted net
income or loss per share includes the impact of "potential" common shares
from the exercise of stock options using the treasury stock method.
As a result, 1996 and 1995 net income or loss per share has been
restated to conform to the new standard. "Potential" common shares included
in the 1995 "diluted" earnings per share calculation consist of dilutive
shares issuable upon the exercise of outstanding common stock. "Potential"
common shares were not included in the 1997 and 1996 "diluted" earnings per
share calculation as the effects would be anti-dilutive.
The following is a reconciliation of the weighted average common shares
used to calculate Basic and Diluted net income or loss per share for the
years 1997, 1996, and 1995:
1997 1996 1995
------ ------ ------
(in thousands)
Weighted average common shares used to
Calculate "basic" net income or loss per share . . . . 6,744 6,528 5,441
Options outstanding. . . . . . . . . . . . . . . . . . --- --- 621
------ ------ ------
Weighted average common shares used to
Calculate "diluted" net income or loss per share . . . 6,744 6,528 6,062
------ ------ ------
------ ------ ------
Options to purchase 1,836,115, 1,374,394 and 46,740 shares of common
stock at the weighted average prices of $4.10, $4.61 and $11.87 per share
were outstanding during 1997, 1996 and 1995, respectively, but were not
included in the computation of diluted net income or loss per share because
the options' exercise prices were greater than the annual average market
price of the common stock, and would have an anti-dilutive effect on the net
loss per share calculation.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash investments,
short-term investments and trade receivables. The Company has investment
policies that limit most investments to short-term low risk instruments.
The Company provides credit, in the normal course of business to a
limited number of financial institutions. The Company performs ongoing credit
evaluations of its customers and maintains an allowance for potential credit
risk.
CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid investments including treasury
bills and money market fund investments purchased with an original maturity
of three months or less to be cash equivalents.
The Company classifies its investments pursuant to the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". Debt and marketable securities
are classified in one of three categories: trading, available-for-sale, or
held to maturity. The Company has no investment securities held for
"trading". Securities classified as "available-for-sale" are primarily
investment grade municipal and corporate bonds, amounting to $16.4 million
and $15.1
23
million as of December 31, 1997 and December 31, 1996, respectively, and
recorded at fair value. Unrealized holding gains and losses, if any, net of
the related tax effect, are reported as a separate component of shareholders
equity until realized. At December 31, 1997 and 1996, amortized cost was
approximately equal to fair value for these securities.
FOREIGN CURRENCY TRANSLATION
The functional currency of foreign operations is deemed to be the local
country's currency. Consequently, assets and liabilities of the Company's
foreign operations are translated at each balance sheet date into United
States dollars using exchange rates in effect at that date in accordance with
Statement of Financial Accounting Standards No. 52. Income and expenses of
the foreign operations are translated at average exchange rates for the
period. Company revenues and corresponding receivables are typically U.S.
dollar denominated and therefore are not impacted by translation adjustments.
The effects of foreign currency translation adjustments are included as a
component of shareholders' equity.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. The cost of equipment and
furniture and fixtures is depreciated using the straight-line method over the
estimated useful lives of the assets, ranging from three to five years.
Betterments, renewals and extraordinary repairs that extend the life of the
asset are capitalized; other repairs and maintenance are expensed. Leasehold
improvements are amortized using the straight-line method over the lesser of
the remaining term of the lease or the estimated economic life of the
improvement. The cost and accumulated depreciation applicable to assets
retired are removed from the accounts and the gain or loss on disposition
recognized in income.
ACCOUNTING FOR STOCK BASED COMPENSATION
The Company has two stock option plans which reserve shares of common
stock for issuance to executives, key employees, consultants and directors.
The Company accounts for stock-based compensation under the provisions of
Accounting Board Opinion No. 25 "Accounting for Stock Issued to Employees"
("APB 25"). The exercise price of options granted under these plans is equal
to the market price of the Company's stock on the date of grant, and
accordingly, no compensation cost is recorded under APB 25. The Company has
adopted the disclosure only provisions of Statement of Financial Accounting
Standards No. 123 "Accounting for Stock-Based Compensation," effective
January 1, 1996. Note 5 of the Consolidated Financial Statements contains a
summary of the pro forma effects to reported net income and earnings per
share for 1997 and 1996 as if the Company had elected to recognize
compensation expense based upon the fair value of the options granted at
grant date as prescribed by SFAS No. 123.
