1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarterly Period Ended May 31, 1997 OR [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Commission File Number: 0-19417 PROGRESS SOFTWARE CORPORATION (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2746201 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 14 Oak Park Bedford, Massachusetts 01730 (Address of principal executive offices) Telephone Number: (617) 280-4000 -------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and, (2) has been subject to such filing requirements for the past 90 days: Yes X No ----- ----- As of July 9, 1997, there were 11,462,796 shares of the Registrant's Common Stock, $.01 par value per share, outstanding. ================================================================================
2 PROGRESS SOFTWARE CORPORATION FORM 10-Q FOR THE THREE MONTHS ENDED MAY 31, 1997 TABLE OF CONTENTS Page PART I. FINANCIAL INFORMATION ITEM 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets as of May 31, 1997 and November 30, 1996 3 Condensed Consolidated Statements of Income for the three and six months ended May 31, 1997 and May 31, 1996 4 Condensed Consolidated Statements of Cash Flows for the six months ended May 31, 1997 and May 31, 1996 5 Notes to Condensed Consolidated Financial Statements 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 14 ITEM 4. Submission of Matters to a Vote of Security Holders 15 ITEM 6. Exhibits and Reports on Form 8-K 16 Signatures 17 2
3 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS PROGRESS SOFTWARE CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) (Unaudited) <TABLE> <CAPTION> May 31, 1997 November 30, 1996 ------------ ----------------- <S> <C> <C> ASSETS Current assets: Cash and equivalents .................................. $ 25,086 $ 30,872 Short-term investments ................................ 70,873 66,451 Accounts receivable (less allowance for doubtful accounts of $5,275 in 1997 and $5,112 in 1996) ...... 30,863 34,452 Inventories ........................................... 1,363 1,257 Other current assets .................................. 8,020 4,367 Deferred income taxes ................................. 3,722 3,552 -------- -------- Total current assets .......................... 139,927 140,951 -------- -------- Property and equipment-net .............................. 23,027 24,230 Capitalized software costs-net .......................... 5,616 5,428 Other assets ............................................ 2,242 2,579 -------- -------- Total ......................................... $170,812 $173,188 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt ..................... $ -- $ 37 Accounts payable ...................................... 7,402 7,989 Accrued compensation and related taxes ................ 12,333 12,385 Income taxes payable .................................. 2,018 3,004 Other current liabilities ............................. 7,385 5,964 Deferred revenue ...................................... 33,068 27,365 -------- -------- Total current liabilities ..................... 62,206 56,744 -------- -------- Deferred income taxes ................................... 2,382 2,345 Long-term debt .......................................... -- 85 Minority interest in subsidiary ......................... 528 221 Commitments and contingency Shareholders' equity: Preferred stock, $.01 par value; authorized, 1,000,000 shares; issued, none Common stock, $.01 par value; authorized, 50,000,000 shares in 1997 and 20,000,000 shares in 1996; issued and outstanding, 11,985,142 shares in 1997 and 12,632,630 shares in 1996 ..................................... 120 126 Additional paid-in capital ............................ 29,692 41,309 Retained earnings ..................................... 76,300 72,280 Unrealized gain on short-term investments ............. 102 241 Cumulative translation adjustments .................... (518) (163) -------- -------- Total shareholders' equity .................... 105,696 113,793 -------- -------- Total ......................................... $170,812 $173,188 ======== ======== </TABLE> See notes to condensed consolidated financial statements. 3
4 PROGRESS SOFTWARE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended May 31, Six Months Ended May 31, -------------------------- ------------------------ 1997 1996 1997 1996 ------- ------ ------- ------ <S> <C> <C> <C> <C> Revenue: Software licenses ...................... $22,975 $20,730 $47,616 $49,723 Maintenance and support services ....... 21,856 20,932 42,559 40,321 ------- ------- ------- ------- Total revenue .................. 44,831 41,662 90,175 90,044 ------- ------- ------- ------- Costs and expenses: Cost of software licenses .............. 2,388 2,231 4,737 4,581 Cost of maintenance and support services 7,222 7,008 14,180 14,010 Sales and marketing .................... 21,364 22,083 42,922 44,007 Product development .................... 6,776 5,866 13,181 11,891 General and administrative ............. 5,698 5,263 11,576 10,489 ------- ------- ------- ------- Total costs and expenses ....... 43,448 42,451 86,596 84,978 ------- ------- ------- ------- Income (loss) from operations ............ 1,383 (789) 3,579 5,066 ------- ------- ------- ------- Other income (expense): Interest income ........................ 1,043 992 1,918 1,941 Interest expense ....................... (3) (1) (7) (6) Foreign currency gain (loss) ........... 471 (4) 283 (303) Minority interest ...................... 182 87 296 256 Other income (expense) ................. 19 (49) 22 (23) ------- ------- ------- ------- Total other income ............. 1,712 1,025 2,512 1,865 ------- ------- ------- ------- Income before provision for income taxes . 3,095 236 6,091 6,931 Provision for income taxes ............... 1,053 81 2,071 2,357 ------- ------- ------- ------- Net income ............................... $ 2,042 $ 155 $ 4,020 $ 4,574 ======= ======= ======= ======= Income per common share .................. $ 0.16 $ 0.01 $ 0.31 $ 0.34 ======= ======= ======= ======= Weighted average number of common and common equivalent shares outstanding ... 13,002 13,121 12,946 13,445 ======= ======= ======= ======= </TABLE> See notes to condensed consolidated financial statements. 4
