ITEM 1. BUSINESS
The statements contained in this Report on Form 10-K and in the annual Report that are not purely historical statements are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding the Company’s expectations, beliefs, hopes, intentions or strategies regarding the future. These forward-looking statements involve risks and uncertainties. Our actual results may differ materially from those indicated in the forward-looking statements. Please see “Risk Factors,” “Special Note Regarding Forward-Looking Statements” and the factors and risks discussed in other reports filed from time to time with the Securities and Exchange Commission.
Overview
Pervasive Software (NASDAQ: PVSW) helps companies get the most out of their data investments through agile, embeddable software including on-premises and cloud-based services for data management, data integration, B2B exchange and analytics. The embeddable Pervasive PSQL™ database engine provides robust database reliability in a near-zero database administration environment for packaged business applications. Pervasive’s multi-purpose data integration platform, available on-premises and in the cloud, accelerates the sharing of information between multiple data stores, applications, and hosted business systems and allows customers to re-use the same software for diverse integration scenarios. Pervasive DataRush™ is an embeddable parallel dataflow platform enabling data-intensive applications such as claims processing, risk analysis, fraud detection, data mining, predictive analytics, sales optimization and marketing analytics. For more than two decades, Pervasive products have delivered value to tens of thousands of customers in more than 150 countries with a compelling combination of performance, flexibility, reliability and low total cost of ownership. Through Pervasive Innovation Labs, the company also invests in exploring and creating cutting edge solutions for the toughest data analysis and data delivery challenges. In addition, significant portions of our database and integration flagship product lines are embeddable into commercial applications for sale through a well-developed channel of independent software vendors (ISVs), Software-as-a-Service (SaaS) vendors, value-added resellers (VARs) and system integrators (SIs).
Our flagship Pervasive PSQL® database, offering unparalleled data management technology combined with very low total cost of ownership (TCO), has millions of server seats licensed since the inception of Pervasive Software Inc. in 1994. The full data management product line also includes specific solutions for data movement and synchronization, and addresses security challenges related to data integrity, accountability, continuity and availability throughout the data lifecycle. The product line is designed for integration by ISVs into client/server and Web applications which are sold predominantly to SMEs and other businesses having little to no information technology (IT) infrastructure, and requiring self-tuning, low-administration products. The product incorporates significant backward compatibility with a range of operating systems, hardware platforms (both 32 and 64 bit) and applications as well as supporting new technologies such as IPv6 and multicore chip sets.
Our data and application integration offering, Pervasive Data Integrator™, features a comprehensive set of visual design tools to rapidly build, test and deploy integration processes, regardless of size and complexity, across hundreds of data formats and applications within and outside of the enterprise. The Pervasive integration product line is designed to grow and scale for the diverse data and application integration needs of all businesses. Our focus on rapid implementation and ease of use helps reduce the complexity, costs and risks associated with traditional labor-intensive integration methods. The product line also features a product for comprehensive profiling of large amounts of data to assess data quality, leveraging commodity multicore hardware.
Pervasive integration allows multi-way connectivity between SaaS and on-premises applications, SaaS-to-SaaS, or on-premises to on-premises. Both traditional ISVs and SaaS vendors opt to embed Pervasive integration within their applications to help provide affordable, predictable integration as part of their software
capability. Pervasive also delivers preconfigured packaged integration solutions that allow even non-technical users to access point-to-point integration within just a few clicks at an affordable subscription fee.
In addition, Pervasive has newer offerings that include:
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Pervasive DataSolutions™-subscription-based integration as a service delivered on-premises or as a multi-tenant service hosted by Pervasive and potentially by our ISV customers,
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Pervasive DataRush™-our high-performance software platform for scalable data-intensive data preparation and analytics, designed to capture the parallel processing capabilities of multi-core technologies,
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Pervasive DataCloud®-a scalable, adaptable platform for hosting Pervasive- or partner-developed services, and
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Pervasive WebDI™-providing a Web-based EDI data exchange service that enables companies to send and receive business information electronically in a seamless, timely and secure manner regardless of their enterprise system.
Our strength is evidenced by the size and diversity of our customer base, serving tens of thousands of customers in virtually every industry and market around the world. We sell products in more than 150 countries through direct sales and channel distribution. Our large customer base includes a distribution channel of ISVs, developers, VARs, systems integrators and partners who have built or deployed applications on top of our data management and data integration platforms as well as a large customer base of end users for our integration products and services. Founded in 1994, Pervasive is headquartered in Austin, Texas, with offices in Greenville, South Carolina; Brussels; Frankfurt; London; and Paris; and a joint venture in Japan. Our Web site address is www.pervasive.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our Web site, http://www.pervasive.com, as soon as reasonably practicable after we file them with, or furnish them to, the Securities and Exchange Commission (SEC). Additionally, you may read and copy materials that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a Web site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, at http://www.sec.gov.
Market Opportunity
Over the past 25 years, businesses of all sizes have invested billions of dollars in application software that enabled them to automate and simplify their business processes. As the sales and implementation of these application packages proliferated, including increasingly heterogeneous environments that use both cloud-based and on-premises software, organizations have faced increasing data and application infrastructure challenges and an entire software market segment emerged to address these challenges. The growth of the infrastructure software market in the United States, we believe, can primarily be traced to the demand for technologies that extend the use of established systems, enable the rapid deployment of new applications, and improve the ability to collaborate and communicate with customers and suppliers.
At the same time, we believe that the software markets as a whole are going through rapid change. The emergence of cloud-based infrastructure and applications is testament to the increasing demand for the scalability and rapid deployment provided by the SaaS delivery model. Organizations increasingly demand software that provides ease of use, re-usability, standards compliance, and cost-effective maintenance. In this environment, having a “value” orientation-delivering flexibility and performance with high return on investment-becomes increasingly critical. As these market disruption trends continue, we believe infrastructure software will be a key ingredient for all businesses as they seek to integrate and streamline their back-end systems and eliminate delays in the management and execution of critical processes. Infrastructure software includes, among other things,
application development tools, integration tools and solutions, business intelligence, database, and security solutions. Additionally, in uncertain economic environments, customers tend to be conservative about investments in new technology and remain loyal to proven technologies.
In addition, the rapid proliferation of commodity multicore hardware, along with exploding data volumes, provides opportunities for companies to leverage affordable servers that have multiple cores in a single box to extract value from large volumes of data-but only if they have software that can effectively scale on multiple cores. The inevitable performance gains traditionally delivered by faster processors under “Moore’s Law” now must rely on a new generation of infrastructure software that can scale on ever-updating multicore hardware platforms.
We believe these trends will favor Pervasive. We believe the market for data infrastructure software, in particular, is experiencing significant market disruption due to the high cost of many competing, more labor-intensive solutions. We further believe well-established value leaders tend to prevail in cost-sensitive markets, and Pervasive, with its strengths in scalable data management and integration solutions, is well-positioned to benefit from the trends in these markets. Pervasive also delivers the Pervasive DataRush platform that powers applications with seamless scalability on multicore servers. Separately, updates to the flagship Pervasive PSQL database enable applications that embed the database to deliver significant performance improvements on dual-core, 4-core and 8-core servers. In addition, the ability to deliver preconfigured packaged integration solutions offers the opportunity to attract non-technical users and address unmet market needs. While the global economic slowdown continues, we believe our value orientation and reputation as an established vendor with highly reliable offerings positions Pervasive to continue to prosper.
The Pervasive Strategy
Our goal is to be the global value leader in embeddable data management, integration and scalable, data-intensive analytics software, enabling businesses to more effectively capitalize on their existing data investments. Pervasive’s family of scalable, high-performance data infrastructure products, combined with a well-established channel, positions us to expand our role in a rapidly evolving software and hardware landscape. Key elements of our strategy are:
Leverage our Core Competencies in Data Infrastructure. We have excelled in simplifying the complexity associated with data management for thousands of client/server and cloud-based applications, representing nearly every industry in every major region of the world. Extensive communication with a diverse set of customers enables us to understand their needs and prioritize the requirements for future product development. This includes identifying needs relevant to a particular horizontal or vertical market. We continue to provide data management solutions of choice for high-volume transaction markets including Accounting, Healthcare, Banking and Financial Services, and Retail Point-of-Sale.
Our low-TCO database is widely installed, with millions of server seats licensed since the inception of Pervasive Software Inc. in 1994. Many of these seats are deployed in SME organizations that have not yet adopted the latest generation of our database products. Therefore, we believe we have an opportunity in upgrading these seats to our new-generation data management products as users adopt emerging technologies including 64-bit, multicore hardware, and new Windows and Linux operating systems. We plan to reach these customers through our well-developed channel of ISVs, VARs, systems integrators and consultants and continue to seek their input to guide our product development activities. We intend to continue joint marketing programs with our channel partners and customers encouraging upgrades to recent versions of our database, upgrades of additional user counts, upgrades to new or additional platforms, as well as upgrades of the ISVs’ applications themselves.
Our upcoming version, Pervasive PSQL v11, is scheduled for release in September 2010. It will deliver improvements in performance and increased simplicity of development, deployment and ease of use, including
digital license management and enforcement. In addition, this release enhances support for new technologies including IPv6 and multicore hardware.
Our ongoing and past investments in training and educating our customers worldwide, our long-term relationships with ISVs and VARs and our success in encouraging them to embed our products into their applications have created a competitive advantage in the marketplace. We intend to continue to build customer loyalty by providing significant revenue opportunities, meaningful certification programs and other offerings via our enhanced marketing, training, consulting and lead-sharing programs, as well as by ensuring customer satisfaction through the delivery of high-quality products and support programs.
Grow our Integration Product and Services Revenues. We continue to deliver our suite of integration products to our existing channel of ISV customers, and new ISV customers, to speed and simplify the movement of data in the field when they win competitive deals, and to enable them to pre-wire their products with embedded integration to interoperate with adjacent business applications, whether on-demand or on-premises. SaaS vendors and ISVs have two critical problems: onboarding new customers rapidly and predictably, including migration of data from existing applications, and providing data integration for existing customers. Today, customers expect migration and integration to be included in the solution. Combining our deep knowledge and more than 25 years of migration and integration expertise, we provide easy-to-use, cost-effective migration and integration technology, services, training and partner programs. These programs help ISVs, Software-as-a-Service (SaaS) vendors and systems integrators transform their applications into “integration-ready” solutions that are scalable from one-time data migration to ongoing application integration within and beyond organizational boundaries while boosting their competitive advantage, time to revenue, customer satisfaction and cost management with self-service options.
We intend to continue investing in product development, marketing and sales activities focused on enhancing and leveraging our integration product line with:
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SaaS companies, including providers of cloud-based CRM, ERP, compensation management, and talent management offerings
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ISVs, including both existing channel partners and new partners
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End users in corporate IT, healthcare, and financial services who seek to integrate multiple applications, including legacy and new, on-premises and hosted, internally or with trading partners
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Business service providers, including those focused on payroll, tax, and employee benefits
Our integration channel business continues to increase as a percentage of our overall revenue. As a channels-oriented company, we are encouraged by these and other wins and believe they align with, and validate, Pervasive’s strategy of winning channel relationships that are more leverageable and profitable in nature. In addition, the growth of subscription revenue as a percentage of overall revenue provides an expanding recurring revenue base.
Our integration product revenues are generated predominantly in North America. However, we continue to market our expanding integration product line to our customer base internationally, including recruiting both exclusive and non-exclusive partners in our existing and target market countries. International sales have typically represented approximately 10% of integration product revenues, compared to approximately 50% for our embedded database business, and we will continue to focus on opportunities in new and existing international markets in fiscal year 2011.
Pursue Growth through Innovation of Complementary Products and Services. We will continue to invest in innovation by allocating dedicated funds for research focused on new ways to serve our existing customers and attract new customers.
Our innovation efforts in fiscal year 2010 focused on the further development of the following new product and service offerings:
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Pervasive DataSolutions™-subscription-based integration as a service delivered on-premises or as a multi-tenant service hosted by Pervasive and potentially by our ISV customers,
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Pervasive DataRush™-our high-performance software platform for scalable data-intensive data preparation and analytics, designed to capture the parallel processing capabilities of multi-core technologies, and
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Pervasive DataCloud®-a scalable, adaptable platform for hosting Pervasive- or partner-developed services.
We will continue to build our Pervasive DataSolutions, Pervasive DataRush and Pervasive DataCloud businesses in fiscal year 2011, as well as continue to invest in additional offerings to serve our existing customers and attract new customers.
Pursue Growth by Acquisition of Complementary Businesses. Where we are confident we can increase shareholder value, we will seek growth opportunities for our business via the acquisition of complementary companies and technologies. We consider complementary businesses to be those involved with data infrastructure software, with a value orientation to their product offerings and with an existing partner channel or the capability of developing a partner channel. We would target the acquisition of relatively mature and stable small to mid-sized businesses through transactions with a reasonable probability of being accretive to earnings within the first year of acquisition.
Our acquisition of the assets of ChanneLinx, Inc., which was completed on July 31, 2009, is an example of our acquisition strategy. We believe that ChanneLinx’ Web-based electronic data interchange technology, WebDI, and customer base will be complementary to our existing operations. The former ChanneLinx team now operates as Pervasive Business Xchange.
Remain Focused on Profitability. Since March 2001, we have reported thirty-eight consecutive quarters of profitability. Our past profitability is a result of our sharp focus on our core data management and data integration businesses and prudent expense management. Our performance was achieved in the midst of a very difficult economic environment and structural change in the software industry. We remain focused on profitability through our management of expenses, increasing marketing and sales productivity around the globe and as a result of our next-generation product releases and product line expansion anticipated in fiscal year 2011 and beyond.
Use of Cash. We have meaningful cash resources relative to the size of our business and have been successful in generating positive cash flow in recent years. Continued positive cash flow generation will allow us to take advantage of suitable acquisition targets and cause us to continue to be active with our share repurchase program. In fiscal years 2007, 2008, 2009 and 2010, we acquired approximately 2.7 million, 2.2 million, 1.9 million and 1.2 million shares, respectively, of our stock on the open market at a total cost of approximately $10.8 million, $9.2 million, $7.5 million and $5.9 million, respectively. And, we began the new fiscal year with a new $10 million of authorized repurchase funds under our most recent Board-approved share repurchase program effective July 27, 2010.