RECLASSIFICATIONS
Certain reclassifications have been made to 1996 and 1995 amounts to
conform to the current year presentation. These classifications did not
change the previously reported net income/(loss), total assets or total cash
flows of the Company for those years.
24
NEW ACCOUNTING STANDARDS
In 1997, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 129, "Disclosure of Information About Capital Structure." SFAS
No. 129 requires companies to disclose certain information about their
capital structure. SFAS No. 129 did not have a material impact on the
Company's consolidated financial statement disclosures.
In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income," which will be adopted by the
Company in the first quarter of 1998. SFAS No. 130 requires companies to
report a new, additional measure of income on the income statement or to
create a new financial statement that has the new measure of income on it.
"Comprehensive Income" is to include foreign currency translation gains and
losses and other unrealized gains and losses that have been previously
excluded from net income or loss and reflected instead in equity. The
Company anticipates that SFAS No.130 will not have a material impact on the
Company's consolidated financial statements.
In 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which will be adopted by the Company in
the 1998 annual consolidated financial statements. SFAS No. 131 requires
companies to report financial and descriptive information about its
reportable operating segments, including segment profit or loss, certain
specific revenue and expense items and segment assets as well as information
about revenues derived from the Company's products and services, the
countries in which the Company earns revenues and holds assets and major
customers. The Company currently provides much of this information in its
current consolidated financial statements and anticipates that SFAS No. 131
will not have a material impact on the Company's consolidated financial
statements.
In 1997, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position
("SOP") 97-2, "Software Revenue Recognition," which will be adopted by the
Company in the first quarter of 1998. SOP 97-2 provides guidance on applying
generally accepted accounting principles in recognizing revenue on software
transactions. The Company anticipates that SOP 97-2 will not have a material
impact on the Company's consolidated financial statements.
3. ACQUISITIONS:
On February 13, 1996, the Company completed the acquisition of all the
outstanding common stock of LORGB. The purchase price of approximately $8.2
million included an issuance of 578,651 shares of the Company's common stock,
approximately $3.3 million in cash and the assumption of options to purchase
approximately 167,000 shares of the Company's common stock. The acquisition
has been recorded using the purchase method of accounting. The aggregate
purchase price has been allocated to the acquired assets and liabilities of
LORGB, of which the net tangible assets were not significant. The allocation
resulted in $8,044,000 allocated to purchased technology, $7,066,000 of which
represented in process research and development. The $7,066,000 was expensed
in the accompanying statements of operations as the technology had not yet
reached technological feasibility and does not have alternative future uses.
The capitalized amount of $977,000 is included in "Purchased software" in the
accompanying balance sheets and is amortized over four years.
25
The following unaudited pro forma results of operations assume the
acquisition occurred as of January 1, 1995 (in thousands, except per share
amounts):
Year Ended December 31, 1996 1995
----------------------- ------- -------
Revenues . . . . . . . . . . . . . . . . . . . . . . $20,254 $25,006
Net income (loss). . . . . . . . . . . . . . . . . . (6,664) 2,884
Income (loss) per share. . . . . . . . . . . . . . . (1.01) 0.43
In the third quarter of 1997, the Company acquired the rights to the
software technology of International Risk Control, Inc. ("IRC") for $585,000
in cash. The Company funded additional development of the software acquired
and released a version of C-ATS FX in late 1997.
4. COMMITMENTS:
The Company and its subsidiaries lease facilities under certain
noncancellable lease agreements accounted for as operating leases with future
minimum rental payments as follows:
Amount
Year Ending December 31, (in thousands)
------------------------ --------------
1998 . . . . . . . . . . . . . . . . . . . . . . . . $888
1999 . . . . . . . . . . . . . . . . . . . . . . . . 707
2000 . . . . . . . . . . . . . . . . . . . . . . . . 641
2001 . . . . . . . . . . . . . . . . . . . . . . . . 246
------
$2,482
------
------
Total rental expense was approximately $974,000, $1,061,000 and $898,000
for the years ended December 31, 1997, 1996 and 1995, respectively.