5 PROGRESS SOFTWARE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) <TABLE> <CAPTION> Six Months Ended May 31, ----------------------- 1997 1996 -------- -------- <S> <C> <C> Cash flows from operating activities: Net income .............................................. $ 4,020 $ 4,574 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization of property and equipment 5,379 4,590 Amortization of capitalized software costs ............ 1,069 805 Amortization of intangible assets ..................... 138 176 Deferred income taxes ................................. (183) 78 Minority interest in subsidiary ....................... (296) (256) Noncash compensation .................................. 16 1 Changes in operating assets and liabilities: Accounts receivable .................................. 2,076 7,128 Inventories .......................................... (109) 226 Other current assets ................................. (3,849) (303) Accounts payable and accrued expenses ................ 1,623 (5,934) Income taxes payable ................................. (622) 713 Deferred revenue ..................................... 7,145 2,064 -------- -------- Total adjustments .................................. 12,387 9,288 -------- -------- Net cash provided by operating activities .......... 16,407 13,862 -------- -------- Cash flows from investing activities: Purchases of investments available for sale ............. (15,475) (38,731) Maturities of investments available for sale ............ 1,075 13,313 Sales of investments available or sale .................. 9,839 19,895 Purchase of property and equipment ...................... (4,646) (5,616) Capitalized software costs .............................. (1,257) (1,217) Increase in other noncurrent assets ..................... 131 (412) -------- -------- Net cash used for investing activities ............. (10,333) (12,768) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock .................. 2,455 1,462 Repurchase of common stock .............................. (14,396) (3,778) Contributions from minority interest .................... 603 -- Payment of obligations under capital leases ............. (116) (39) -------- -------- Net cash used for financing activities ............. (11,454) (2,355) -------- -------- Effect of exchange rate changes on cash ................... (406) (174) -------- -------- Net decrease in cash and equivalents ...................... (5,786) (1,435) Cash and equivalents, beginning of period ................. 30,872 33,465 -------- -------- Cash and equivalents, end of period ....................... $ 25,086 $ 32,030 ======== ======== Supplemental disclosure of noncash financing activities: Income tax benefit from employees' exercise of stock options .......................................... $ 302 $ 168 ======== ======== </TABLE> See notes to condensed consolidated financial statements 5
6 PROGRESS SOFTWARE CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared by Progress Software Corporation (the Company) pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the audited financial statements included in the Company's Annual Report and Form 10-K for the fiscal year ended November 30, 1996. In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited financial statements, and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results to be expected for the full fiscal year. 2. Income Per Common Share Income per common share is computed on a fully-diluted basis using the weighted average number of common and common equivalent shares outstanding during each period presented. 3. Inventories Inventories are stated at the lower of cost (first-in, first-out) or market and are comprised of product media, documentation, and packaging. 4. Income Taxes The Company provides for income taxes at the end of each interim period based on the estimated effective tax rate for the full fiscal year. Cumulative adjustments to the tax provision are recorded in the interim period in which a change in the estimated annual effective rate is determined. 5. Contingency and Litigation The Company's 401(k) Plan has approximately $900,000 in Guaranteed Investment Contracts (GICs) issued by Mutual Benefit Life Insurance Company (MBLI). On July 16, 1991, the Insurance Commissioner of the State of New Jersey took possession and control of MBLI's assets. In April 1994, a rehabilitation plan was approved by the Superior Court of New Jersey. Pursuant to the rehabilitation plan, the GICs are supported by a group of life insurance companies and are paid out from the assets of MBL Life Assurance Corporation, the successor to MBLI. On May 23, 1997, the Company initiated a process to purchase the GICs from the 401(k) Plan to enable participants to choose other investment vehicles prior to the end of the rehabilitation plan. The purchase transaction requires the approval of the Department of Labor and the Internal Revenue Service. Assuming no objection or other impediment to the transaction, the Company expects the purchase transaction to be completed before the end of the Company's current fiscal year and not to have a material effect on the Company's consolidated financial position or results of operations. The Company is a defendant in litigation entitled NEWSTAR TECHNOLOGIES INC. V. PROGRESS SOFTWARE CORPORATION of Canada Ltd. and Progress Software Corporation, No. 97-CU-121571, pending in the Ontario (Canada) Court of Justice (General Division), commenced April 4, 1997. Newstar claims that the 6
7 Company entered into a contract with it under which Newstar was entitled to purchase the Company's software and receive product support from the Company under specific terms which differ substantially from the Company's standard terms and conditions. The purported contract cited by Newstar was prepared by Newstar and executed by a lower-level Company salesperson in the name of a Company sales executive followed by the initials of the salesperson. The Company denies the existence of a binding contract, on various grounds, including that the salesperson did not have the authority to sign the sales executive's name and that Newstar knew or should have known of that fact. Newstar seeks (a) an injunction mandating that the Company comply with the terms of the purported contract, (b) a declaration that the purported contract is of full force and effect, (c) an order restraining the Company from terminating the purported contract, (d) damages of $200 million, (e) special damages of an unstated amount, (f) punitive damages of $20 million, (g) costs of the litigation, and (h) such other and further relief as the court deems just. The evidence offered by the