Products
Our software products offer customers a proven, cost-effective way to better manage, integrate, secure and analyze their data. Delivered both directly and through ISVs, VARs, SIs, SaaS providers and other vendors, our products are designed to provide solid business value while reducing the time, complexity and cost associated with data infrastructure projects. Our focus on easily embedded technology for solutions that provide proven
reliability and scalability reflects our belief in the strategic importance of this value proposition for our partners and customers, where high performance, flexibility for growth, and time to market are paramount.
Data Management Product Line
We offer a wide range of products for secure data management that are designed to deliver faster return on investment (ROI), business flexibility, revenue opportunities and accountability for data infrastructure investments at a low TCO.
Pervasive PSQL®, our core database product offering, combines the high performance associated with enterprise-class databases with numerous low-maintenance features and is ideally suited for client/server, standalone or hosted applications deployed on a variety of the most popular operating systems and access methods (ODBC, ADO.NET, JDBC, etc.).
Our offerings allow a broad range of customers to:
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Build low-TCO applications for use in SME environments characterized by little to no IT infrastructure or in departments within large enterprises;
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Develop, upgrade or migrate applications that support a broad range of operating systems, including Windows and Linux; and
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Embed our database inside their commercial or internally developed application, permitting development of a tightly integrated application.
Our most recent version, Pervasive PSQL v11, is scheduled for release in September 2010. Pervasive PSQL v11 delivers improvements in performance and increased simplicity of development, deployment and ease of use. It allows OEMs and ISVs to enforce intellectual property integrity with enhanced digital licensing management. In addition, this release enhances support for Internet Protocol version 6 (IPv6) and multicore technologies.
Pervasive DataExchange™ Real-Time Backup Edition, our core replication offering, features targeted solutions to data movement and synchronization problems like maintaining an off-site warm backup, driving transactional data into a data portal, and connecting remote databases.
Pervasive Backup Agent™ is designed to complement existing, traditional weekly or nightly backup solutions. Pervasive Backup Agent helps provide improved integrity and reliability to traditional backups by allowing the Pervasive PSQL database to be in use and operational while buffering all changes to the database while it is accessed by third-party backup software. This allows the backup software to complete a full Point-in-Time image of the database while avoiding file access issues associated with users interacting with the system while files are being modified. When installed directly onto a server along with Pervasive PSQL, the product requires no configuration settings and no database administrator maintenance. Pervasive Backup Agent can be integrated into existing backup processes and can run in conjunction with most complementary third-party backup products.
Pervasive AuditMaster®, our core security product offering, monitors and reports activity occurring in a Pervasive PSQL database, leveraging deep-level capture, report and alert technology to enable monitoring of mission-critical data without the high costs of application redevelopment and deployment, training, or ongoing maintenance. This technology is particularly relevant for users needing compliance, monitoring and notification of personal data or information. Target markets include accounting and healthcare, both of which continue to deal with increased regulatory requirements brought about by the Sarbanes-Oxley Act, the Health Insurance Portability and Accountability Act (HIPAA) and related regulations.
Data and Application Integration Product Line
Our data integration and data quality products have been developed on a unified, open integration platform designed to grow and scale for diverse integration projects, providing what we believe is the industry’s best combination of performance, flexibility and TCO.
Our integration products reduce the complexity, costs and risks associated with traditional labor-intensive integration methods by providing a versatile, agile and configurable integration architecture for rapid implementation and ease of use. This flexibility enables businesses to create and fine-tune their solutions for frequently changing needs and requirements. Our integration products, which feature a comprehensive set of easy-to-use visual design tools to rapidly build and test integration processes, regardless of size and complexity, across hundreds of data formats and applications within and outside of the enterprise, include:
Pervasive Data Integrator™ aggregates and integrates data quickly and cost-effectively for legacy migrations as well as continuous processing, targeting the needs in the traditional Extract, Transform and Load, or ETL, market as a feed for data warehouses and ultimately business intelligence tools. The product also is ideal for integrating multiple business applications within or across organizations for real-time, event-driven integration closely aligned with key business processes. Pervasive’s technology and business model supports rapid adoption by non-programmers for simple integration tasks all the way to complex, high-volume multi-processor implementations that handle millions of transactions. Pervasive Data Integrator, through our UniversalCONNECT! Strategy, provides an exceptional range of connectivity to both data sources and targets, including all major databases, flat files and legacy formats as well as SaaS and on-premises applications and formats including Microsoft Dynamics (CRM, GP and AX); enterprise applications (SAP, Oracle, PeopleSoft, JD Edwards); SaaS applications (Salesforce, NetSuite, Xactly, Daptiv, Workday, SuccessFactors, Taleo, Jira); standards-based formats (HIPAA, HL7, NCPDP SWIFT, EDI); message queues (JMS and Websphere MQ) and enterprise service buses. The product is offered in both perpetual and subscription-based licensing models and in localized Japanese and Chinese versions in addition to the English-language offering.
Pervasive Data Profiler™ is designed to reduce the complexities, risk, and expense associated with manually checking data, improving IT productivity, eliminating costly rework, and increasing ROI around applications and business processes. It allows rapid assessment, profiling and validation of complete data sets rather than relying on sampling. Pervasive Data Profiler is fast and easy to deploy, and has an engine specifically designed for testing/auditing large amounts of transactional data, creating positive effects on business processes, reducing expenses, and lessening risk to IT departments and their companies. Pervasive Data Profiler’s highly scalable, data-intensive throughput is built on the Pervasive DataRush™ technology, designed to scale automatically to deliver parallel data processing on multi-core servers.
Pervasive Data Profiler takes advantage of Pervasive’s data connectivity and integration capabilities, providing access for a variety of data source types, including major databases, flat files, and legacy formats. Pervasive Data Profiler delivers actionable, at-a-glance charts backed by drill-down analysis with percentages of success rate and specific counts.
Pervasive Data MatchMerge™ allows for rapid identification of data redundancies and data quality issues such as duplicates that cause inaccuracies within various data applications. The solution leverages Pervasive Data Integrator and Pervasive DataRush™ as the underlying technology platforms. Browser-based Pervasive Data MatchMerge is equipped with tunable algorithms for identifying potentially duplicate records and a means to rectify them within the intuitive Merge user-interface. The solution is capable of incorporating third-party and standardization applications by using standard APIs. Its tunable fuzzy matching algorithms allow analysts to quickly iterate through multiple combinations of matching and scoring properties.
Pervasive Integration Hub™ provides a comprehensive solution to a common integration scenario-a centralized hub needs to integrate with large numbers of business or trading partners, typically using different
data file formats and protocols and employing different data semantics and rules. The Pervasive Integration Hub provides organizations with a central location and master process to manage profiles, define rules, and organize and validate customer data. In addition, reaching data sources behind the business partner firewall is often a challenge. Browser-based Pervasive Integration Hub includes distributed “intelligent agents” that can be used to both extract data from business partner systems, as well as update and insert data back into business partner applications.
Pervasive Metadata Manager™ is a metadata warehouse solution. In addition to automating the capture of application and integration metadata, Pervasive Metadata Manager provides reporting for lineage and impact analysis for data integration groups. It also has extensive search capabilities to discover metadata across all artifacts within its repository. The product extensions capture granular details for all the applications that are touched by integration processes as well as captures the details of the process logic and transformation that takes place for every data element that is moved between systems.
Pervasive Integration Manager™ is a browser-based management console, providing single-point administration, performance monitoring, integration engine deployment and job scheduling of integration processes running on remote integration engines. With the ability to remotely administer any number of integration points throughout the organization, customers can build out their integration infrastructure as required, using a flexible and scalable architecture designed for easy manageability.
Business to Business Data Interchange Product Line
Our business to business data interchange product is managed by our Pervasive Business Xchange team. Pervasive Business Xchange offers scalable solutions to small and medium businesses as well as Fortune 100 companies. Pervasive Business Xchange solutions can be used independently or as part of our integrated complete e-business suite. This flexibility allows businesses to incorporate our applications to address their current needs while establishing a technology framework that can be expanded in the future as their resources and Web presence expand.
Pervasive WebDI is our Web-based business-to-business electronic data interchange solution that provides supply-chain management and internal and external data exchange and integration functionality. Pervasive WebDI is a hosted solution, currently being migrated to the Microsoft Windows Azure platform, to connect businesses intelligently and provide efficient supplier management, sales and customer service and enterprise integration and data exchange, both internally and externally. The Web-based solution allows suppliers to connect with customers and streamline business processes.
New Product Innovation
We are investing in innovation by allocating dedicated funds for research focused on new ways to serve our existing customers and attract new customers. Innovation efforts are focused on the conceptual design and prototype development of extensions to existing products as well as new products and services. Our innovation efforts in fiscal year 2010 focused on three product and service offerings: Pervasive DataSolutions, Pervasive DataCloud and Pervasive DataRush.
Pervasive DataSolutions™ is our first step toward realizing the power of Integration-as-a-Service. We have formed a team focused on the delivery of highly targeted application-specific solutions to provide customers and partners with data services-based integration that can be configured and deployed within hours. The first product delivered by this team is Pervasive DataSynch™ for QuickBooks and Salesforce. Made available in June 2007 via salesforce.com’s AppExchange Web site, Pervasive DataSynch automatically synchronizes customer, product and order information between Salesforce and QuickBooks. Pervasive has since introduced Pervasive DataSynch for QuickBooks and Microsoft Dynamics CRM, Pervasive DataSynch for QuickBooks Online and Salesforce, Pervasive DataRep for Salesforce, Pervasive DataSynch for FreshBooks and Salesforce, and Pervasive Integrated
Credit Card Processor. Pervasive DataSolutions anticipates launching additional data services-based offerings, which could range from data profiling to data auditing to any number of easily consumable connections for popular business and consumer applications. In addition, the Pervasive DataSolutions website functions as a WebStore for both Pervasive-developed and partner-developed cloud-hosted preconfigured subscription-based solutions.
Pervasive DataCloud® leverages the Amazon Web Services Elastic Computer Cloud to provide a scalable, adaptable platform for hosting Pervasive or partner-developed services. The platform currently has more than 200 customers consuming its services. New capabilities include a cloud-hosted environment for development of hosted integration for the other product teams within Pervasive as well as outside partners to integrate cloud-based endpoints.
Pervasive DataRush™ addresses the gap between available hardware processing power, exploding volumes of data and what the software industry has been able to deliver in terms of commercial applications to exploit multicore hardware and efficiently extract useful intelligence from massive data sets. Pervasive DataRush is a platform designed to enable applications to tap the capacity of multicore processors in order to deal with the ever-increasing data volumes and yield better, more actionable insights. Pervasive DataRush powers applications such as Pervasive DataMatcher, Pervasive MatchMerge and Pervasive Data Profiler, all designed to scale seamlessly on large, complex datasets with the ability to profile or match rapidly on widely available multicore servers.
Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations” elsewhere in this Report on Form 10-K for product line revenue information.
Sales and Marketing
Indirect Channel Sales and Channel Marketing
Many organizations rely on our channel to help them develop, deploy, maintain and integrate business-critical data and packaged and on-demand applications. Our products and marketing approach are specifically tailored to meet the needs of our channel partners and their customers. We believe our sharp focus on our customers and their end-users provides us with multiple sales opportunities, a cost-effective, value-added source of service and technical support and a large, loyal and well-educated channel that develops and deploys applications using our offerings.
Our channel sales and marketing organizations focus on our worldwide channels by targeting software developers who build packaged and SaaS applications and VARs, SIs and consultants who sell to and implement the applications for end users. These organizations have developed a number of programs utilized by the sales organization to support our channel partners, such as our Original Equipment Manufacturer (OEM) program for ISVs and partner programs for Web and systems integrators, consultants and VARs. These programs are worldwide in scope and capture leads from a variety of activities including direct response marketing and advertising, joint marketing and public relations.
Our OEM program focuses on recruiting and retention of independent software vendors worldwide who embed our products on an OEM basis. The OEM program is designed to build mutually beneficial strategic relationships between Pervasive and ISVs or SaaS vendors and generate ongoing royalties for us through licensing contracts, which are typically for three-year terms. This program offers our OEM partners joint marketing services, volume discounts, specialized technical support, training and consulting, which enable delivery of tightly integrated solutions to end users.
Our other sales and marketing programs recruit and retain software developers and channel partners who develop applications that are designed to be deployed with shrink-wrap versions of our data management
products. These programs include trade shows, direct mail, telemarketing and telesales activities and hands-on seminars that are designed to further recruit, develop, support and train software developers and channel partners to facilitate the deployment of on-premises and SaaS applications based on our products. If the sales volumes of these applications become sufficient, the sales group recruits these software developers into our OEM program.
Our international channel sales organizations utilize a channel of distribution partners and OEMs worldwide. The distribution partners implement sales and marketing programs for a particular region, typically using our distributor or master distributor programs. In addition to managing these distributor relationships, the international sales groups recruit and support software developers and channel partners with the same programs as the domestic sales groups. We currently have international offices located in Brussels, Frankfurt, London and Paris and a joint venture in Japan.
Direct Sales and Marketing
Unlike typical SME organizations, many mid-sized companies and larger enterprises have access to significant IT resources, and therefore tend to rely less on third parties for packaged solutions. Our approach for reaching these prospective customers is based generally on a direct marketing and direct sales model.
Our direct marketing efforts are comprised largely of in-house direct email campaigns, Web, social media, communities and referral programs as well as industry tradeshows, specifically targeting IT departments and business managers as well as vertical marketing initiatives aimed at the Financial Services and Healthcare sectors. The primary goal of these marketing campaigns is to direct potential customers back to corporate and product Web sites and have them download white papers, strategic reports, and other general strategic marketing materials as well as trial versions of our software products, in particular, our integration, Pervasive DataSolutions and Pervasive DataRush products. Through our press and industry analyst relationships, the marketing team seeks industry endorsements that drive target customer buying within the integration segment. We also focus on cross-sell and upsell opportunities among our installed customer base.