5. COMMON STOCK:
As of December 31, 1997, the Company had reserved shares of its common
stock for the following outstanding commitments of both current and available
future unexercised grants and stock issues under the plans:
Number
of Shares
-----------
1988 Incentive Stock Plan. . . . . . . . . . . . . . 324,250
1995 Stock Plan. . . . . . . . . . . . . . . . . . . 2,386,962
1995 Employee Stock Purchase Plan. . . . . . . . . . 125,071
1995 Director Option Plan. . . . . . . . . . . . . . 105,000
-----------
2,941,283
-----------
-----------
1988 INCENTIVE STOCK PLAN
The Company's 1988 Incentive Stock Plan (the "1988 Plan") provided for
the grant of incentive stock options to employees of the Company, and for the
grant of nonstatutory stock options or stock purchase rights to employees and
consultants of the Company. The exercise price of all incentive stock options
granted under the 1988 Plan are at least equal to the fair market value (as
determined by the Board of Directors) of the
26
common stock on the date of grant, subject to subsequent repricing actions.
The exercise price of all nonstatutory stock options granted under the 1988
Plan is required to be at least 85% of the fair market value of the common
stock on the date of grant. The term of options granted under the 1988 Plan
shall be ten years for an incentive stock option and ten years and one day
for a nonstatutory stock option
As of November 7, 1996, the Board of Directors authorized a repricing of
the 1988 Plan. All stock options granted under the Plan with an option
exercise price greater than 85% of the fair market value of the Company's
stock on November 7, 1996 were repriced. There were 85,292 stock options
under the 1988 Plan with an exercise prices of $5.00 - $8.00 that were
canceled and repriced at an exercise price of $4.69. No further grants will
be made under this plan.
Option activity under the 1988 Plan was as follows:
Options
Available Number Weighted
for Grant of Shares Range Average
------------ --------- -------------- ---------
Balance, December 31, 1994. . . . . 139,168 988,417 $0.10 - $5.00 $1.74
-------- -------- ------------- -----
Granted . . . . . . . . . . . . . (120,242) 120,242 $3.10 - $8.00 $5.24
Canceled. . . . . . . . . . . . . 169,758 (169,758) $0.70 - $8.00 $3.79
Exercised . . . . . . . . . . . . -- (335,903) $0.10 - $8.00 $1.49
-------- -------- ------------- -----
Balance, December 31, 1995. . . . . 188,684 602,998 $0.10 - $8.00 $2.03
-------- -------- ------------- -----
Granted . . . . . . . . . . . . . -- -- -- --
Canceled. . . . . . . . . . . . . 64,555 (64,555) $1.00 - $8.00 $3.88
Exercised . . . . . . . . . . . . -- (178,430) $0.10 - $8.00 $0.90
Repriced grants . . . . . . . . . (85,292) 85,292 $4.69 $4.69
Repriced canceled . . . . . . . . 85,292 (85,292) $5.00 - $8.00 $5.58
-------- -------- ------------- -----
Balance, December 31, 1996. . . . . 253,239 360,013 $0.20 - $4.69 $2.03
-------- -------- ------------- -----
Granted . . . . . . . . . . . . . -- -- -- --
Canceled. . . . . . . . . . . . . 11,469 (11,469) $0.70 - $4.69 $4.41
Exercised . . . . . . . . . . . . -- (24,294) $0.70 - $4.69 $1.56
-------- -------- ------------- -----
Balance, December 31, 1997. . . . . 264,708 324,250 $0.20 - $4.69 $2.00
-------- -------- ------------- -----
-------- -------- ------------- -----
At December 31, 1997, options to purchase 313,717 shares were
exercisable at a weighted average share price of $1.91 under the 1988 Plan.