plaintiff to date does not support its claims. Newstar moved for a preliminary injunction; however, that motion was stayed by agreement to allow the parties to participate in voluntary non-binding mediation which took place on July 7, 1997. During this session a tentative settlement was reached which the parties anticipate will be finalized in the near future. Pursuant to such settlement, Newstar will become an Application Partner of the Company under mutually acceptable terms and conditions reasonably consistent with arrangements entered into with other Application Partners. If, for any reason, the settlement is not finalized, the Company will defend the action vigorously. Naf Naf S.A. commenced an expert proceeding in the Paris Trade Court, Paris, France, against Progress Software S.A., Timeless S.A. and Digital Equipment France in May 1996. In June 1997, Naf Naf petitioned the court to add Progress Software Corporation as a party to the expert proceeding, which petition has been granted. The basis of the proceeding is alleged late availability of Progress Software products and alleged product deficiencies after delivery by Timeless to Naf Naf of such products. At this time, no specific damage claim has been formally filed under French legal proceeding rules with the court. The Company intends to vigorously defend itself in this proceeding. While the outcome of this claim cannot be predicted with certainty, management does not believe that the outcome will have a material adverse effect on the Company's consolidated financial position or results of operations. The Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company's consolidated financial position or results of operations. 6. New Accounting Pronouncement In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS 128), "Earnings per Share." SFAS 128 establishes a different method of computing net income per share than is currently required under the provisions of Accounting Principles Board Opinion No. 15 (APB 15). Under SFAS 128, the Company will be required to present both basic net income per share and diluted net income per share. Basic net income per share for the three-month and six-month periods ended May 31, 1997 would have been $.17 and $.32 per share, respectively as compared with $.01 and $.35 per share for the corresponding periods in fiscal 1996. Diluted net income per share under SFAS 128 for these periods is not expected to be materially different from primary earnings per share under APB 15. The Company plans to adopt SFAS 128 in its first quarter of fiscal 1998 and at that time all historical net income per share data presented will be restated to conform to the provisions of SFAS 128. 7. Subsequent Event On June 27, 1997, the Company agreed to acquire Apptivity Corporation, a developer of Java-based application development tools, for a payment of approximately $3,800,000 in cash, the assumption of approximately $1,000,000 of liabilities and the issuance of approximately 400,000 shares of its common stock. The acquisition is expected to close in mid-July. The acquisition will be accounted for as a purchase and a substantial portion of the purchase price is expected 7
8 to be allocated to in-process software development costs. This non-recurring charge will be reflected in the Company's results for the third quarter ended August 31, 1997. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENTS The Private Securities Litigation Reform Act of 1995 contains certain safe harbors regarding forward-looking statements. From time to time, information provided by the Company or statements made by its directors, officers or employees may contain "forward-looking" information which involve risks and uncertainties. Actual future results may differ materially. Statements indicating that the Company "expects," "estimates," "believes," "is planning" or "plans to" are forward-looking, as are other statements concerning future financial results, product offerings or other events that have not yet occurred. There are several important factors which could cause actual results or events to differ materially from those anticipated by the forward-looking statements. Such factors, some of which are described in great detail below under the heading "Factors That May Affect Future Results," include, but are not limited to, the receipt and shipment of new orders, the timely release of enhancements to the Company's products, which could be subject to software release delays, the growth rates of certain market segments, the positioning of the Company's products in those market segments, variations in the demand for customer service and technical support, pricing pressures and the competitive environment in the software industry, consumer use of the Internet, and the Company's ability to penetrate international markets and manage its international operations. Although the Company has sought to identify the most significant risks to its business, the Company cannot predict whether, or to what extent, any of such risks may be realized nor can there be any assurance that the Company has identified all possible issues which the Company might face. RESULTS OF OPERATIONS The following table sets forth certain income and expense items as a percentage of total revenue, and the percentage change in dollar amounts of such items, for the three and six months ended May 31, 1997 and May 31, 1996. <TABLE> <CAPTION> Percentage of Total Revenue Period-to-Period Change -------------------------------------------------- ---------------------------- Three Months Ended May 31, Six Months Ended May 31, Three Months Six Months ------------------------- ----------------------- 1997 Compared 1997 Compared 1997 1996 1997 1996 to 1996 to 1996 ---- ---- ---- ---- ------------- ------------ <S> <C> <C> <C> <C> <C> <C> Revenue Software licenses 51% 50% 53% 55% 11% (4)% Maintenance and support services 49 50 47 45 4 6 --- --- --- --- Total revenue 100 100 100 100 8 0 --- --- --- --- Cost and expenses: Cost of software licenses 5 5 5 5 7 3 Cost of maintenance and support services 16 17 16 15 3 1 Sales and marketing 48 53 47 49 (3) (2) Product development 15 14 15 13 16 11 General and administrative 13 13 13 12 8 10 --- --- --- --- Total costs and expenses 97 102 96 94 2 2 --- --- --- --- Income from operations 3 (2) 4 6 275 (29) Other income 4 2 3 2 67 35 --- --- --- --- Income before provision for income taxes 7 0 7 8 1,211 (12) Provision for income taxes 2 0 2 3 1,200 (12) --- --- --- --- Net income 5% 0% 5% 5% 1,217% (12)% === === === === </TABLE> The Company's total revenue increased 8% from $41,662,000 in the second quarter of fiscal 1996 to $44,831,000 in the second quarter of fiscal 1997. The Company's total revenue of $90,175,000 in the first six months of fiscal 1997 remained relatively constant as compared to the total revenue from the comparable period of fiscal 1996. Software license revenue increased 11% from $20,730,000 in the second quarter of fiscal 1996 to $22,975,000 in 8