We employ a sales model that sells directly into enterprises at both the corporate and departmental level. Sales Executives are part of a well-defined and comprehensive sales process based upon a sales methodology used by everyone in the sales organization. The sales force is supported by customer relationship management system software (CRM) that supports the sales methodology, combined with marketing automation and accounting software, as well as a staff of highly trained Sales Engineers who provide high-quality technical pre-sales support during the sales cycle.
Because of the small footprint of our software combined with its ease of use, we reap the benefits of deploying a sales model that is primarily through a staff of Sales Executives. This model facilitates conducting the majority of our sales efforts via a telephone/Web-demonstration process composed of interviews with potential customers to determine their interest level and needs, resulting in on-target product recommendations. As a result, a combination of customer-needs driven interactive demonstrations of our products using the Web for presentation, often with a specific problem from the customer, shown as a proof of concept, is produced. By using the Web for delivering these proofs of concept and the interactive demonstrations, Pervasive is able to maintain a lower sales cost, which ultimately translates into our ability to offer greater integration capabilities at an overall lower TCO. In addition, Pervasive has introduced a family of prepackaged integration solutions that are marketed and downloadable via the Web, allowing customers to rapidly access a point-to-point integration solution through an affordable subscription fee.
Customer Service and Technical Support
We offer multiple levels of worldwide customer service, including technical support and product maintenance. First-level support responds to most customer inquiries that are routine in scope via telephone and
email. Second-level support responds to escalated technical issues and supports our large partners with dedicated technical expertise.
Our Customer Service and Support departments are committed to understanding the wide variety of business applications involving data management and integration. In order to assist customers quickly and successfully, a great deal of domain knowledge must be acquired by each member of the team. Each technical support specialist must have a working knowledge of a broad range of databases, applications, and development and operating environments, including UNIX, Linux, SQL queries, VB, C#, Java, CRM and ERP interfaces, .NET Framework, Web services and SOA, among many others. In addition, developer-level support ensures that developers can obtain assistance from a team knowledgeable in the developer’s programming language and toolset of choice, resulting in a shortened time to market for the developer’s internal or commercial application.
Our Web site includes a comprehensive on-line support area that is monitored and updated continually by the Customer Service department. With this extensive library of Web-based resources, customers have 24/7 access to the documentation, maintenance releases, FAQs, interactive tutorials and knowledge base they need to answer their questions and resolve their problems quickly and easily. Customers may also submit an electronic support request form, via the Web site, to Customer Service inquiring about specific problems or requesting support for more detailed, particular concerns. There are also online developer forums, documentation and knowledge base areas on the corporate Web site to enable customers and partners to more effectively utilize Pervasive products.
Worldwide customer service is provided through our corporate offices in Austin, Texas as well as international partners who handle local first-level support in the local language.
Professional Services
The Professional Services Group (PSG) is focused primarily on accelerating and maximizing integration ROI for customers. This group, consisting of Implementation, Solution and Training Services, has steadily built a record of success and fast deployment for clients.
In order to provide further evidence of the performance of our integration tools and applications, PSG can develop proofs of concept and benchmarks on a sample of a customer’s integration project, or on other sample migration or integration processes. Through PSG’s consultative experience, it can also suggest ways to improve and optimize throughput or system performance.
PSG works closely with clients to architect and build special applications and/or functionality around the integration tools as needed to optimize project performance. PSG also works with clients to ensure that the integration tools are properly embedded and have full connectivity to other internal or external applications.
The Implementation Services group in PSG is available to assist customers, partners and sales prospects with benchmarking/proofs of concept, rapid, client-oriented deployment and implementation, or long-term consulting. Our team is composed of developers, product specialists, and business analysts devoted to delivering customer and partner success.
The Solution Services group helps with enterprise-level deployments and partner (ISVs, BSPs, and SaaS vendors) connectivity and embeddability into their own product stack. Our team is comprised of business analysts, developers and project managers.
The Training Services group in PSG provides multiple training options each month in Austin, Texas. These classes are open to all licensed users of the current version of our software as well as prospects. Users can take standard product training and follow-up with focused workshop sessions. Additional consulting time can be
scheduled after each session to augment course learning. The same courses and workshops are also available on-site at the customer’s location and via the Web.
Enablement Services focuses on three core areas including partner enablement, solution enablement and connectivity enablement, to help accelerate our ISVs’ and other partners’ efforts to get to market rapidly with Pervasive integration technology.
We also have a rich network of Channel partners who can supplement PSG with specialized consulting expertise.
PSG will also fulfill demand for fee-based consulting services from our database software developer customers and channel partners. These consulting services may include development services to migrate applications on competing databases to Pervasive PSQL, migrate existing on-premises applications to on-demand, upgrade existing applications to the latest Pervasive PSQL release, and optimize database functionality through performance testing, database schema design and review, and the delivery of services related to Pervasive DataExchange or Pervasive AuditMaster offerings. Consulting opportunities are often referred to our channel partners to strengthen channel loyalty, build the channel’s technical ability and increase the resource base available for future growth.
Research and Development
We have made substantial investments in research and development through both internal development and technology acquisition. As of June 30, 2010, we had 73 employees in research and development and our research and development expenditures for fiscal year 2010 and 2009 were $11.8 million and $10.6 million, respectively. We will continue to invest heavily in focused research and development resources.
Our development efforts consist primarily of driving significant levels of innovation into new and current product lines with primary goals being continuous improvement of the performance of existing product features, the addition of new differentiating product features, the simplified development with and deployment and use of our products, and the on-going investment in emerging platform opportunities.
Our research and development investments in fiscal 2011 are focused on the following:
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Embedded database technology-We continue to commit significant development resources to enhancing Pervasive PSQL with performance, features and functionality required by SME customers today and the channel of ISVs, VARs and consultants who serve them. Our database engineering team is continually focused on keeping our product up-to-date with the ever-changing environment, and the known or anticipated needs of our ISV customer base. This team also continues to improve the digital licensing capabilities of our product in order to simplify deployment and improve reporting of software licenses sold through our ISV and VAR channels and used by their end user customers. We continue to work on multicore enablement of our database engine for an upcoming release (Pervasive PSQL v11 MC scheduled for release in September 2010) to support the latest in multicore processors in rapidly commoditizing hardware.
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Next generation integration product-Version 10 of Pervasive Data Integrator will offer enhanced functionality within a new RESTful-oriented services platform. A brand-new browser-based user interface based on Rich Internet Application (RIA) technology will be offered on a new Services-Oriented Architecture (SOA) platform. The SOA platform will provide additional deployment options, and improved enterprise and internet scalability. It will also offer new real-time event-based capabilities. Advanced repository, mapping and management console features are also expected to be added in version 10. The product also will be updated to allow embedding of the Pervasive DataRush highly parallel engine including a new dataflow-based user interface.
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Expanded data quality capabilities-Pervasive has extended our matching capabilities using Pervasive DataRush technology. We also are partnering with data quality content providers. The Pervasive
MatchMerge offering is being updated with a browser-based interface based on Rich Internet Application (RIA) technology.
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Connectivity expansion-We continue to invest in our integration products so that they can connect a growing range of on-premises and on-demand applications, enabling us to partner with application vendors and participate in market segments that are experiencing rapid growth. We are evolving our frameworks to enable partners to rapidly develop connectivity as well.
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Platform expansion-Our integration products are deployable on a wide variety of industry-standard platforms such as UNIX (Sun Solaris, IBM-AIX and HP-UX), Linux and the various Microsoft Windows platforms including Server 2008 and Windows 7. This includes both 32-bit and 64-bit support. Our goal is to offer the most easily deployed and most scalable, single integration solution available in the market and extend our appeal to a broader range of ISVs, SaaS vendors and systems integrators.
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Integration embeddability-We continue to invest development resources in the further enhancement of our embeddable integration technology so that our customers can rapidly embed robust data services within both traditional and SOA-style environments. These capabilities are essential for ISVs worldwide to help them to pre-wire competitive advantage into their applications to better fit within customer infrastructure, vastly improving data and application integration capabilities.
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Data solutions-We continue to invest in data solutions offerings, delivering data solutions on-demand in a fast, easy and affordable manner. Future data solutions offerings may take the form of data auditing, data profiling or other data services to complement our subscription-based data synchronization solution, Pervasive DataSynch.
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Parallel processing for multi-core-We continue to invest resources in the further development of our Pervasive DataRush product line. Our goal is to offer extensible libraries for data preparation and data analytics and the most scalable and easy-to-use 100% Java engine to allow software developers to quickly build highly parallel, data-intensive applications that take full advantage of the parallel processing capabilities of proliferating high-core count chip technologies. We have invested in extending Pervasive DataRush by adding the extensible core analytics library.
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Pervasive Business Xchange-The former ChanneLinx team will leverage other Pervasive technologies to extend its WebDI solution to address last-mile integration for customers. The group will also explore extensions of its portal technology.
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New products and services-We continue to invest resources in the development of extensions to our existing products as well as the discovery of new products and services to serve our existing customers and attract new customers.
Competition
We encounter competition for our embedded database products primarily from large, public companies, including Microsoft, Oracle, Sybase/SAP, IBM, and Progress. In particular, Sybase’s small memory footprint database software product, Adaptive Server Anywhere, and Microsoft’s product, SQL Server, directly compete with our product.
The market for our integration products is highly competitive and subject to rapidly changing technology. We principally compete against custom code, where potential customers have sufficient internal technical resources to develop solutions in-house. In addition, we face competition from vendors of ETL (extract, transform and load) , data warehousing and application integration software products. Such competitors include IBM, Oracle, Business Objects/SAP, Informatica, and Information Builders as well as niche vendors in specific verticals and the SaaS integration marketplace. And, because there are relatively low barriers to entry in the
software market, we may encounter additional competition from other established or emerging companies providing integration products based on existing, new or open-source technologies.
Open-source software may impact our business to the extent interest, demand and use increases in the database or integration segments and poses a challenge to our business model. Firms adopting the open-source software model typically provide customers software produced by loosely associated groups of unpaid programmers, make licenses available to end users at nominal cost, and earn revenue on complementary services and products, without having to bear the full costs of research and development for the open-source software. To the extent competing open-source software products gain increasing market acceptance, sales of our products may decline, we may have to reduce prices we charge for our products, and our revenue and operating margins may decline. Broad adoption of open source databases in the SME market or broad adoption of open source integration solutions could have a material adverse impact on our business.
Proprietary Rights
Our success depends to a significant degree upon our ability to protect our software and other proprietary technology. We rely primarily on a combination of copyright, trademark and trade secret laws, confidentiality procedures and contractual provisions to protect our proprietary rights. However, these measures afford us only limited protection. In addition, we rely in part on “shrink wrap” and “click wrap” licenses that are not signed by the end user and, therefore, may be unenforceable under the laws of certain jurisdictions. Therefore, our efforts to protect our intellectual property may not be adequate. We cannot be certain that others will not develop technologies that are similar or superior to our technology or design around the copyrights and trade secrets owned by us. Unauthorized parties may attempt to copy aspects of our products or to obtain and use information we regard as proprietary. Although we believe software piracy may be a problem, we are unable to determine the extent to which piracy of our software products occurs. In addition, portions of our source code have been developed in foreign countries, where we have used third-party service providers, with laws that do not protect our proprietary rights to the same extent as the laws of the United States.
Employees
As of June 30, 2010, Pervasive employed 229 full-time employees, including 83 in sales and marketing, 73 in research and development, 39 in professional services, customer service and technical support, and 34 in general and administrative. We are not subject to any collective bargaining agreement, and we believe that our relationships with our employees are good.
Facilities
Our leased headquarters facility in Austin, Texas, consists of approximately 94,000 square feet, approximately 14,000 of which has been subleased to a third party. The facility provides additional space and expansion options and is leased through October 2011. We currently lease additional offices in Greenville, South Carolina; Brussels; Frankfurt; London and Paris.
ITEM 1A.
ITEM 1A. RISK FACTORS
You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below are not the only ones we face. Any of the following risks could harm our business, financial condition or results of operations. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment. Please see the “Special Note Regarding Forward-Looking Statements” elsewhere in this Report on Form 10-K.
Our Financial Results May Vary Significantly from Quarter to Quarter
Our operating results have varied significantly from quarter to quarter at times in the past and may continue to vary significantly from quarter to quarter in the future, which could make our future operating results difficult to predict and increase the likelihood that future results may fall below analyst or investor expectations thereby causing our stock price to decline. Such variations are due to a number of factors, many of which are outside our control. These factors include:
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fluctuations in demand for our products, upgrades to our products, or our services;
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fluctuations in the demand for and deployment of client/server applications in which our Pervasive PSQL products are designed to be embedded;
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fluctuations in demand for our products due to the potential impact of deteriorating economic conditions on our customer base;
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seasonality of purchases and the timing of product sales and shipments;
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unexpected delays in introducing new products and services or improvements to existing products and services;
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new product releases, licensing models or pricing policies by our competitors;
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acquisitions or mergers involving us, our competitors or customers;
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impact of changes to our product distribution strategy and pricing policies;
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lack of order backlog;
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loss of significant customer or distributor;
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changes in purchasing and/or payment practices by our distributors or other customers;
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a reduction in the number of ISVs who embed our products or VARs who sell and deploy our products;
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changes in the mix of domestic and international sales;
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impact of changes to our geographic investment levels and business models;
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changes in the cost of routine business activities;
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gains or losses associated with discontinued operations;
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changes in our business plan or strategy;
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impact of severance charges associated with departing employees;
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write-downs of the recorded book value of assets;
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changes in generally accepted accounting principles in the United States; and
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costs associated with the compliance requirements of Section 404 of the Sarbanes-Oxley Act of 2002.