1995 STOCK PLAN
In January 1995, the Company adopted the 1995 Stock Plan (the "1995
Plan"). The Company had initially reserved 500,000 common shares for issuance
under the 1995 Plan and in May 1996 and again in May 1997, shareholders
approved 1,000,000 additional shares to the 1995 Plan. Under the 1995 Plan,
the Company may grant incentive stock options or grant nonstatutory stock
options and stock purchase rights (SPR) to employees, officers and
consultants. Nonqualified options and SPRs granted under the 1995 Plan have a
term of ten years and will be issued at a price determined by the Company's
Board of Directors at the date of grant. Incentive stock options granted
under the 1995 Plan may be granted only to employees of the Company, may have
a term of up to ten years, and must be issued at a price equal to the fair
market value of the Company's common stock at the date of grant.
As of November 7, 1996, the Board of Directors authorized a repricing
of the 1995 Plan. All stock options granted under the Plan with an option
exercise price greater than 85% of the fair market value of the
27
Company's stock on November 7, 1996 were repriced. There were 699,100 stock
options under the 1995 Plan with an exercise prices of $5.50-$12.00 that were
canceled and repriced at an exercise price of $4.69.
Option activity under the 1995 Plan was as follows:
Options
Available Number Weighted
for Grant of Shares Range Average
---------- --------- -------------- --------
Balance, January 1, 1995. . . . . . 500,000 -- -- --
Authorized. . . . . . . . . . . . 1,000,000 -- -- --
Granted . . . . . . . . . . . . . (397,000) 397,000 $6.88 -$12.00 $8.09
Canceled. . . . . . . . . . . . . 5,937 (5,937) $11.75 -$12.00 $11.83
Exercised . . . . . . . . . . . . -- -- -- --
---------- --------- -------------- ------
Balance, December 31,1995 . . . . . 1,108,937 391,063 $6.88 - $12.00 $8.03
---------- --------- -------------- ------
Granted . . . . . . . . . . . . . (1,032,200) 1,032,200 $4.69 - $7.13 $5.52
Granted (LORGB assumed options) . (167,861) 167,861 $0.08 - $0.16 $0.08
Canceled. . . . . . . . . . . . . 202,020 (202,020) $4.69 - $12.00 $6.96
Exercised . . . . . . . . . . . . -- (42) $7.13 $7.13
Repriced grants . . . . . . . . . (699,100) 699,100 $4.69 $4.69
Repriced canceled . . . . . . . . 699,100 (699,100) $5.50 - $12.00 $7.02
---------- --------- -------------- ------
Balance, December 31, 1996. . . . . 110,896 1,389,062 $0.08 - $4.69 $4.13
---------- --------- -------------- ------
Authorized. . . . . . . . . . . . 1,000,000 -- -- --
Granted . . . . . . . . . . . . . (650,500) 650,500 $4.25 -$8.00 $5.53
Canceled. . . . . . . . . . . . . 327,684 (327,684) $4.25 -$7.13 $4.58
Exercised . . . . . . . . . . . . -- (112,996) $0.08 -$4.87 $2.97
---------- --------- -------------- ------
Balance, December 31, 1997. . . . . 788,080 1,598,882 $0.08 - $8.00 $4.69
---------- --------- -------------- ------
---------- --------- -------------- ------
At December 31, 1997, options to purchase 517,638 shares were
exercisable at a weighted average share price of $3.63 under the 1995 Plan.
1995 EMPLOYEE STOCK PURCHASE PLAN
In January 1995, the Company adopted the 1995 Employee Stock Purchase
Plan and reserved 200,000 shares of the Company's common stock for issuance
under this plan. Under the terms of this plan, the Company allows eligible
employees to purchase shares of common stock at 85% of the lower of the fair
market value of the common stock at the beginning or at the end of each
offering period. Offering periods under this plan will commence on January 1
and July 1 of each year and end on June 30 and December 31, respectively.
The first offering commenced on July 3, 1995. During 1995, 19,007 shares
were subscribed under the plan and issued on January 1, 1996 at an average
purchase price of $6.06 per share. During 1996, 15,055 and 20,815 shares were
subscribed under the plan and issued on July 1, 1996 and January 1, 1997 at
average purchase prices of $5.10 and $4.375 per share, respectively. During
1997, 20,052 and 22,971 shares were subscribed under the plan and issued on
July 1, 1997 and January 1, 1998 at purchase prices of $3.72 and $4.04 per
share, respectively.