9 the second quarter of fiscal 1997. Software license revenue decreased 4% from $49,723,000 in the first six months of fiscal 1996 to $47,616,000 in the first six months of fiscal 1997. The increase in software license revenue in the second quarter of fiscal 1997 as compared to the period one year ago is due to greater sales of the Company's flagship product, PROGRESS Versions 7 and 8, and a slowdown in the rate of decline of PROGRESS Version 6. In addition, sales from the Company's newest product, WebSpeed, have continued to increase since its release in the fourth quarter of fiscal 1996. The decrease in software license revenue in the first six months of fiscal 1997 as compared to the period one year ago resulted from the slowdown in the Company's business which began in the second quarter of fiscal 1996. The slowdown was due primarily to increased competition and the transition some of the Company's Application Partners faced in the marketplace as they moved their applications to PROGRESS Versions 7 and 8 and WebSpeed. During the first six months of fiscal 1997, the Company entered into 105 new Application Partner agreements worldwide (29 in North America and 76 outside North America). Maintenance and support services revenue increased 4% from $20,932,000 in the second quarter of fiscal 1996 to $21,856,000 in the second quarter of fiscal 1997. Maintenance and support services revenue increased 6% from $40,321,000 in the first six months of fiscal 1996 to $42,559,000 in the first six months of fiscal 1997. The maintenance and support services revenue increase was primarily a result of growth in the Company's installed customer base, renewal of maintenance contracts and increased consulting revenues. Total revenue generated in markets outside North America increased from $25,228,000 in the second quarter of fiscal 1996 to $27,461,000 in the second quarter of fiscal 1997, but represented 61% of total revenue in each period. Total revenue generated in markets outside North America would have represented 63% of total revenue in the second quarter of fiscal 1997 if exchange rates had been constant as compared to the exchange rates in the effect in the second quarter of fiscal 1996. Total revenue generated in markets outside North America increased from $52,333,000 in the first six months of fiscal 1996 to $53,630,000 in the first six months of fiscal 1997 and increased as a percentage of total revenue from 58% in the first six months of fiscal 1996 to 59% in the first six months of fiscal 1997. Total revenue generated in markets outside North America would have represented 61% of total revenue in the first six months of fiscal 1997 if exchange rates had been constant as compared to the exchange rates in the effect in the first six months of fiscal 1996. Cost of software licenses consists primarily of cost of product media, documentation, duplication, packaging, royalties and amortization of capitalized software costs. Cost of software licenses increased 7% from $2,231,000 in the second quarter of fiscal 1996 to $2,388,000 in the second quarter of fiscal 1997, but remained approximately the same percentage of software license revenue in each period. Cost of software licenses increased 3% from $4,581,000 in the first six months of fiscal 1996 to $4,737,000 in the first six months of fiscal 1997 and increased as a percentage of software license revenue from 9% to 10%. The percentage increase was due to an increase in amortization of capitalized software costs and higher royalty expense. Cost of software licenses as a percentage of software license revenue can vary depending upon the relative product mix in a given period. Cost of maintenance and support services consists primarily of costs of providing customer technical support, education and consulting. Cost of maintenance and support services increased 3% from $7,008,000 in the second quarter of fiscal 1996 to $7,222,000 in the second quarter of fiscal 1997, but remained approximately the same percentage of maintenance and support services revenue in each period. Cost of maintenance and support services in the first six months of fiscal 1997 remained relatively constant as compared to the first six months of 1996, but decreased as a percentage of maintenance and support services revenue from 35% to 33%. The percentage decrease was due primarily to improved consulting margins in the North America consulting business and, to a lesser extent, a slight reduction in the technical support, education and consulting staff in the first six months of fiscal 1997 as compared to the first six months of fiscal 1996. The Company decreased its technical support, education, and consulting staff from 224 at May 31, 1996 to 211 at May 31, 1997. Sales and marketing expenses decreased 3% from $22,083,000 in the second quarter of fiscal 1996 to $21,364,000 in the second quarter of fiscal 1997 and decreased as a percentage of total revenue from 53% to 48%. Sales and marketing expenses decreased 2% from $44,007,000 in the first six months of fiscal 1996 to $42,922,000 in the first six months of fiscal 1997 and decreased as a percentage of total revenue from 49% to 47%. The dollar and percentage decrease in sales and marketing expenses was primarily due to a reduction of the sales, sales support and 9