We also derive a significant portion of our revenues from relatively large transactions. The sales cycles for these transactions tend to be longer than the sales cycles on smaller orders. This longer sales cycle for large
transactions makes it difficult to predict the quarter in which these sales will occur. Accordingly, our operating results may fluctuate from quarter to quarter based on the existence and timing of larger transactions. A reduction in large transactions during any quarter could materially impact our revenues.
Additionally, significant portions of our expenses are not variable in the short term and cannot be quickly reduced to respond to decreases in revenues. Therefore, if our revenues are below our expectations, our operating results are likely to be adversely and disproportionately affected. In addition, we may change our prices, modify our distribution strategy and policies, accelerate our investment in research and development, sales or marketing efforts in response to competitive pressures or pursue new market opportunities. Any one of these activities may further limit our ability to adjust spending in response to revenue fluctuations.
Seasonality May Contribute to Fluctuations in Our Quarterly Operating Results
Our business has, on occasion, experienced seasonal customer buying patterns. In past years, we have generally experienced relatively weaker demand in the quarter ending September 30. Demand for our products in Europe and Japan will generally decline in the summer months because of reduced corporate buying patterns during the vacation season. We believe this pattern may occur in the future and may contribute to fluctuations in our quarterly operating results.
Adverse Economic Conditions May Harm Our Operating Results
Our revenue and profitability depend on the overall demand for our products and services, which in turn depends on general economic and business conditions. The nature and extent of the effect of the current adverse economic conditions on our ability to sell our products and services is uncertain. A softening of demand for our products and services caused by weakening of the economy may result in decreased revenues. In addition, such adverse economic conditions may impact our customer’s ability to pay for the products they have purchased and as a consequence, we may not be able to collect our accounts receivable balances and our reserves for doubtful accounts and write-offs of accounts receivable may increase. There can be no assurance we will be able to effectively promote revenue growth rates if the current adverse economic conditions continue or deteriorate.
We Generally Operate Without a Backlog
We generally operate with virtually no order backlog because our software products are shipped and revenue is recognized shortly after orders are received. This lack of backlog makes product revenues in any quarter unpredictable and substantially dependent on orders booked and shipped throughout that quarter. Accordingly, a material decrease in orders in any quarter could have a materially adverse effect on our revenues and operating results.
Our Performance Depends on Market Acceptance of Pervasive PSQL and Our Integration Products
We derive a substantial portion of our revenues from the license of our Pervasive PSQL® products. Continued market acceptance of Pervasive PSQL may be influenced heavily by factors outside of our control, such as new product offerings or promotions by competitors, mergers and acquisitions of customers and competitors, the product development and deployment cycles of developers and resellers who embed or bundle our products into packaged software applications and demand for applications of the type built on our products. Market acceptance of Pervasive PSQL Summit v10.10 (first released in June 2008) and future upgrades also may be influenced by factors in our control such as product quality, relative demand for feature and functionality upgrades and any future product announcements or price changes.
Revenue from our embedded database product, Pervasive PSQL, increased in fiscal years 2010 and 2009 relative to fiscal year 2008. We believe the increase in 2010 and 2009 was primarily due to a number of relatively large transactions with database customers and the release of our latest version of Pervasive PSQL
version 10 in June 2008. Our embedded database and related products represented approximately 60% of our revenue in fiscal year 2010. In addition, we believe the integration products we acquired in fiscal year 2004 as a result of our acquisition of Data Junction Corporation represent a growth opportunity as we invest in opportunities presented by the acquired business and related innovative initiatives. Our integration products represented approximately 35% of our revenue in fiscal year 2010. A reduction in our embedded database business, or our inability to grow our integration products business, could have a material adverse effect on our business, operating results and financial condition.
Our Efforts to Develop and Maintain Brand Awareness of Our Products May Not be Successful
Brand awareness is important given competition in the market for data infrastructure software products. We are aware of other companies that use the word “Pervasive” either in their marks alone or in combination with other words. We expect that it may be difficult or impossible to prevent third-party usage of the Pervasive name and variations of this name for competing goods and services. Competitors or others who use marks similar to our brand name may cause confusion among actual and potential customers, which could prevent us from achieving significant brand recognition. If we fail to promote and maintain our brand or incur significant expenses in an unsuccessful attempt to promote or maintain our brand, our business, operating results and financial condition could be materially adversely affected.
We Must Succeed in the Data Management Software Market as Well as the Data Integration Software Market if We are to be Successful
Our long-term strategic plan depends upon the successful development and introduction of products and solutions that address the needs of the data management software market as well as the data integration software market. In order for us to succeed in these markets, we must align strategies and objectives and focus a significant portion of our resources toward serving these markets.
In addition, our success in these markets will depend on several factors, many of which are outside our control including:
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growth of the data management infrastructure software market;
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growth of the data integration software market;
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deployment of our products by enterprises; and
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emergence of substitute technologies and products.
If we are unable to succeed in these markets, our business may be harmed.
Defects or Disruptions in Our Ability to Deliver Our Products Across Various Platforms Could Diminish Demand for Our Service and Subject Us to Substantial Liability
As we continue to provide more of our products from third party data hosting platforms, there is the potential for there to be defects or disruptions in our ability to deliver our products to our customers. These potential disruptions could result in unanticipated downtime for our customers and harm our reputation and our business. In addition, our customers may use our service in unanticipated ways that may cause a disruption in service for other customers attempting to access their data. Since our customers use our service for important aspects of their business, any errors, defects, disruptions in service or other performance problems with our service could hurt our reputation and may damage our customers’ businesses. If that occurs, customers could elect not to renew, or delay or withhold payment to us, we could lose future sales or customers may make warranty or other claims against us, which could result in an increase in our provision for doubtful accounts, an increase in collection cycles for accounts receivable or the expense and risk of litigation.
Interruptions or Delays in Service From Our Third-Party Data Center Hosting Facilities Could Impair the Delivery of Our Service and Harm Our Business
We currently serve some of our customers from third-party data center hosting platforms. Any damage to, or failure of, the third parties’ systems generally could result in interruptions in our service. Interruptions in our service may reduce our revenue, cause us to issue credits or pay penalties, cause customers to terminate their subscriptions and adversely affect our renewal rates and our ability to attract new customers. Our business will also be harmed if our customers and potential customers believe our service is unreliable.
If Our Security Measures Are Breached and Unauthorized Access is Obtained to a Customer’s Data or Our Data, Our Service May be Perceived as not Being Secure and We May Incur Significant Legal and Financial Exposure and Liabilities
While we have derived the majority of our historical revenues from on premise delivery of our products, we are increasingly offering our products on third party hosted platforms. This method of delivery of our products involves the storage and transmission of customers’ proprietary information, and security breaches could expose us to a risk of loss of this information, litigation and possible liability. These security measures may be breached as a result of third-party action, employee error, malfeasance or otherwise, during transfer of data to additional data centers or at any time, and result in someone obtaining unauthorized access to our data or our customers’ data.
We May Face Problems in Connection With Past Acquisitions, Joint Ventures or Licensing Arrangements
On July 31, 2009, we announced the completion of our purchase of assets of Greenville, South Carolina-based ChanneLinx, Inc. for total consideration of approximately $2.6 million in cash. We cannot be certain we will ultimately realize all of the anticipated benefits of this acquisition to the extent that such benefits are dependent on uncertainties, including the successful integration of ChanneLinx’ employees and technologies with our existing operations and our ability to retain existing ChanneLinx customers following the acquisition.
On December 8, 2003 we announced the completion of our acquisition of privately held Data Junction Corporation, a pioneering data and application integration company based in Austin, Texas, for approximately $16.6 million in cash, net of $6.5 million of cash held by Data Junction at the time of closing of the transaction, and 5 million shares of our common stock. We cannot be certain we will ultimately realize all of the anticipated benefits of the acquisition. In particular we may not realize the strategic and operational benefits we had anticipated, including greater revenue and market opportunities, maintaining industry leadership and consistent profitability.
In July 2001, we formed a business venture with AG-TECH Corporation, a company developing, selling and importing packaged software, to sell and support certain of our products in Japan. AG-TECH has been engaged in the sales and support of Btrieve (predecessor to Pervasive PSQL) and Pervasive PSQL products since 1986. In conjunction with the joint venture, AG-TECH launched a new operating division staffed with specialists experienced in selling and supporting Pervasive PSQL to assume responsibility for OEM sales, packaged software sales, technical support and localization and translation of our products into Japanese. In connection with the new business venture, we obtained a less than 20% ownership interest in AG-TECH and the ability to elect one director to the AG-TECH Board of Directors. While this venture has been successful to date, we cannot be certain that this venture will continue to be successful, which could result in our inability to successfully operate in Japan. In addition, as part of our venture, we executed a three year master distributor agreement with AG-TECH, the initial term of which expired June 30, 2004. This agreement has been renewed twice, most recently for an additional five-year term which expires June 30, 2012. We cannot be certain that we will continue to be able to renew our agreement with AG-TECH on terms and conditions at least as favorable to Pervasive as those contained in our present agreement. Further, we may be unable to maintain or increase Japanese market demand for our products.
We May Face Problems in Connection With Future Acquisitions, Joint Ventures or Licensing Agreements
In the future, we may acquire additional businesses, products and technologies, or enter into joint venture or licensing arrangements, that could complement, modify or expand our business. Our negotiations of potential acquisitions or joint ventures and our integration of acquired businesses, products or technologies could divert management time and resources. Any future acquisitions could require us to issue dilutive equity securities, reduce our cash and marketable securities, incur debt or contingent liabilities, amortize intangibles, or write-off purchased research and development and other acquisition-related expenses. If we are unable to fully integrate acquired businesses, products or technologies with our existing operations, we may not receive the intended benefits of acquisitions. In addition, market reactions to acquisitions are difficult to predict and if we do announce any future acquisitions, such market reactions may cause our stock price to fluctuate.
If Our Goodwill or Amortizable Intangible Assets Become Impaired We May Be Required to Record a Significant Charge to Earnings
Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is tested for impairment at least annually. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively impacting our results of operations.
We May Face Problems in Connection With Product Line Expansion
In the future, we may acquire, license or develop additional products. Future product line expansion may require us to modify or expand our business and expend significant time and resources. If we are unable to fully integrate new products with our existing operations, we may not receive the intended benefits of such product line expansion and related expenditures.
A Small Number of Distributors and Sales Related to Accounting Software Applications Account for a Significant Percentage of Our Revenues
The loss of a major distributor, changes in a distributor’s payment practices, changes in the financial stability of a major distributor or any reduction in orders by such distributor, including reductions due to market or competitive conditions, combined with the potential inability to replace the distributor on a timely basis, or any modifications to our pricing or distribution channel strategy could materially adversely affect our business, operating results and financial condition. Many of our ISVs, VARs and end users place their orders through distributors. A relatively small number of distributors have accounted for a significant percentage of our revenues. In the fiscal year ended June 30, 2010, one distributor (our joint venture partner in Japan, AG-TECH Corporation) accounted for an aggregate of approximately 11% of our revenues, as compared to 10% in the fiscal year ended June 30, 2009. Additionally, sales related to accounting software applications has, at various times, represented as much as 20% of our revenues. Furthermore, there has been consolidation taking place among our ISVs that could narrow the number of customers who sell our products. For example, one of our ISVs, The Sage Group plc, has acquired Timberline Software Corporation, Softline Limited, ACCPAC International Inc., Sage Sesame and TAS Software, five of our ISVs. The Sage Group family of companies has, at various times, represented approximately 10% of our revenues. As a result, we expect we will continue to depend on a limited number of distributors, certain of our ISV customers and sales related to accounting software applications for a significant portion of our revenues in future periods and the loss of a significant distributor or ISV customer could materially adversely affect our business, operating results and financial condition. Moreover, we expect that such distributors and sales related to accounting software applications will vary from period to period. Our
distributors have not agreed to any minimum order requirements. Although we forecast demand and plan accordingly, if a distributor purchases excess product, we may be obligated to accept the return of some products.
We Depend on Our Indirect Sales Channel
Our failure to grow our indirect sales channel or the loss of a significant number of members of our indirect channel partners would have a material adverse effect on our business, financial condition and operating results. We derive a substantial portion of our revenues from indirect sales through a channel consisting of ISVs, VARs, SIs, consultants and distributors. Our sales channel could be adversely affected by a number of factors, many of which are outside of our control, including:
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the failure of ISVs to develop, and the failure of VARs to sell, products based on emerging platforms supported by us;
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pressures placed on the sales channel to sell competing products;
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our failure to adequately support the sales channel;
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consolidation of certain of our indirect channel partners;
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competing product lines offered by certain of our indirect channel partners; and
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business model or licensing model changes of our channel partners or their competitors.
We cannot be certain we will be able to continue to attract additional indirect channel partners or retain our current channel partners. In addition, we cannot be certain our competitors will not attempt to recruit certain of our current or future channel partners. Such competitive actions may have an adverse effect on our ability to attract and retain channel partners, which, in turn, may have a material adverse effect on our business, financial condition and operating results.
We May Not Be Able to Sustain or Develop Strategic Relationships
From time to time, we enter into strategic collaborative relationships with other companies in areas such as product development, marketing, distribution and implementation, which allow us to realize a variety of benefits. Many of our current strategic relationships are informal, or, if written, terminable with little or no notice. Additionally, many of our current and potential strategic partners are either actual or potential competitors with us. For these reasons, we may not be able to sustain our current strategic relationships or enter into successful new strategic relationships in the future, which could have a material adverse effect on our business, operating results and financial condition.
We Depend on Third-Party Technology in Our Products
We rely upon certain software we license from third parties, including software integrated with our internally developed software and used in our products to perform key functions. These third-party software licenses may not continue to be available to us on commercially reasonable terms. The loss of, or inability to maintain or obtain any of these software licenses, could result in shipment delays or reductions until we develop, identify, license and integrate equivalent software. Any delay in product development or shipment could damage our business, operating results and financial condition.