1995 DIRECTOR OPTION PLAN
In January 1995, the Company adopted the 1995 Director Option Plan. The
Company has authorized 105,000 shares of the Company's common stock for
issuance under the 1995 Director Option Plan, and 80,000
28
options were granted under this plan at an exercise price of $8.00 per share.
Options must be issued at the fair market value of the Company's common stock
at date of grant, have a term of ten years and vest 33% each year following
the date of grant. At December 31, 1997, options to purchase 60,000 shares
were exercisable at $8.00 per share under the 1995 Director Option Plan.
During 1997, options to purchase 20,000 shares were canceled under the
Director Option Plan.
OPTION FAIR VALUE
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation," issued in
October 1995. In accordance with the provisions of SFAS No. 123, the
Company applies Opinion 25 and related interpretations in accounting for its
stock option plans and, accordingly, does not recognize compensation cost as
the exercise price equals the fair value of common stock at the date of
grant. If the Company had elected to recognize compensation cost based on
the fair value of the options granted at grant date as prescribed by SFAS No.
123, net income (loss) and income (loss) per share would have been changed to
the pro forma amounts indicated in the table below.
1997 1996 1995
------------- ------------- -------------
(in thousands, except per share amounts)
------------------------------------------
Net income (loss) - as reported. . . . . . . . . . . . . . . $ (2,581) $ (6,197) $ 3,485
Net income (loss) - pro forma. . . . . . . . . . . . . . . . $ (3,994) $ (6,985) $ 3,309
Basic income (loss) per share - as reported. . . . . . . . . $ (0.38) $ (0.95) $ 0.64
Basic income (loss) per share - pro forma. . . . . . . . . . $ (0.59) $ (1.07) $ 0.61
Diluted income (loss) per share - as reported. . . . . . . . $ (0.38) $ (0.95) $ 0.57
Diluted income (loss) per share - pro forma. . . . . . . . . $ (0.59) $ (1.07) $ 0.55
The fair value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions: a
weighted average risk-free interest rate of 5.80% corresponding to government
securities with original maturities similar to the estimated option life of
approximately one year beyond vest date; annual volatility of the Company's
stock price of 65%; and a dividend yield of 0.0%. The effects of applying
the provisions of SFAS No. 123 are not likely to be representative of the
effects on the pro forma net income (loss) in future years. The weighted
average of fair values of options granted during 1997 and 1996 were
approximately $2.34 for both years. The options outstanding and exercisable
under all option plans are as follows:
Options Outstanding at December 31, 1997 Options exercisable at December 31, 1997
---------------------------------------------- ------------------------------------------------
Weighted Number Weighted
Number Weighted Average Exercisable as of Average
Range of of Shares Average Remaining December 31, Exercise
Exercise Price Outstanding Exercise Price Contract Life 1997 Price
-------------- ------------ --------------- ------------- ----------------- ---------
$0.08 - $2.00 322,132 $0.46 4.44 321,077 $0.46
$2.01 - $4.00 53,146 $3.00 6.07 52,302 $3.00
$4.01 - $6.00 1,378,854 $4.81 8.72 451,601 $4.69
$6.01 - $8.00 249,000 $7.16 7.78 66,375 $7.84
------------- --------- ----- ---- ------- -----
$0.08 - $8.00 2,003,132 $4.35 7.84 891,355 $3.30
------------- --------- ----- ---- ------- -----
------------- --------- ----- ---- ------- -----
29
6. INCOME TAXES:
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." This
statement provides for a liability approach under which deferred income taxes
are provided based upon enacted tax laws and rates applicable to the periods
in which the taxes become payable.