10 marketing staff and, to a lesser extent, a slight reduction in the level of discretionary marketing spending. The amount of discretionary marketing expenses can vary from period to period depending on the timing of significant trade shows, advertising campaigns and direct mail solicitations. The Company's sales, sales support and marketing staff decreased from 502 at May 31, 1996 to 473 at May 31, 1997. The Company expects the level of the sales, sales support and marketing staff for the remainder of fiscal 1997 to be within the range which has prevailed over the past several quarters. Product development expenses increased 16% from $5,866,000 in the second quarter of fiscal 1996 to $6,776,000 in the second quarter of fiscal 1997 and increased as a percentage of total revenue from 14% to 15%. Product development expenses increased 11% from $11,891,000 in the first six months of fiscal 1996 to $13,181,000 in the first six months of fiscal 1997 and increased as a percentage of total revenue from 13% to 15%. The dollar and percentage increases were due primarily to higher average personnel costs and other related costs to support continued new product development efforts. The major product development efforts in the first six months of fiscal 1997 related to the development of the next versions of the WebSpeed and PROGRESS product lines. The product development staff decreased from 220 at May 31, 1996 to 201 at May 31, 1997. The Company expects the product development staff to increase during the remainder of fiscal 1997 from the level at May 31, 1997, but there can be no assurance that the Company will be successful in recruiting new employees or retaining current employees. The Company capitalized $608,000 of software development costs in the second quarter of fiscal 1996 and $633,000 in the second quarter of fiscal 1997 in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." The Company capitalized $1,217,000 of software development costs in the first six months of fiscal 1996 and $1,257,000 in the first six months of fiscal 1997. The amounts capitalized represented 9% of total product development costs in each period presented for fiscal 1996 and fiscal 1997. Capitalized software costs are amortized over the estimated life of the product (four years) and amounts amortized are included in cost of software licenses for the period. General and administrative expenses include the costs of the finance, human resources, legal, information systems and administrative departments of the Company. General and administrative expenses increased 8% from $5,263,000 in the second quarter of fiscal 1996 to $5,698,000 in the second quarter of fiscal 1997, but remained approximately the same percentage of total revenue in each period. General and administrative expenses increased 10% from $10,489,000 in the first six months of fiscal 1996 to $11,576,000 in the first six months of fiscal 1997 and increased as a percentage of total revenue from 12% to 13%. The dollar and percentage increases in general and administrative expenses were primarily due to higher average personnel costs and other related costs. The Company's general and administrative staff decreased from 187 at May 31, 1996 to 180 at May 31, 1997. Other income increased $687,000 from $1,025,000 in the second quarter of fiscal 1996 to $1,712,000 in the second quarter of fiscal 1997 due primarily to a foreign currency gain of $471,000 in 1997 versus a foreign currency loss of $4,000 in 1996 and an increase in other income-minority interest. All revenue, costs and expenses attributable to the Company's joint venture in Japan are included in the Company's revenue, costs and expenses. To account for the fact that the Company owns only a 51% interest in the joint venture, other income (expense) reflects that portion of the joint venture's income or loss which is attributable to the 49% minority interest in the joint venture. The joint venture generated a net loss in each period presented and the Company recorded as "other income - minority interest" an amount equal to 49% of the joint venture's net loss. The foreign currency gain in the second quarter of fiscal 1997 relates primarily to unrealized market gains on foreign currency option contracts related to the Company's intercompany hedging programs. The Company's effective tax rate was 34% for each period presented for fiscal 1996 and 1997 and was based upon the estimated effective tax rate for the full fiscal year. LIQUIDITY AND CAPITAL RESOURCES The Company had $95,959,000 in cash and short-term investments at May 31, 1997. The cash and short-term investments decrease of $1,364,000 from $97,323,000 at November 30, 1996 was primarily due to common stock repurchases and property and equipment purchases offset by cash generated from operations. 10
11 The Company purchased $5,616,000 of property and equipment in the first six months of fiscal 1996 and $4,646,000 in the first six months of fiscal 1997. The purchases consisted primarily of computer equipment and software, furniture and fixtures, and leasehold improvements. The Company financed these purchases primarily from cash generated from operations. In September 1996, the Board of Directors authorized, through September 30, 1997, the purchase of up to 3,000,000 shares of the Company's common stock, at such times when the Company deems such purchases to be an effective use of cash, for various purposes including the issuance of shares pursuant to the Company's stock option plans. The Company purchased 488,200 shares of its common stock for $8,424,000 in the second quarter of fiscal 1997. For the first six months of fiscal 1997, the Company has purchased 839,200 shares of its common stock at a cost of $14,396,000. At May 31, 1997, there remained approximately 2,100,000 shares of common stock authorized for repurchase. The Company's 401(k) Plan has approximately $900,000 in Guaranteed Investment Contracts (GICs) issued by Mutual Benefit Life Insurance Company (MBLI). On July 16, 1991, the Insurance Commissioner of the State of New Jersey took possession and control of MBLI's assets. In April 1994, a rehabilitation plan was approved by the Superior Court of New Jersey. Pursuant to the rehabilitation plan, the GICs are supported by a group of life insurance companies and are paid out from the assets of MBL Life Assurance Corporation, the successor to MBLI. On May 23, 1997, the Company initiated a process to purchase the GICs from the 401(k) Plan to enable participants to choose other investment vehicles prior to the end of the rehabilitation plan. The purchase transaction requires the approval of the Department of Labor and the Internal Revenue Service. Assuming no objection or other impediment to the transaction, the Company expects the purchase transaction to be completed before the end of the Company's current fiscal year and not to have a material effect on the Company's consolidated financial position or results of operations. The Company is party to two legal proceedings. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company's consolidated financial position or results of operations. See Part II, Item 1 - Legal Proceedings for further details. On June 27, 1997, the Company agreed to acquire Apptivity Corporation, a developer of Java-based application development tools, for a payment of approximately $3,800,000 in cash, the assumption of approximately $1,000,000 of liabilities and the issuance of approximately 400,000 shares of its common stock. The acquisition is expected to close in mid-July. The acquisition will be accounted for as a purchase and a substantial portion of the purchase price is expected to be allocated to in-process software development costs. This non-recurring charge will be reflected in the Company's results for the third quarter ended August 31, 1997. The Company believes that existing cash balances together with funds generated from operations will be sufficient to finance the Company's operations and meet its foreseeable cash requirements (including planned capital expenditures, lease commitments, and other long-term obligations) through the next twelve months. NEW ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS 128), "Earnings per Share." SFAS 128 establishes a different method of computing net income per share than is currently required under the provisions of Accounting Principles Board Opinion No. 15 (APB 15). Under SFAS 128, the Company will be required to present both basic net income per share and diluted net income per share. Basic net income per share for the three-month and six-month periods ended May 31, 1997 would have been $.17 and $.32 per share, respectively as compared with $.01 and $.35 per share for the corresponding periods in fiscal 1996. Diluted net income per share under SFAS 128 for these periods is not expected to be materially different from primary earnings per share under APB 15. The Company plans to adopt SFAS 128 in its first quarter of fiscal 1998 and at that time all historical net income per share data presented will be restated to conform to the provisions of SFAS 128. 11
12 FACTORS THAT MAY AFFECT FUTURE RESULTS The Company operates in a rapidly changing environment that involves certain risks and uncertainties, some of which are beyond the Company's control. The following discussion highlights some of these risks. The Company may experience significant fluctuations in future quarterly operating results that may be caused by many factors, including changes in demand for the Company's products, introduction, enhancement or announcement of products by the Company and its competitors, market acceptance of new products, size and timing of significant orders, budgeting cycles of customers, mix of distribution channels, mix of products and services sold, mix of international and North American revenues, foreign currency movements relative to the United States dollar, changes in the level of operating expenses, changes in the Company's sales incentive plans, customer order deferrals in anticipation of new products announced by the Company or its competitors and general economic conditions. Revenue forecasting is uncertain, in large part, because the Company generally ships its products upon receipt of orders. This uncertainty is compounded because each quarter's revenue is derived disproportionately from orders booked and shipped during the third month, and disproportionately in the latter half of that month. In contrast, most of the Company's expenses are relatively fixed, including costs of personnel and facilities, and are not easily reduced. Thus, an unexpected reduction in the Company's revenue, or a decrease in the rate of growth of such revenue, would have a material adverse effect on the profitability of the Company. The Company develops, markets and supports its core product line, the PROGRESS Application Development Environment, the PROGRESS RDBMS and the PROGRESS Dataserver Architecture (collectively, "PROGRESS"). In May 1997, the Company began shipping the latest major enhancement to the PROGRESS product line, PROGRESS Version 8.2. In October 1996, the Company began shipments of WebSpeed, an open development and deployment environment that enables organizations to build transaction processing applications on the Internet and corporate intranets. In June 1997, the Company introduced WebSpeed Version 2.0, which is expected to begin commercial shipments in July 1997. The Company's Crescent Division develops and markets a collection of advanced tools and components to Visual Basic and Visual J++ development teams. The Crescent Division began offering these products commercially in January 1995 and has since released major enhancements to its existing line of products as well as new products. Although the Company believes that PROGRESS, WebSpeed and the Crescent line of products have features and functionality which enable the Company to compete effectively with other vendors of application development products, ongoing enhancements to PROGRESS, WebSpeed and the Crescent line of products will be required to enable the Company to maintain its competitive position. There can be no assurance that the Company will be successful in developing and marketing enhancements to its products on a timely basis, or that the enhancements will adequately address the changing needs of the marketplace. Delays in the release of enhancements may negatively affect results. The Company has derived most of its revenue from PROGRESS and other products which complement PROGRESS and are generally licensed only in conjunction with PROGRESS. Accordingly, the Company's future results depend on continued market acceptance of PROGRESS and any factor adversely affecting the market for PROGRESS could have a material adverse effect on the Company's business and its financial results. Future results may also depend upon the Company's continued successful distribution of PROGRESS through its Application Partner channel and may be impacted by downward pressure on pricing, which may not be offset by increases in volume. Application Partners resell PROGRESS along with their own applications and any adverse effect on their business related to competition, pricing and other factors could have a material adverse effect on the Company's business, financial condition and operating results. The Company experiences significant competition from a variety of sources with respect to the marketing and distribution of its products. Some of these competitors have greater financial, marketing or technical resources than the Company and may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products than can the Company. Increased competition could make it more difficult for the Company to maintain its market presence. 12