We May be Unable to Protect Our Intellectual Property and Proprietary Rights
Our success depends to a significant degree upon our ability to protect our software and other proprietary technology. We rely primarily on a combination of copyright, trademark and trade secret laws, confidentiality procedures and contractual provisions to protect our proprietary rights. However, these measures afford us only limited protection. In addition, we rely in part on “shrink wrap” and “click wrap” licenses that are not signed by
the end user and, therefore, may be unenforceable under the laws of certain jurisdictions. Therefore, our efforts to protect our intellectual property may not be adequate. We cannot be certain that others will not develop technologies that are similar or superior to our technology or design around the copyrights and trade secrets owned by us. Unauthorized parties may attempt to copy aspects of our products or to obtain and use information we regard as proprietary. Although we believe software piracy may be a problem, we are unable to determine the extent to which piracy of our software products occurs. In addition, portions of our source code have been developed in foreign countries, such as in India where we have used third-party service providers, with laws that do not protect our proprietary rights to the same extent as the laws of the United States.
We may be subjected to claims of intellectual property infringement by third parties as the number of products and competitors in our industry segment continues to grow and the functionality of products in different industry segments increasingly overlaps. Any infringement claims, with or without merit, could be time-consuming, result in costly litigation, divert management attention and resources, cause product shipment delays or the loss or deferral of sales or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In the event of a successful claim of intellectual property infringement against us, should we fail or be unable to either license the technology or similar technology or develop alternative technology on a timely basis, our business, operating results and financial condition could be materially adversely affected.
We Must Adapt to Rapid Technological Change
Our future success will depend upon our ability to continue to enhance our current products and to develop and introduce new products on a timely basis that keep pace with technological developments and new industry standards and satisfy increasingly sophisticated customer requirements. Rapid technological change, frequent new product introductions and enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards characterize the market for our products. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. As a result of the complexities inherent in client/server and Web computing environments and in data and application integration solutions, and the performance demanded by customers for data infrastructure software products, new products and product enhancements can require long development and testing periods. As a result, significant delays in the general availability of such new releases or significant problems in the installation or implementation of such new releases could have a material adverse effect on our business, operating results and financial condition. We have experienced delays in the past in the release of new products and new product enhancements. In the future, we may not be successful in developing and marketing, on a timely and cost-effective basis, new products or new product enhancements that respond to technological change, evolving industry standards or customer requirements, avoiding difficulties that could delay or prevent the successful development, introduction or marketing of these products, or achieving market acceptance for our new products and product enhancements, any of which could have a material adverse effect on our business, operating results and financial condition.
Our Software May Contain Errors or Defects
Software products such as ours may contain errors, sometimes called “bugs,” particularly when first introduced or when new versions or enhancements are released. From time to time, we discover software errors in certain of our new products after their introduction. Despite our testing, current versions, new versions or enhancements of our products may still have errors after commencement of commercial shipments. Errors or defects in our products may result in loss of revenues, delay in market acceptance, diversion of development resources or injury to our brand and reputation and could materially adversely affect our business, operating results and financial condition.
We May Become Subject to Product or Professional Services Liability Claims
A product or professional services liability claim, whether or not successful, could damage our reputation and our business, operating results and financial condition. Our license and service agreements with our customers typically contain provisions designed to limit our exposure to potential product or service liability claims. However, these contract provisions may not preclude all potential claims. Product or professional services liability claims could require us to spend significant time and money in litigation or to pay significant damages.
We Compete with Microsoft while Simultaneously Supporting Microsoft Technologies
We currently compete with Microsoft in the market for data management products while simultaneously maintaining a working relationship with Microsoft. Microsoft has a longer operating history, a larger installed base of customers and substantially greater financial, distribution, marketing and technical resources than us. As a result, we may not be able to compete effectively with Microsoft now or in the future, and our business, operating results and financial condition may be materially adversely affected.
We expect that Microsoft’s commitment to and presence in the data management products market will continue to assert competitive pressure. We believe that Microsoft will continue to incorporate SQL Server database technology into its operating system software and certain of its server software offerings, possibly at no additional cost to its users. Microsoft currently licenses a royalty-free limited version of its SQL Server database technology. We believe that Microsoft will also continue to enhance its SQL Server database technology and that Microsoft will continue to invest in various sales and marketing programs involving certain of our channel partners.
In addition, Microsoft has grown its presence in the software applications market. For example, they acquired Great Plains Software, a former channel partner of Pervasive, and Navision, both of which are accounting software vendors. Microsoft has also entered the customer relationship management software market. We believe that Microsoft will continue to grow its presence in the software applications market and in doing so, may have a negative impact on the financial stability of other software application vendors who use our products, or may influence other software application vendors to use Microsoft infrastructure software products instead of those available from us.
We believe we must maintain a working relationship with Microsoft to achieve success. Many of our customers use Microsoft-based operating platforms. Thus, it is critical to our success that our products be closely integrated with Microsoft technologies. Notwithstanding our historical and current support of Microsoft platforms, Microsoft may in the future promote technologies and standards more directly competitive with or not compatible with our technology.
We Face Significant Competition From Other Companies
We encounter competition for our embedded database products primarily from large, public companies, including Microsoft, Oracle, Sybase/SAP, IBM and Progress. In particular, Sybase’s small memory footprint database software product, Adaptive Server Anywhere, and Microsoft’s product, SQL Server, directly compete with our products.
The market for our integration products is highly competitive and subject to rapidly changing technology. We principally compete against custom code, where potential customers have sufficient internal technical resources to develop solutions in-house. In addition, we face competition from vendors of ETL (extract, transform and load), data warehousing and application integration software products. Such competitors include IBM, Oracle, Business Objects/SAP, Informatica, and Information Builders, as well as niche vendors in specific verticals and the SaaS marketplace. In addition, we compete or may compete against database vendors that
currently offer, or may develop, products with functionalities that compete with our integration solutions. These products typically operate specifically with these competitors’ proprietary databases. Such competitors include IBM, Microsoft, Sybase/SAP and Oracle. And, because there are relatively low barriers to entry in the software market, we may encounter additional competition from other established or emerging companies providing integration products based on existing, new or open-source technologies.
Open-source software, which is an emerging trend in the software marketplace, may impact our business as interest, demand and use increases in the database and integration segments and poses a challenge to our business model. Firms adopting the open-source software model typically provide customers software produced by loosely associated groups of unpaid programmers, make licenses available to end users at nominal cost, and earn revenue on complementary services and products, without having to bear the full costs of research and development for the open-source software. To the extent competing open-source software products gain increasing market acceptance, sale of our products may decline, we may have to reduce prices we charge for our products, and our revenue and operating margins may decline. Mass adoption of open source databases in the SME market could have a material adverse impact on our database business.
Software-as-a-Service (SaaS) vendors have and may continue to enter our market and could cause a change in revenue models from licensing of client/server and Web-based applications to renting applications. Our competitors may be more successful than we are in adopting these revenue models and capturing related market share.
Most of our competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers. In addition, some competitors have demonstrated a willingness to, or may willingly in the future, incur substantial losses as a result of deeply discounted product offerings or aggressive marketing campaigns. For example, Microsoft, Oracle, IBM and Sybase all currently license royalty-free limited versions of their database technologies. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of competitive products, than we can. There is also a substantial risk that changes in licensing models or announcements of competing products by competitors such as Microsoft, Oracle, Sybase/SAP, IBM, Progress, MySQL/Oracle, Ascential/IBM, Business Objects/SAP, Informatica, Information Builders or others could result in the cancellation of customer orders in anticipation of the introduction of such new licensing models or products. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address customer needs, which may limit our ability to sell our products through particular partners. Accordingly, new competitors or alliances among, or consolidations of, current and new competitors may emerge and rapidly gain significant market share in our current or anticipated markets. We also expect competition will increase as a result of software industry consolidation. Increased competition is likely to result in price reductions, fewer customer orders, reduced margins and loss of market share, any of which could materially adversely affect our business, operating results and financial condition. We cannot be certain we will be able to compete successfully against current and future competitors or that the competitive pressures we face will not materially adversely affect our business, operating results and financial condition.
We are Susceptible to a Shift in the Market for Client/Server Applications Toward Web-Based or Hosted Applications
We have derived substantially all of our historical embedded database product revenues from the use of our products in client/server applications. We expect to rely on continued market demand for client/server applications indefinitely. However, we believe market demand may shift from client/server applications to Web-based or hosted applications. If so, we cannot be certain our existing client/server developers will migrate to Web-based or hosted applications and continue to use our products or that other developers of Web-based or hosted applications would select our data management products. In addition, this shift could result in a change in
revenue models from licensing of client/server applications to renting of Web-based or hosted applications from SaaS vendors. A decrease in client/server application sales coupled with an inability to derive revenues from the Web-based or hosted application market could have a material adverse effect on our business, operating results and financial condition.
We Depend on International Sales and Operations
We anticipate for the foreseeable future we will derive a significant portion of our revenues from sources outside North America. In the fiscal year ended June 30, 2010, we derived 30% of our revenues outside North America. Our international operations are generally subject to a number of risks. These risks include:
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foreign laws and business practices favoring local competition;
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dependence on local channel partners;
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compliance with multiple, conflicting and changing government laws and regulations;
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longer sales cycles;
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greater difficulty or delay in collecting payments from customers;
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difficulties in staffing and managing foreign operations;
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foreign currency exchange rate fluctuations and the associated effects on product demand and timing of payment;
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increased tax rates in certain foreign countries;
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complexities with financial reporting in foreign countries;
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quality control of certain development, translation or localization activities;
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political, social and economic instability; and
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reduced or different protections for intellectual property rights in some foreign countries.
We may expand or modify our operations internationally. Despite our efforts, we may not be able to expand or modify our operations internationally in a timely and cost-effective manner. Such an outcome would limit or eliminate any sales growth internationally, which in turn would materially adversely affect our business, operating results and financial condition. Even if we successfully expand or modify our international operations, we may be unable to maintain or increase international market demand for our product.
We expect our international operations will continue to place financial and administrative demands on us, including operational complexity associated with international facilities, administrative burdens associated with managing relationships with foreign partners, and treasury functions to manage foreign currency risks and collections.
Fluctuations in the Relative Value of Foreign Currencies Can Affect Our Business
To date, the majority of our transactions have been denominated in U.S. dollars. The majority of our international operating expenses and substantially all of our sales in Japan have been denominated in currencies other than the U.S. dollar. Therefore, our operating results may be adversely affected by changes in the relative value of the U.S. dollar. Certain of our international sales are denominated in U.S dollars, especially in Europe. Any strengthening of the U.S. dollar against the currencies of countries where we sell products denominated in U.S. dollars will increase the relative cost of our products and could negatively impact our sales in those countries. To the extent our international operations expand or are modified, our exposure to exchange rate fluctuations may increase. We have, on occasion, entered into limited hedging transactions to mitigate our exposure to currency fluctuations. Despite these hedging transactions, exchange rate fluctuations have caused,
and will continue to cause, currency transaction gains and losses. Although these transactions have not resulted in material gains and losses to date, similar transactions could have a damaging effect on our business, results of operations or financial condition in future periods.
We Must Continue to Hire and Retain Skilled Personnel
Our success depends in large part on our ability to attract, motivate and retain highly skilled employees on a timely basis, particularly executive management, sales and marketing personnel, software engineers and other senior personnel. Our efforts to attract and retain highly skilled employees could be harmed by our past or any future workforce reductions. Our failure to attract and retain the highly trained technical personnel who are essential to our product development, marketing, service and support teams may limit the rate at which we can generate revenue and develop new products or product enhancements. This could have a material adverse effect on our business, operating results and financial condition.
We issue stock options and restricted stock as key components of our overall compensation. There is pressure on public companies from shareholders generally and various organizations to reduce the rate at which companies issue stock options and restricted stock to employees, which may make it more difficult to obtain shareholder approval of equity compensation plans when required. In addition, we believe expensing stock options and restricted stock will increase shareholder pressure to limit future grants and could make it more difficult for us to grant stock options and restricted stock to employees in the future. As a result, we may lose top employees to non-public, start-up companies or may generally find it more difficult to attract, retain and motivate highly skilled employees, either of which could materially and adversely affect our business, results of operations and financial condition.
We Have Anti-Takeover Provisions
Our Restated Certificate of Incorporation and Amended and Restated Bylaws contain certain provisions that may have the effect of discouraging, delaying or preventing a change in control or unsolicited acquisition proposals that a stockholder might consider favorable. These provisions include provisions to authorize the issuance of “blank check” preferred stock, establish advance notice requirements for stockholder nominations for elections to the Board of Directors or for proposing matters that can be acted upon at stockholders’ meetings; eliminate the ability of stockholders to act by written consent; require super-majority voting to approve certain amendments to the Restated Certificate of Incorporation; limit the persons who may call special meetings of stockholders; and provide for a Board of Directors with staggered, three-year terms. In addition, certain provisions of Delaware law and our 1997 Stock Incentive Plan and our 2006 Equity Incentive Plan may also have the effect of discouraging, delaying or preventing a change in control or unsolicited acquisition proposals.
Further, in October 2000, our Board of Directors approved the adoption of a shareholder rights plan (the Rights Plan). The Rights Plan will expire in October 2010.
We May Elect to Raise Additional Capital Which Might Not Be Available or Which, if Available, May Be on Terms That Are Not Favorable to Us
We may elect to raise additional funds, and we cannot be certain we will be able to obtain additional financing on favorable terms, if at all. If we issue equity securities, the ownership percentage of our stockholders would be reduced, and the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. If we borrow money, we may incur significant interest charges, which could harm our profitability. Holders of debt would also have rights, preferences or privileges senior to those of existing holders of our common stock. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our product, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could seriously harm our business, operating results and financial condition.
The Price of Our Stock Has Been Volatile and Could Continue to Fluctuate Substantially
Our common stock is traded in the NASDAQ Global Market. The market price of our common stock has been volatile and could fluctuate substantially based on a variety of factors outside of our control, in addition to our financial performance. Furthermore, stock prices for many companies, including our own, fluctuate widely for reasons that may be unrelated to operating results.