The provision for income taxes consisted of the following components for
the years ended December 31 (in thousands):
1997 1996 1995
-------- --------- --------
Current provision:
Federal. . . . . . . . . . . . . . $ --- $ --- $ 1,034
State and local. . . . . . . . . . --- --- 312
Foreign. . . . . . . . . . . . . . 936 902 1,004
-------- --------- --------
936 902 2,350
Deferred benefit:
Federal. . . . . . . . . . . . . . (865) (818) (426)
State and local. . . . . . . . . . . . (71) (84) (47)
-------- --------- --------
(936) (902) (473)
Total provision for income taxes . . . . $ --- $ --- $ 1,877
-------- --------- --------
-------- --------- --------
The provision for income taxes for the years ended December 31, 1997,
1996 and 1995 differs from the amount obtained by applying the statutory
Federal income tax rate to income before taxes as follows (in thousands):
1997 1996 1995
------- --------- --------
Federal tax expense (benefit) at statutory rate. . . . . . $ (903) $ (2,169) $ 1,877
State income taxes, net of Federal benefit . . . . . . . . (351) -- 166
Foreign income taxes incurred. . . . . . . . . . . . . . . 761 902 799
Foreign tax credits utilized . . . . . . . . . . . . . . . (761) (818) (763)
Change in valuation allowance. . . . . . . . . . . . . . . 1,925 (171) ---
FSC benefit. . . . . . . . . . . . . . . . . . . . . . . . -- -- (73)
Non-deductible write-off of in-process research and development -- 2,473 --
Tax credits. . . . . . . . . . . . . . . . . . . . . . . . (630) (234) (137)
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . (41) 17 8
------- --------- --------
Total provision for income taxes . . . . . . . . . . . . . . $ -- $ -- $ 1,877
------- --------- --------
------- --------- --------
30
The components of the net deferred tax asset at December 31, 1997 and
1996 are as follows (in thousands):
1997 1996
------ -------
Revenue deferred for financial reporting purposes. . $3,087 $3,156
Items not currently deductible for tax purposes. . . 501 171
Foreign tax credits. . . . . . . . . . . . . . . . . 761 --
General business credits . . . . . . . . . . . . . . 909 --
Net operating loss carryforward. . . . . . . . . . . 931 --
------ -------
6,189 3,327
Valuation allowance. . . . . . . . . . . . . . . . . (3,582) (1,657)
------ -------
Net deferred tax asset . . . . . . . . . . . . . . . $2,607 $1,670
------ -------
------ -------
For income tax reporting purposes, the Company has Federal and State net
operating loss carryforwards of approximately $2,500,000 and $1,000,000,
respectively, and Federal and State research and development tax credit
carryforwards of approximately $110,000 and $124,000, respectively, all of
which will expire on various dates through 2012. The Internal Revenue Code
contains provisions which may limit the amount of tax carryforwards available
to be used in any given year upon the occurrence of certain events, including
changes in ownership interests. Due to certain limitations of the benefits
related to tax carrybacks, the current year operating loss and the
uncertainty of future results, the Company has provided a valuation allowance
related to a portion of the deferred tax asset.
The Company's tax returns for 1990 through 1993 are currently being
examined by the Internal Revenue Service ("IRS") which has issued a notice of
assessment related to its position on foreign tax credits related to foreign
withholding taxes on the Company's software license revenue. If the IRS
position were to prevail in full, the net tax cost for this assessment at
December 31, 1997 would be approximately $2.3 million, excluding interest and
penalties. The Company is currently seeking competent authority relief,
which, if successful, will eliminate any potential double taxation. In
management's opinion the ultimate resolution of this matter will not have a
material adverse effect on the results of operations.