13 In addition, current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties, thereby increasing their ability to deliver products which address the needs of the Company's prospective customers. Current and potential competitors also may be more successful than the Company in having their products or technologies widely accepted. There can be no assurance that the Company will be able to compete successfully against current and future competitors and its failure to do so could have a material adverse affect upon the Company's business, financial condition and operating results. The Company hopes that WebSpeed, the Crescent Division products and other new products will contribute positively to the Company's future results. The market for Internet transaction processing products, such as WebSpeed, is highly competitive and will depend in large part on the commercial acceptance of the Internet as a medium for all types of commerce. Because global commerce and online exchange of information on the Internet and other similar open wide area networks are new and evolving, it is difficult to predict with any assurance that the infrastructure or complementary products necessary to make the Internet a viable medium for all types of commerce will develop. The market for products such as those in the Crescent Division is extremely competitive and may be affected by changes in Microsoft's strategy with respect to Visual Basic and Visual J++ and the add-on product market for such products, and market acceptance of products competitive with Visual Basic and Visual J++. Overlaying the risks associated with the Company's existing products and enhancements are ongoing technological developments and rapid changes in customer requirements. The Company's future success will depend upon its ability to develop and introduce in a timely manner new products that take advantage of technological advances and respond to new customer requirements. The Company is currently developing new products intended to help organizations meet the future needs of application developers. The development of new products is increasingly complex and uncertain, which increases the risk of delays. There can be no assurance that the Company will be successful in developing new products incorporating new technology on a timely basis, or that its new products will adequately address the changing needs of the marketplace. The marketplace for these new products is intensely competitive and characterized by low barriers to entry. As a result, new competitors possessing technological, marketing or other competitive advantages may emerge and rapidly acquire market share. Approximately 51% of the Company's total revenue in the first six months of fiscal 1997 was attributable to international sales made through international subsidiaries. Because a substantial portion of the Company's total revenue is derived from such international operations which are conducted in foreign currencies, changes in the value of these foreign currencies relative to the United States dollar may affect the Company's results of operations and financial position. The Company engages in certain currency-hedging transactions intended to reduce the effect of fluctuations in foreign currency exchange rates on the Company's results of operations. However, there can be no assurance that such hedging transactions will materially reduce the effect of fluctuation in foreign currency exchange rates on such results. If for any reason exchange or price controls or other restrictions on the conversion of foreign currencies were imposed, the Company's business could be adversely affected. Other potential risks inherent in the Company's international business generally include longer payment cycles, greater difficulties in accounts receivable collection, unexpected changes in regulatory requirements, export restrictions, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, political instability, reduced protection for intellectual property rights in some countries, seasonal reductions in business activity during the summer months in Europe and certain other parts of the world, and potentially adverse tax consequences, any of which could adversely impact the success of the Company's international operations. There can be no assurance that one or more of such factors will not have a material adverse effect on the Company's future international operations and, consequently, on the Company's business, financial condition and operating results. The Company's future success will depend in large part upon its ability to attract and retain highly skilled technical, managerial and marketing personnel. Competition for such personnel in the software industry is intense. There can be no assurance that the Company will continue to be successful in attracting and retaining the personnel it requires to successfully develop new and enhanced products and to continue to grow and operate profitably. The Company's success is heavily dependent upon its proprietary software technology. The Company relies principally on a combination of contract provisions and copyright, trademark and trade secret laws to protect its 13
14 proprietary technology. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. Policing unauthorized use of the Company's products is difficult. There can be no assurance that the steps taken by the Company to protect its proprietary rights will be adequate to prevent misappropriation of its technology or independent development by others of similar technology. In addition, litigation may be necessary in the future to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claim of infringement or invalidity. Although the Company believes that its products and technology do not infringe on any existing proprietary rights of others, there can be no assurance that third parties will not assert infringement claims in the future. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and operating results. The Company also utilizes certain technology which it licenses from third parties, including software which is integrated with internally developed software and used in the Company's products to perform key functions. There can be no assurance that functionally similar technology will be available on commercially reasonable terms in the future. The market price of the Company's common stock, like that of other technology companies, is highly volatile and is subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new products by the Company or its competitors, changes in financial estimates by securities analysts, or other events or factors. The Company's stock price may also be affected by broader market trends unrelated to the Company's performance. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is a defendant in litigation entitled NEWSTAR TECHNOLOGIES INC. V. PROGRESS SOFTWARE CORPORATION of Canada Ltd. and Progress Software Corporation, No. 97-CU-121571, pending in the Ontario (Canada) Court of Justice (General Division), commenced April 4, 1997. Newstar claims that the Company entered into a contract with it under which Newstar was entitled to purchase the Company's software and receive product support from the Company under specific terms which differ substantially from the Company's standard terms and conditions. The purported contract cited by Newstar was prepared by Newstar and executed by a lower-level Company salesperson in the name of a Company sales executive followed by the initials of the salesperson. The Company denies the existence of a binding contract, on various grounds, including that the salesperson did not have the authority to sign the sales executive's name and that Newstar knew or should have known of that fact. Newstar seeks (a) an injunction mandating that the Company comply with the terms of the purported contract, (b) a declaration that the purported contract is of full force and effect, (c) an order restraining the Company from terminating the purported contract, (d) damages of $200 million, (e) special damages of an unstated amount, (f) punitive damages of $20 million, (g) costs of the litigation, and (h) such other and further relief as the court deems just. The evidence offered by the plaintiff to date does not support its claims. Newstar moved for a preliminary injunction; however, that motion was stayed by agreement to allow the parties to participate in voluntary non-binding mediation which took place on July 7, 1997. During this session a tentative settlement was reached which the parties anticipate will be finalized in the near future. Pursuant to such settlement, Newstar will become an Application Partner of the Company under mutually acceptable terms and conditions reasonably consistent with arrangements entered into with other Application Partners. If, for any reason, the settlement is not finalized, the Company will defend the action vigorously. Naf Naf S.A. commenced an expert proceeding in the Paris Trade Court, Paris, France, against Progress Software S.A., Timeless S.A. and Digital Equipment France in May 1996. In June 1997, Naf Naf petitioned the court to add Progress Software Corporation as a party to the expert proceeding, which petition has been granted. The basis of the proceeding is alleged late availability of Progress Software products and alleged product deficiencies after 14
15 delivery by Timeless to Naf Naf of such products. At this time, no specific damage claim has been formally filed under French legal proceeding rules with the court. The Company intends to vigorously defend itself in this proceeding. While the outcome of this claim cannot be predicted with certainty, management does not believe that the outcome will have a material adverse effect on the Company's consolidated financial position or results of operations. The Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company's consolidated financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS a) On April 25, 1997, the Annual Meeting of Shareholders of the Company was held at the offices of the Company located at 14 Oak Park, Bedford, Massachusetts. b) Joseph W. Alsop, Larry R. Harris, Robert J. Lepkowski, Michael L. Mark, Arthur J. Marks, Amram Rasiel and James W. Storey were elected at the Annual Meeting to serve as directors of the Company. c) At the Annual Meeting, the Shareholders also voted (i) to fix the number of directors at seven, (ii) to amend the Company's Restated Articles of Organization to authorize an increase in the authorized Common Stock, $.01 par value per share, of the Company from 20,000,000 shares to 50,000,000 shares, and (iii) to approve and adopt the 1997 Stock Incentive Plan. The following votes were tabulated on the aforementioned proposals: 1. Fixing the numbers of directors at seven: <TABLE> <CAPTION> Affirmative Negative Votes Votes Cast Votes Cast Abstaining ---------- ---------- ---------- <S> <C> <C> <C> <C> 10,905,451 85,292 67,116 <CAPTION> 2. To elect the following seven directors: Joseph W. Alsop, Larry R. Harris, Robert J. Lepkowski, Michael L. Mark, Arthur J. Marks, Amram Rasiel and James W. Storey Nominee For Withhold Authority ------- --- ------------------ <S> <C> <C> Joseph W. Alsop 10,468,240 589,619 Larry R. Harris 10,471,041 586,818 Robert J. Lepkowski 10,467,241 590,618 Michael L. Mark 10,471,341 588,318 Arthur J. Marks 10,469,541 588,318 Amram Rasiel 10,470,141 587,718 James W. Storey 10,469,541 588,318 </TABLE> 15
16 <TABLE> <CAPTION> Affirmative Negative Votes Broker Votes Cast Votes Cast Abstaining Non-Votes ---------- ---------- ---------- --------- <S> <C> <C> <C> <C> 3. Amending the Company's Restated 9,091,013 1,888,627 78,219 Articles of Organization to authorize an increase in the authorized Common Stock, $.01 par value per share, of the Company from 20,000,000 shares to 50,000,000 shares 4. Approving and adopting the 4,943,390 1,733,159 82,167 4,299,143 Company's 1997 Stock Incentive Plan </TABLE> d) Not applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits: 10.18 - 1997 Stock Incentive Plan 11.1 - Statement regarding computation of per share earnings 27.1 - Financial Data Schedule (EDGAR Version only) b) Reports on Form 8-K: No reports on Form 8-K were filed during the quarter ended May 31, 1997. 16
17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PROGRESS SOFTWARE CORPORATION (Registrant) Dated: July 14, 1997 /s/ Joseph W. Alsop ------------------------------- Joseph W. Alsop President and Treasurer (Principal Executive Officer) Dated: July 14, 1997 /s/ Norman R. Robertson ------------------------------- Norman R. Robertson Vice President, Finance and Chief Financial Officer (Principal Financial Officer) Dated: July 14, 1997 /s/ David H. Benton, Jr. ------------------------------- David H. Benton, Jr. Corporate Controller (Principal Accounting Officer) 17