During the seventeen fiscal quarters ending June 30, 2010, the Company has acquired approximately 8.6 million shares of its common stock on the open market at a total cost of approximately $36.0 million, or approximately $4.16 price per share. The Company’s Board of Directors recently approved a new stock repurchase plan effective July 27, 2010, whereby the Company may repurchase additional shares of its common stock with a value of up to $10 million. Depending on market conditions and other factors, such purchases may be commenced or suspended at any time without prior notice. There can be no assurance that we will continue to buy any of our common stock under our share repurchase program or that any past or future repurchases will have a positive impact on our stock price. Important factors that could cause us to discontinue our share repurchases include, among others, unfavorable market conditions, the market price of our common stock, the nature of other investment opportunities presented to us from time to time, and the availability of funds necessary to continue purchasing common stock.
We May Be Exposed to Potential Risks if We Do Not Have an Effective System of Disclosure Controls or Internal Controls or Fail on an On-going Basis to Properly Address and Implement Section 404 of Sarbanes-Oxley
We must comply, on an on-going basis, with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (SOX), including those provisions that establish the requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting. If we fail to maintain an effective system of disclosure controls or internal control over financial reporting, including satisfaction of the requirements of Section 404 of SOX, we may not be able to accurately or timely report on our financial results or adequately identify and reduce the likelihood of fraud. Additionally, if we were to identify any material weakness over our internal control over financial reporting, we also cannot ensure that we could correct any such material weakness to allow our management to conclude that our internal controls over financial reporting are effective in time to enable our independent registered public accounting firm to attest that such assessment will have been fairly stated in any report to be filed with the SEC or attest that we have maintained effective internal control over financial reporting. As a result, the financial position of our business could be harmed; current and potential future shareholders could lose confidence in us and/or our reported financial results, which may cause a negative effect on our trading price; and we could be exposed to litigation or regulatory proceedings, which may be costly or divert management attention.
Our Reported Financial Results May be Adversely Affected by New Accounting Pronouncements or Changes in Existing Accounting Standards and Practices
We prepare our financial statements in conformity with accounting principles generally accepted in the U.S. These accounting principles are subject to interpretation by the Financial Accounting Standards Board (FASB), the SEC and various organizations formed to interpret and create appropriate accounting standards and practices. New accounting pronouncements and varying interpretations of accounting standards and practices have occurred and may occur in the future. New accounting pronouncements or a change in the interpretation of existing accounting standards or practices may have a significant effect on our reported financial results and may even affect our reporting of transactions completed before the change is announced or effective.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements in the “Letter to Stockholders” in the Annual Report and this Report on Form 10-K under “Business,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Report constitute forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934. Forward-looking statements include statements regarding the Company’s expectations, beliefs, hopes, intentions or strategies regarding the future. These statements involve known and unknown risks, uncertainties, and other factors that may cause our or our industry’s actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, those listed under “Risk Factors” and elsewhere in this Report on Form 10-K.
In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could”, “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of such terms or other comparable terminology.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. We are under no duty to update any of the forward-looking statements after the date of this Report to conform such statements to actual results.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2010 fiscal year that remained unresolved.
ITEM 2.
ITEM 2. PROPERTIES
Our leased headquarters facility in Austin, Texas, consists of approximately 94,000 square feet, approximately 14,000 of which has been subleased to a third party. The facility provides additional space and expansion options and is leased through October 2011. We currently lease offices in Greenville, South Carolina, Brussels, Frankfurt, London and Paris. We believe our existing facilities are suitable and will be adequate to meet our needs for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The company is not a party to any material legal proceeding.
On January 21, 2010, JuxtaComm-Texas Software, LLC (“JuxtaComm”) filed a complaint (as amended April 22, 2010) in the Eastern District of Texas against 20 defendants, including Pervasive, alleging patent infringement. The case is currently in the early discovery phase. We filed an answer to the complaint on May 5, 2010. On July 15, 2010, JuxtaComm filed its Disclosure of Asserted Claims and Infringement Contentions. We filed our patent Invalidity Contentions on September 13, 2010. The patent in question, United States Patent number 6,195,662 titled “System for Transforming and Exchanging Data Between Distributed Heterogeneous Computer Systems,” was issued on February 27, 2001 with a filing date of June 26, 1998. Data Junction Corporation, acquired by Pervasive in December 2003, has been in the data integration business since the mid-1980s and sold its data transformation products long prior to the filing of the Juxtacomm patent. Pervasive’s products use the DataJunction data transformation engine and therefore we believe the patent is either invalid or our products do not infringe the patent. Additionally, there exists substantial “prior art” to point to in our defense and we believe we will prevail either (a) in our patent invalidity contentions or (b) our non-infringement contentions. Pervasive intends to vigorously defend itself and believes the outcome of this proceeding will not have a material adverse effect on our business, operating results or financial condition.
ITEM 4.
ITEM 4. (Removed and Reserved)
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of the Company is traded in the Nasdaq Global Market under the symbol PVSW. The Company completed its initial public offering and commenced trading on September 26, 1997. The following tables set forth the high and low closing sales prices of the Company’s common stock for each quarterly period during the two years ended June 30, 2010.
As of August 31, 2010, there were approximately 235 stockholders of record (which number does not include the number of stockholders whose shares are held by a brokerage house or clearing agency, but does include such brokerage house or clearing agency as one record holder.
The Company has never paid a cash dividend on its common stock and does not intend to pay cash dividends on its common stock in the foreseeable future.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
On July 27, 2010, we announced the authorization of a new $10.0 million stock repurchase plan which became effective on July 27, 2010. During the three months ended June 30, 2010 and the 27 days ended July 27, 2010, we repurchased 460,746 and 345,265 shares of common stock at a cost of approximately $2.3 million and $1.7 million, respectively, under the prior stock repurchase plan approved in March 2009. The transactions occurred in open market purchases. The repurchase program may be suspended or discontinued at any time without prior notice.
The Company had no sales of unregistered securities in fiscal year ended June 30, 2010.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this Form 10-K. The consolidated statements of income data for the fiscal years ended June 30, 2008, 2009 and 2010 and the consolidated balance sheet data at June 30, 2009 and 2010 are derived from audited consolidated financial statements included elsewhere in this Form 10-K. The consolidated statements of income data for the periods ended June 30, 2006 and 2007 and the consolidated balance sheet data at June 30, 2006, 2007 and 2008 are derived from audited consolidated financial statements not included herein.
(1) Total costs and expenses include the impact of SFAS 123(R) share-based payments of $3.0 million, $2.1 million, $1.8 million, $1.7 million and $1.8 million for the years ended June 30, 2006, 2007, 2008, 2009 and 2010, respectively. See Note 2 Summary of Significant Accounting Policies.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated in the forward-looking statements. Please see the “Special Note Regarding Forward-Looking Statements” elsewhere in this Report on Form 10-K.
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) includes the following sections:
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Executive Overview that discusses at a high level our business, our operating results and some of the trends that affect our business.
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Critical Accounting Policies and Estimates that we believe are important to understanding the assumptions and judgments underlying our financial statements.
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Results of Operations that begins with a table summarizing results of operations expressed as percentages of revenues for the periods presented, followed by a more detailed discussion of our revenue and expenses.
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Liquidity and Capital Resources which discusses key aspects of our statements of cash flows, changes in our balance sheets and our financial commitments.
You should note that this MD&A discussion contains forward-looking statements that involve risks and uncertainties. Please see the section entitled “Special Note Regarding Forward-Looking Statements” at the end of Item 1A for important information to consider when evaluating such statements.
You should read this MD&A in conjunction with the Consolidated Financial Statements and related Notes.
Executive Overview
Our Business
Pervasive Software (NASDAQ: PVSW) helps companies get the most out of their data investments through agile and embeddable software and cloud-based services for data management, data integration, B2B exchange and analytics. The embeddable Pervasive PSQL™ database engine provides robust database reliability in a near-zero database administration environment for packaged business applications. Pervasive’s multi-purpose data integration platform, available on-premises and in the cloud, accelerates the sharing of information between multiple data stores, applications, and hosted business systems and allows customers to re-use the same software for diverse integration scenarios.
Our PSQL database products generated approximately 60% of our revenue during fiscal year 2010. Channel adoption trends for version 10 of our Pervasive PSQL database have been good since its launch in September 2007, along with subsequent updates including Pervasive PSQL v10.10, which is Microsoft Certified for Windows Server 2008, and Pervasive PSQL v10 SP3 for compatibility with Windows 7. Our most recent version, Pervasive PSQL v11, is scheduled for release in September 2010. Pervasive PSQL v11 delivers improvements in performance and increased simplicity of development, deployment and ease of use, including enhanced digital license management and enhanced support for IPv6 and multi-core technologies.
Our Integration products generated approximately 35% of our revenue and are well-received by our existing and new customers, including end users and commercial cloud and on-premises software developers alike.
Our solid results in both of our core product lines allow us to continue to fund our commitment to innovation. We intend to continue to invest in innovation by allocating dedicated funds for research focused on new ways to serve our existing customers and attract new customers. Our innovation efforts in fiscal year 2008,
2009 and 2010 have resulted in the introduction and further development of various new product and service offerings:
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Pervasive DataSolutions-subscription-based integration as a service delivered on-premises or as a multi-tenant service hosted by Pervasive and potentially by our ISV customers,
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Pervasive DataRush-our high-performance software platform for scalable data-intensive data preparation and analytics, designed to capture the parallel processing capabilities of multi-core technologies, and
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Pervasive DataCloud®-a scalable, adaptable platform for hosting Pervasive- or partner-developed services.
For more than two decades, Pervasive products have delivered value with a compelling combination of performance, flexibility, reliability and low total cost of ownership. In addition, significant portions of our database and integration flagship product lines are embeddable into commercial applications for sale predominantly through a well-developed channel of independent software vendors (ISVs), Software-as-a-Service (SaaS) vendors, value-added resellers (VARs) and system integrators.
On July 31, 2009, we completed the purchase of assets from Greenville, SC-based ChanneLinx, Inc., a Web-based electronic data interchange (Web DI) technology company, for total consideration of approximately $2.6 million in cash. The acquired business, which now operates as Pervasive Business Xchange, is complementary to the Company’s other products and operations. Pervasive Business Xchange has provided additional revenues of $1.7 million for the period August 1, 2009 to June 30, 2010.
We develop, market, sell and support our offerings worldwide through our principal office in Austin, Texas and our Greenville, South Carolina office and through international offices in Brussels, Frankfurt, Paris and London and a joint venture in Japan.
Our Operating Results
Our comparative results for the fiscal year ended June 30, 2010:
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Revenue was $47.2 million and $47.2 million in the fiscal years ending June 30, 2010 and 2009, respectively. The company closed two relatively large transactions with database customers representing approximately $2.4 million in revenue during the first quarter of fiscal year 2010 and approximately $3.0 million in revenue during the third quarter of fiscal year 2009.
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Net income was $4.1 million and $5.3 million in the fiscal years ending June 30, 2010 and 2009, respectively.
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Operating income, a financial measure before interest income and taxes, was $5.6 million and $6.7 million in the fiscal years ending June 30, 2010 and 2009, respectively.
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We continued to generate positive cash flow from operations with $6.6 million and $6.5 million in the fiscal years ending June 30, 2010 and 2009, respectively. We ended fiscal year 2010 with $40.4 million in cash and marketable securities.
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We acquired approximately 1.2 million shares of our common stock, at a cost of approximately $6.1 million in the fiscal year ending June 30, 2010. Issued and outstanding shares of common stock as of June 30, 2010 totaled approximately 17.2 million.
Market Trends
Over the past 25 years, businesses of all sizes have invested billions of dollars in application software that enabled them to automate and simplify their business processes. As the sales and implementation of these
application packages proliferated, including increasingly heterogeneous environments that use both cloud-based and on-premises software, organizations have faced increasing data and application infrastructure challenges and an entire software market segment emerged to address these challenges. The growth of the infrastructure software market in the United States, we believe, can primarily be traced to the demand for technologies that extend the use of established systems, enable the rapid deployment of new applications, and improve the ability to collaborate and communicate with customers and suppliers.
At the same time, we believe that the software markets as a whole are going through rapid change. The emergence of cloud-based infrastructure and applications is testament to the increasing demand for the scalability and rapid deployment provided by the SaaS delivery model. Organizations increasingly demand software that provides ease of use, re-usability, standards compliance, and cost-effective maintenance. In this environment, having a “value” orientation-delivering flexibility and performance with high return on investment-becomes increasingly critical. As these market disruption trends continue, we believe infrastructure software will be a key ingredient for all businesses as they seek to integrate and streamline their back-end systems and eliminate delays in the management and execution of critical processes. Infrastructure software includes, among other things, application development tools, integration tools and solutions, business intelligence, database, and security solutions. Additionally, in uncertain economic environments, customers tend to be conservative about investments in new technology and remain loyal to proven technologies.
In addition, the rapid proliferation of commodity multicore hardware, along with exploding data volumes, provides opportunities for companies to leverage affordable servers that have multiple cores in a single box to extract value from large volumes of data-but only if they have software that can effectively scale on multiple cores. The inevitable performance gains traditionally delivered by faster processors under “Moore’s Law” now must rely on a new generation of infrastructure software that can scale on ever-updating multicore hardware platforms.
We believe these trends will favor Pervasive. We believe the market for data infrastructure software, in particular, is experiencing significant market disruption due to the high cost of many competing, more labor-intensive solutions. We further believe well-established value leaders tend to prevail in cost-sensitive markets, and Pervasive, with its strengths in scalable data management and integration solutions, is well-positioned to benefit from the trends in these markets. Pervasive also delivers the Pervasive DataRush platform that powers applications with seamless scalability on multicore servers. Separately, updates to the flagship Pervasive PSQL database enable applications that embed the database to deliver significant performance improvements on dual-core, 4-core and 8-core servers. In addition, the ability to deliver preconfigured packaged integration solutions offers the opportunity to attract non-technical users and address unmet market needs. While the global economic slowdown continues, we believe our value orientation and reputation as an established vendor with highly reliable offerings positions Pervasive to continue to prosper.