31
7. WORLDWIDE OPERATIONS:
The Company operates in a single industry segment and has wholly-owned
foreign subsidiaries in the United Kingdom and Switzerland that conduct sales
representative activities in Europe and a wholly-owned subsidiary that
conducts sales representative activities in Japan. All license agreements are
entered into between the parent company and the clients, and all license and
service fees are paid directly to the parent company in U.S. dollars. United
States operations include revenue and results of operations in the United
States as well as export revenue from all clients recognized on a worldwide
basis. Subsidiary revenues consist solely of payments from the parent company
for services performed for the benefit of the parent company at a rate of
cost plus 10%. Such transfers are eliminated in the consolidated financial
statements. Identifiable assets are those assets that can be directly
associated with a particular geographic area and subsidiary. The Company's
operations by geographic area were as follows (in thousands):
1997 1996 1995
-------- -------- --------
Revenue:
United States . . . . . . . . . . . . . . . . . . . . $ 18,454 $ 20,145 $ 22,298
United Kingdom. . . . . . . . . . . . . . . . . . . . 2,784 2,405 2,050
Japan . . . . . . . . . . . . . . . . . . . . . . . . 1,954 1,723 2,059
Switzerland . . . . . . . . . . . . . . . . . . . . . 288 450 798
Eliminations. . . . . . . . . . . . . . . . . . . . . $(5,026) $(4,578) $(4,907)
-------- -------- ---------
Consolidated. . . . . . . . . . . . . . . . . . . . . . . $ 18,454 $ 20,145 $ 22,298
-------- -------- ---------
-------- -------- ---------
Operating income/(loss):
United States . . . . . . . . . . . . . . . . . . . . (3,952) (7,377) 4,000
United Kingdom. . . . . . . . . . . . . . . . . . . . 186 162 190
Japan . . . . . . . . . . . . . . . . . . . . . . . . 173 117 134
Switzerland . . . . . . . . . . . . . . . . . . . . . 52 38 107
-------- -------- ---------
Consolidated. . . . . . . . . . . . . . . . . . . . . . . $ (3,541) $ (7,060) $ 4,431
-------- -------- ---------
-------- -------- ---------
1997 1996 1995
-------- -------- ---------
Identifiable assets:
United States . . . . . . . . . . . . . . . . . . . . $ 29,816 $ 32,079 $ 37,418
United Kingdom. . . . . . . . . . . . . . . . . . . . 796 1,048 1,045
Japan . . . . . . . . . . . . . . . . . . . . . . . . 610 587 560
Switzerland . . . . . . . . . . . . . . . . . . . . . 102 79 79
Eliminations. . . . . . . . . . . . . . . . . . . . . (684) (794) (602)
-------- -------- ---------
Consolidated. . . . . . . . . . . . . . . . . . . . . . . $ 30,640 $ 32,999 $ 38,500
-------- -------- ---------
-------- -------- ---------
The Company's export sales to unaffiliated non-U.S. customers are as
follows (in thousands):
1997 1996 1995
-------- -------- ---------
Japan . . . . . . . . . . . . . . . . . . . . . . . . $ 6,269 $ 7,269 $ 7,468
United Kingdom. . . . . . . . . . . . . . . . . . . . 3,722 3,915 4,006
Europe, excluding United Kingdom. . . . . . . . . . . 3,472 3,571 4,460
Other . . . . . . . . . . . . . . . . . . . . . . . . 1,861 1,671 1,864
-------- -------- ---------
$ 15,324 $ 16,426 $ 17,798
-------- -------- ---------
-------- -------- ---------
Sales to a major client accounted for 10% of revenues in 1995. No major
client accounted for more than 10% of revenues in 1997 or 1996.
32
********************************************************************************
STOCK The Company's common stock is traded on the Nasdaq National
TRADING Market under the symbol CATX. C-ATS Software Inc. completed
INFORMATION its initial public offering on March 20, 1995. The quarterly
high and low bid prices over the past eight quarters were as
follows
High Low
-------- -------
Fiscal 0000
Xxxxxx Xxxxxxx 5 7/8 5
Third Quarter 7 1/4 4 1/2
Second Quarter 5 1/8 4 1/8
First Quarter 5 3/4 4 3/8
Fiscal 0000
Xxxxxx Xxxxxxx 5 1/8 4 3/8
Third Quarter 6 1/4 4 7/8
Second Quarter 7 1/2 5 5/8
First Quarter 7 7/8 6 1/8
BID PRICE QUOTATIONS ARE AS REPORTED BY THE NATIONAL ASSOCIATION OF SECURITY
DEALERS, INC. ALL BID PRICES REFLECT INTERDEALER PRICES, WITHOUT RETAIL MARKUP,
MARKDOWN, OR COMMISSION AND MAY NOT REPRESENT ACTUAL TRANSACTIONS.
AS OF MARCH 2, 1998, THERE WERE APPROXIMATELY 750 SHAREHOLDERS OF RECORD OF
COMMON STOCK OF THE COMPANY. C-ATS SOFTWARE INC. HAS NEVER PAID DIVIDENDS AND
HAS NO PRESENT PLANS TO DO SO. ON MARCH 2, 1998, THE CLOSING BID PRICE WAS
$4.688 PER SHARE.
********************************************************************************
33