Risks to our Success
Risks and uncertainties include, among others, our ability to attract and retain existing and/or new customers; our ability to issue new products or releases of solutions that meet customers’ needs or achieve acceptance by the Company’s customers; changes to current accounting policies which may have a significant, adverse impact upon the Company’s financial results; the introduction of new products by competitors or the entry of new competitors; our ability to preserve our key strategic relationships; our ability to hire and retain key employees; and economic and political conditions in the US and abroad. All of these factors, as well as those discussed in Item 1A - Risk Factors, may result in significant fluctuations in our quarterly operating results and/or our ability to sustain or increase our profitability.
Going Forward
In 2011, the Company is focused on:
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the continued marketing of our embedded database product, Pervasive PSQL Summit v10.10, and our next version release, Pervasive PSQL 11, scheduled for release in September 2010;
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growing the sales of our integration product line both through direct sales and through highly leverageable indirect channels;
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continuing the investment in new product and service innovation, including the further advancement of our innovation initiatives from fiscal 2010: Pervasive DataSolutions (to take advantage of market trends in Integration-as-a-Service and other on demand data solutions), Pervasive DataCloud (to provide a scalable cloud-based platform for development and deployment of both Pervasive- and partner-developed on-demand services) and Pervasive DataRush (to serve revolutionary next-generation analytics by capturing the parallel processing capabilities of proliferating multi-core technologies).
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growing the Pervasive Business Xchange Web-based electronic data interchange business and customer base; and,
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the continued focus on generating profitable results and positive cash flows, while we look for opportunities to reduce our issued and outstanding shares, putting to work our approved share repurchase program.
We remain committed to a strategic balance of investment in both our flagship and emerging products while also maintaining an intense focus on operating profitability.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions are reviewed periodically. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following represent our critical accounting policies:
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Revenue Recognition
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Sales Returns and Bad Debt Reserves
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Goodwill and Other Intangible Assets
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Stock-Based Compensation Expense
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Taxes
Revenue Recognition-We license our software through OEM license agreements with software developers, or ISVs and through shrink-wrap software licenses, sold through ISVs, VARs, systems integrators and distributors, or direct to end users. Revenues are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant Company obligations with regard to implementation remain, the fee is fixed or determinable and collectability is probable. Revenues related to OEM license agreements involving nonrefundable fixed minimum license fees are generally recognized upon delivery of the product master or first copy if no significant vendor obligations remain. Per copy royalties related to OEM license agreements in excess of a fixed minimum amount are recognized as revenue when such amounts are reported to
us. Revenue from post contract support and the right to receive unspecified upgrades is recognized ratably over the contract term. We generally provide telephone support to customers and end users in the 30 days immediately following the sale at no additional charge and at a minimal cost per call. We accrue the cost of providing this support. Revenue from consulting services and training is recognized when the related services are performed. We enter into agreements with certain distributors that provide for certain stock rotation and price protection rights. These rights allow the distributor to return product in a non-cash exchange for other products or for credits against future purchases. Revenue from shipping and handling is recognized at the shipping date. Shipping and handling costs are included in costs of product license revenues in the Consolidated Statements of Income.
Where software licenses are sold with maintenance or other services, we allocate the total fee to the various elements based on the fair values of the elements. We determine the fair value of each element in the arrangement based on vendor-specific objective evidence (“VSOE”) of fair value. VSOE of fair value is based upon the normal pricing and discounting practices for those products and services when sold separately and, for support services, is additionally measured by the renewal rate. If we do not have VSOE for one of the delivered elements of an arrangement, but do have VSOE for all undelivered elements, we use the residual method to record revenue. Under the residual method, the arrangement fee is first allocated to the undelivered elements based upon their VSOE of fair value; the remaining arrangement fee, including any discount, is allocated to the delivered element. If the residual method is not used, discounts, if any, are applied proportionately to each element included in the arrangement based on each element’s fair value without regard to the discount.
Sales Returns and Bad Debt Reserves-We reserve the cost of estimated sales returns, stock rotation and price protection rights as well as uncollectible accounts based on experience. We evaluate quarterly the adequacy of the reserve for sales returns, stock rotation and price protection. Because these reserves are based on our judgments and estimates, our reserves may not be adequate to cover actual sales returns and other allowances. If our reserves are not adequate, our net sales could be adversely affected.
Goodwill and Other Intangible Assets-We assess whether goodwill and indefinite-lived intangibles are impaired on an annual basis and review for triggering events on an ongoing basis. Upon determining the existence of goodwill and/or indefinite-lived intangibles impairment, we measure impairment based on the amount by which the book value of goodwill and/or indefinite-lived intangibles exceeds its fair value. The fair value of an asset is the amount at which that asset could be bought or sold in a current transaction between willing parties in an orderly transaction between market participants. Additional impairment assessments may be performed on an interim basis if we encounter events or changes in circumstance that would indicate that, more likely than not, the book value of goodwill and/or indefinite-lived intangibles has been impaired.
Stock-Based Compensation Expense-We account for employee share-based compensation costs, to include stock options and restricted stock, in accordance with ASC 718 Compensation - Stock Compensation. We utilize the Black-Scholes option pricing model to estimate the fair value of employee stock option compensation at the date of grant, which requires the input of highly subjective assumptions, including expected volatility and expected life. Historical volatility was used in estimating the fair value of our share-based awards rather than implied volatility, while the expected life was estimated to be four years based on historical trends since our initial public offering. Further, we estimate forfeitures for options granted, which are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. The estimated fair value is charged to earnings on a straight-line basis over the vesting period of the underlying awards, which is generally four years. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options having no vesting restrictions and being fully transferable. Accordingly, our estimate of fair value may not represent the value assigned by a third-party in an arms-length transaction. While our estimate of fair value and the associated charge to earnings materially impacts our results of operations, it has no impact on our cash position.
Taxes-Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective
tax bases and net operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
We estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes and net operating loss and tax credit carryforwards. These differences result in deferred tax assets and liabilities. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not more likely than not, we establish a valuation allowance. Prior to fiscal year 2006, we had concluded that a valuation allowance was required for all periods presented to the extent that we do not anticipate the ability to utilize a portion of the deferred tax assets. In subsequent years, we were able to determine that we expected to realize a portion of our deferred tax assets in excess of the net recorded amount, resulting in an adjustment to the deferred tax asset valuation allowance. Additionally, the valuation allowance was reduced by Canada net operating loss carryforwards that expired prior to utilization and were previously offset by a valuation allowance. State tax credit carryforwards are subject to potential expiration if not utilized by certain dates in the future. The valuation allowance remaining at June 30, 2010 relates entirely to estimated expiration of state tax credit carryforwards prior to utilization.
We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and recording the related assets and liabilities. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are occasionally under audit by tax authorities in various jurisdictions. Although we believe we have appropriate support for the positions taken on our tax returns, we have recorded a liability for our best estimate of the probable loss on certain of these positions. We believe that our accruals for tax liabilities are adequate for all open years, based on our assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter, which matters result primarily from intercompany transfer pricing. Although we believe our recorded assets and liabilities are reasonable, tax regulations are subject to interpretation and tax litigation is inherently uncertain; therefore our assessments can involve both a series of complex judgments about future events and rely heavily on estimates and assumptions. Although we believe the estimates and assumptions supporting our assessments are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in historical income tax provisions and recorded assets and liabilities. Based on the results of an audit or litigation, a material effect on our income tax provision, net income, or cash flows in the period or periods for which that determination is made could result. Due to the complexity involved, we are not able to estimate the range of reasonably possible losses in excess of amounts recorded.
Results of Operations
The following table sets forth for the periods indicated the percentage of revenues represented by certain lines in our consolidated statements of income.
Revenues
Revenue from our embedded database product, Pervasive PSQL, increased in fiscal years 2010 and 2009 relative to fiscal year 2008. We believe the increase in 2010 and 2009 was primarily due to a number of relatively large transactions with database customers and the release of our latest version of Pervasive PSQL version 10 in June 2008. Our embedded database and related products represented approximately 60% of our revenue in fiscal year 2010. In addition, we believe the integration products we acquired in fiscal year 2004 as a result of our acquisition of Data Junction Corporation represent a growth opportunity as we invest in opportunities presented by the acquired business and related innovative initiatives. Our integration products represented approximately 35% of our revenue in fiscal year 2010. A reduction in our embedded database business, or our inability to grow our integration products business, could have a material adverse effect on our business, operating results and financial condition.
We generated total revenue of $42.5 million, $47.2 million and $47.2 million for the fiscal years ended June 30, 2008, 2009 and 2010, respectively, which represents an increase of 11% from fiscal 2008 to 2009 and 2010. Our product license revenues were $29.3 million, $32.3 million and $30.8 million for the fiscal years ended June 30, 2008, 2009 and 2010, respectively, which represents an increase of 10% from fiscal 2008 to 2009, and a decrease of 5% from fiscal 2009 to 2010. Our service and other revenues were $13.1 million, $14.9 million and $16.4 million for the fiscal years ended June 30, 2008, 2009 and 2010, respectively, which represents an increase of 14% from fiscal 2008 to 2009, and an increase of 10% from fiscal 2009 to 2010.
International revenues, consisting of all revenue from customers located outside of North America, were $16.2 million, $16.5 million and $14.2 million in fiscal 2008, 2009 and 2010, representing 38%, 35% and 30% of total revenue, respectively. The decrease in international revenue in fiscal year 2010 is primarily attributed to a decrease in our embedded database revenue in Europe. We expect international revenue will continue to account for a significant portion of our revenue in the future.
Costs and Expenses
Cost of Product Licenses. Cost of product licenses consists primarily of the cost to manufacture and fulfill orders for our shrink-wrap software products, payment of license fees for third-party technologies embedded in our products and amortization of purchased technology. Cost of product licenses was $2.2 million, $1.3 million and $1.2 million in fiscal 2008, 2009 and 2010, representing 5%, 3% and 3% of total revenues respectively. The decrease in cost of product licenses revenue in fiscal year 2009 is primarily the result of the completion during the second quarter of fiscal year 2009 of the amortization of purchased technology associated with the acquisition of Data Junction. We anticipate that cost of product licenses revenue in fiscal year 2011 will be consistent with fiscal year 2010.
Cost of Services and Other. Cost of services and other consists primarily of the cost to provide technical support, primarily telephone support, which is typically provided within 30 days of purchase, and the costs to deliver professional services and training services to others. Cost of services and other was $4.2 million, $4.6 million and $4.8 million in fiscal 2008, 2009 and 2010, representing 10% of total revenues for each of the fiscal years. We anticipate cost of services and other in fiscal year 2011 will be consistent with fiscal year 2010.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, foreign sales office expenses, travel and entertainment, marketing programs and promotional expenses. Sales and marketing expenses were $17.9 million, $18.7 million and $18.9 million in fiscal 2008, 2009 and 2010, representing 43%, 40% and 40% of total revenues, respectively. Sales and marketing expenses increased in fiscal 2009 primarily due to an increase in costs related to sales and marketing personnel and increased investment in marketing programs in support of new product releases and our efforts around our innovation products. Sales and marketing expenses increased in fiscal 2010 primarily due to an increase in our sales and marketing personnel and investment in marketing programs in support of our new products and services as well as our acquisition of ChanneLinx in July 2009. We anticipate sales and marketing expenses will increase during fiscal year 2011 as we increase our sales and marketing personnel and invest in marketing programs to support continued growth in our integration products and in support of our new products and services.
Research and Development. Research and development expenses consist primarily of personnel and related costs. Research and development expenses were $10.2 million, $10.6 million and $11.8 million in fiscal 2008, 2009 and 2010, representing 24%, 22% and 25% of total revenues, respectively. Research and development expenses increased in fiscal year 2009 primarily due to increased investment in innovation of extensions to existing products as well as new products and services. Research and development expenses increased in fiscal year 2010 primarily due to increased research and development spending as a result of the acquisition of ChanneLinx in July 2009. We anticipate our research and development spending in fiscal year 2011 will be consistent with fiscal year 2010.
General and Administrative. General and administrative expenses consist primarily of personnel salaries and other costs of our finance, human resources and administrative departments. General and administrative expenses were $5.1 million, $5.4 million and $4.9 million in fiscal year 2008, 2009 and 2010, representing 12%, 11% and 10% of total revenues, respectively. We believe our general and administrative expenses in fiscal year 2011 will be consistent with fiscal year 2010.
Share-based compensation expense. Share-based compensation expense reflects non-cash compensation expense associated with restricted stock purchase rights and employee stock options accounted for under ASC 718 Compensation-Stock Compensation. (See Notes 2 and 6 to the Consolidated Financial Statements.) Share-based compensation expense was included in costs and expenses as follows:
We believe our share-based compensation expense in fiscal year 2011 will be consistent with fiscal year 2010.
Interest and Other Income. Interest and other income consists primarily of interest earned on various investments and was approximately $1.7 million, $0.7 million and $0.2 million in fiscal years 2008, 2009 and 2010, respectively. The decrease in interest and other income in fiscal 2009 and 2010 is primarily the result of lower yields on invested funds and investing a portion of our investments in tax-advantaged instruments.
Provision for Income Taxes. Provision for income taxes related to operations was approximately $1.4 million, $2.1 million and $1.8 million in fiscal 2008, 2009 and 2010, respectively. The provision for income taxes in fiscal years 2008, 2009 and 2010 consist of income taxes related to both our foreign and domestic operations, offset by tax credits generated and other permanent tax differences.
Quarterly Results from Operations
The following table sets forth selected unaudited quarterly information for our last eight fiscal quarters. This information has been prepared on the same basis as the audited consolidated financial statements appearing elsewhere in this Report, and we believe all necessary adjustments (consisting only of normal recurring adjustments) have been included in the amounts stated below. We also believe this information presents fairly the results of each period when read in conjunction with the audited consolidated financial statements and notes.
Our operating results have varied significantly from quarter to quarter in the past and may continue to vary significantly from quarter to quarter in the future due to a variety of factors. Such fluctuations may result in volatility in the price of our
common stock. We establish our expenditure levels based on expectations as to future revenue, and, if revenue levels are below expectations, expenses can be disproportionately high. As a result, a drop in near term demand for our products could significantly affect both revenues and profits in any quarter. In the future, our operating results may fluctuate for this reason or as a result of a number of other factors, including increased expenses, timing of product releases, increased competition, variations in the mix of sales, announcements of new products by us or our competitors and capital spending patterns of our customers. As a result of these factors, there can be no assurance we will be able to maintain profitability on a quarterly basis. See “Risk Factors.”
Liquidity and Capital Resources
Cash provided by operations was $7.9 million, $6.5 million and $6.6 million for fiscal 2008, 2009 and 2010, respectively. Cash provided by operations decreased in fiscal 2009 as compared to fiscal year 2008 primarily as a result of an increase in our trade receivables.
We invested, net, $13.5 million and $8.0 million in marketable securities in fiscal 2009 and 2010, respectively. We received net proceeds of $3.1 million from the sale or maturity of marketable securities in fiscal 2008. In addition, we purchased property and equipment totaling approximately $0.7 million, $0.8 million and $0.6 million in fiscal 2008, 2009 and 2010, respectively. This property consisted primarily of computer hardware and software for general upgrade requirements for all fiscal years.
During fiscal years 2008, 2009 and 2010, we repurchased approximately 2.2 million, 1.9 million and 1.2 million shares, respectively, of common stock at a cost of approximately $9.2 million, $7.6 million and $6.1 million, respectively. In July 2010, we announced the authorization of a new $10.0 million stock repurchase plan which became effective on July 27, 2010. Depending on market conditions and other factors, such purchases may be commenced or suspended at any time without prior notice.
During fiscal years ended June 30, 2008, 2009 and 2010, we received approximately $0.4 million, $0.2 million and $0.4 million, respectively, in proceeds from the exercise of stock options resulting in the issuance of shares of our common stock of approximately 144,000, 62,000 and 147,000 for the fiscal years ending June 30, 2008, 2009 and 2010, respectively.
We are exploring new opportunities to build, license or acquire products and services for introduction to and through our expansive worldwide channel. Any such transaction could cause us to issue dilutive equity securities, reduce our cash and marketable securities, or incur debt or contingent liabilities.
On June 30, 2010, we had $38.9 million in working capital including $40.4 million in cash, cash equivalents and marketable securities, compared to working capital of $41.6 million at June 30, 2009.
Summary Disclosures About Contractual Obligations
The following table summarizes our contractual obligations at June 30, 2010 and the effect such obligations are expected to have on our liquidity and cash flow in future periods:
Off-Balance Sheet Arrangements
As of June 30, 2010, we are not involved in any off-balance sheet arrangements, as defined in Item 303 (a)(4)(ii) of SEC Regulation S-K.
Recently Issued Accounting Standards
In December 2007, the FASB issued guidance on Business Combinations, which was incorporated into ASC 805 (formerly Statement No. 141(R)), that establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. This guidance was adopted by the Company on July 1, 2009 and will apply prospectively to business combinations completed on or after that date, which includes the ChanneLinx acquisition discussed in Note 8.
In December 2007, the FASB issued guidance on Non-controlling Interests in Consolidated Financial Statements, which was incorporated into ASC 810-10-65-1 (formerly Statement No. 160), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a parent’s ownership interest and the valuation of retained non-controlling equity investments when a subsidiary is deconsolidated. This guidance also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. This guidance was adopted by the Company on July 1, 2009 and did not have a significant impact on its consolidated financial statements.
In April 2008, the FASB issued guidance on Determination of the Useful Life of Intangible Assets, which was incorporated into ASC 350-30-65-1 (formerly FSP FAS 142-3), that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance was adopted by the Company on July 1, 2009 and did not have a significant impact on its consolidated financial statements.
In June 2009, the FASB issued ASU 2009-01, Topic 105-Generally Accepted Accounting Principles (formerly SFAS No. 168), which establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with generally accepted accounting principles. ASU 2009-01 explicitly recognizes rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. ASU 2009-01 was adopted by the Company on July 1, 2009 and did not have a significant impact on its consolidated financial statements.
In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force to amend certain guidance in FASB Accounting Standards Codification ™ (ASC) 605, Revenue Recognition, 25, “Multiple-Element Arrangements”. The amended guidance in ASC 605-25 (1) modifies the separation criteria by eliminating the criterion that requires objective and reliable evidence of fair value for the undelivered item(s), and (2) eliminates the use of the residual method of allocation and instead requires that arrangement consideration be allocated, at the inception of the arrangement, to all deliverables based on their relative selling price. The amended guidance becomes effective for the Company on July 1, 2010. The Company does not expect the amended guidance to have a significant impact on its consolidated financial statements.
The FASB also issued ASU 2009-14, Certain Revenue Arrangements That Include Software Elements-a consensus of the FASB Emerging Issues Task Force, to amend the scope of arrangements under ASC 985,
Software, 605, “Revenue Recognition” to exclude tangible products containing software components and non-software components that function together to deliver a product’s essential functionality.
The amended guidance in ASC 605-25 and ASC 985-605 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early application and retrospective application permitted. The Company expects to prospectively apply the amended guidance in ASC 985-605, concurrently with the amended guidance in ASC 605-25, beginning on July 1, 2010. The Company is in the process of evaluating the impact the amendments to ASC 605-25 and ASC 985-605 will have on its consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The majority of our operations are based in the United States and, accordingly, the majority of our transactions are denominated in U.S. dollars. However, we do have foreign-based operations where transactions are denominated in foreign currencies and are subject to market risk with respect to fluctuations in the relative value of currencies. Currently, we have operations in Belgium, Germany, France and England and a joint venture in Japan, and conduct transactions in the local currency of each location. If the U.S. dollar to Japanese yen rate had remained unchanged throughout fiscal 2008, the result would have been a decrease in revenue and operating income of approximately $0.6 million. If the U.S. dollar to Japanese yen rate had remained unchanged throughout fiscal 2009, the result would have been a decrease in revenue and operating income of approximately $0.3 million. If the U.S. dollar to Japanese yen rate had remained unchanged throughout fiscal 2010, the result would have been a decrease in revenue and operating income of approximately $0.2 million. If the U.S. dollar to euro rate had remained unchanged throughout fiscal 2008, the result would have been an increase in operating income of approximately $0.3 million. If the U.S. dollar to euro rate had remained unchanged throughout fiscal 2009, the result would have been a decrease in operating income of approximately $0.5 million. If the U.S. dollar to euro rate had remained unchanged throughout fiscal 2010, the result would have been a decrease in operating income of approximately $0.1 million. The impact of fluctuations in the relative value of all other currencies for fiscal 2008, 2009 and 2010 was not material.
We monitor our foreign currency exposure and, from time to time, will attempt to reduce exposure through hedging. Gains and losses on foreign currency hedging were not material to the consolidated financial statements for fiscal years ended June 30, 2008, 2009, and 2010 as such hedging activities were minimal.
We are subject to interest rate risk on our cash and marketable securities investments; however, this risk is limited as our investment policy requires us to invest in short-term securities and maintain an average maturity of one year or less.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by this Item 8 are listed in Item 15(a)(1) and begin at page of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, under supervision and with the participation of the Chief Executive Office and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures, as defined under
Exchange Act Rule 13a-15(e). Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2010, (i) the disclosure controls and procedures were effective to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report On Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined under Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
All internal control systems, no matter how well designed, have inherent limitations and may not prevent or detect misstatements. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to financial reporting reliability and financial statement preparation and presentation. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls become inadequate because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2010. In making the assessment, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment, management concluded that, as of June 30, 2010, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
The effectiveness of our internal control over financial reporting as of June 30, 2010 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report, which is included in Part IV, Item 15(a)(1) of this Report.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal controls over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information regarding directors and corporate governance matters is incorporated herein by reference from the section entitled “Election of Directors” of the Company’s definitive Proxy Statement (the “Proxy Statement”) to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, for the registrants’ Annual Meeting of Stockholders to be held on November 15, 2010. The Proxy Statement is anticipated to be filed within 120 days after the end of the registrant’s fiscal year ended June 30, 2010.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company, and their ages as of August 31, 2010, and biographical summaries are as follows:
John E. Farr has served as our President, Chief Executive Officer and Director since January 2006. Previously, Mr. Farr served as our Chief Financial Officer from July 2001 to January 2006, as Vice President, Finance, from October 1998 to July 2001, as Director of Finance from April 1997 to October 1998 and as Controller from November 1994 to April 1997. Prior to joining Pervasive, Mr. Farr served as an auditor and in audit management for KPMG LLP, an international accounting firm, from 1982 to 1994. Mr. Farr received a B.B.A. in Accounting from Southwestern University.
Randall G. Jonkers has served as our Chief Financial Officer since January 2006 and as Vice President, Finance since October 2005. Prior to joining Pervasive, Mr. Jonkers served as CFO and Executive Vice President of WSNet, a privately owned satellite broadcasting and equipment reseller from 1998 to 2005. Mr. Jonkers also served as CFO for Healthway Communications International Inc., a privately owned high-technology company, from 1995 to 1998; in various corporate accounting and reporting roles for Dell Computer Corporation from 1989 to 1995; as an auditor for Coopers & Lybrand from 1987 to 1989; as well as active and reserve duty in the U.S. Army as a Material Management Officer and Chief Logistics Officer. Mr. Jonkers received a B.B.A. in Accounting from the University of Texas at Austin.
Michael Hoskins has served as our Chief Technology Officer since June 2004 and as General Manager of Integration Products since October 2006 (and previously from December 2003 to June 2004). Mr. Hoskins has also served as a Director since December 2003. Prior to joining Pervasive, Mr. Hoskins served as President and Director of Data Junction Corporation for 15 years. Mr. Hoskins joined Data Junction in 1988 as Vice President of Sales. Mr. Hoskins graduated from the Bowling Green State University with a bachelor of business administration and a major in finance.
Stephen Padgett has served as our Vice President, Information Technology since May 2006. Prior to joining Pervasive, Mr. Padgett was CTO and Executive Vice President, Customer Acquisitions for Supportkids, Inc., a private child support collections company, where he oversaw the development of technology and customer management from 1998 to 2003. Mr. Padgett led technology infrastructure development at Tivoli Systems, Inc., a provider of enterprise system management solutions, from 1994 to 1998. He was a Senior Manager at Dell Computer Corporation from 1989 to 1994 and a Manager for Price Waterhouse, an international accounting firm, from 1984 to 1989. Mr. Padgett received an MBA in Information Systems Management and a BBA in Communications from the University of Texas at Austin.
These are no family relationships among any of our executive officers.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation is incorporated herein by reference from the section entitled “Executive Compensation and Related Information” of the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners and management is incorporated herein by reference from the section entitled “Stock Ownership of Certain Beneficial Owners and Management” of the Proxy Statement. Information regarding securities authorized for issuance under our equity compensation plans is incorporated herein by reference from the section entitled “Employment Contracts and Change of Control Arrangements” of the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information regarding certain relationships and related transactions is incorporated herein by reference from the section entitled “Certain Relationships and Related Transactions” of the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services appears in the Proxy Statement under the heading “Audit and Non-Audit Fees” and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following consolidated financial statements of the Company are filed as part of this Annual Report on Form 10-K as follows:
Index to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at June 30, 2009 and 2010
Consolidated Statements of Income for each of the three years in the period ended June 30, 2010
Consolidated Statements of Changes in Stockholders’ Equity for each of the three years in the period ended June 30, 2010
Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 2010
Notes to the Consolidated Financial Statements
(a)(2) Financial Statement Schedules
Schedule II-Valuation and Qualifying Accounts is filed on page S-1 of this Report on Form 10-K.
(b) Exhibits
+
Incorporated by reference to the Company’s Current Report on Form 8-K filed August 13, 2003.
* Incorporated by reference to the Company’s Registration Statement on Form S-1 (File No. 333-32199).
** Incorporated by reference to the Company’s Current report on Form 8-K filed January 24, 2006.
*** Incorporated by reference to the Company’s Registration Statement on Form 8-A filed on October 24, 2000 (File No. 000-23043).
**** Incorporated by reference to the Company’s Current report on Form 8-K filed September 6, 2007.
++
Incorporated by reference to the Company’s Current Report on Form 8-K filed September 24, 2004.
++++
Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed February 5, 2007.
+++
Incorporated by reference to the Company’s Current Report on Form 8-K filed February 22, 2007.
+++++
Incorporated by reference to the Company’s Current Report on Form 8-K filed July 17, 2007.
++++++
Incorporated by reference to the Company’s Current Report on Form 8-K filed January 13, 2009.
(c) Any financial statement schedules required to be filed as part of this Annual Report on Form 10-K are set forth in section (a)(2) above.
All other schedules have been omitted because they are not applicable, not required under the instructions, or the information requested is set forth in the consolidated financial statements or related notes thereto.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SCHEDULE II
PERVASIVE SOFTWARE INC.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
S-1
PERVASIVE SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pervasive Software Inc.:
We have audited Pervasive Software Inc. (a Delaware Corporation) and subsidiaries’ (the “Company”) internal control over financial reporting as of June 30, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2010, based on criteria established in Internal Control-Integrated Framework issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of June 30, 2010 and 2009 and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the three years in the period ended June 30, 2010 and the related financial statement schedule, and our report dated September 13, 2010 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Dallas, Texas
September 13, 2010
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pervasive Software Inc:
We have audited the accompanying consolidated balance sheets of Pervasive Software Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of June 30, 2010 and 2009, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended June 30, 2010. Our audits of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 Pervasive Software, Inc. and subsidiaries as of June 30, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of June 30, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated September 13, 2010 expressed an unqualified opinion on the effective operation of the Company’s internal control over financial reporting.
/s/ GRANT THORNTON LLP
Dallas, Texas
September 13, 2010
PERVASIVE SOFTWARE INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
PERVASIVE SOFTWARE INC.
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes
PERVASIVE SOFTWARE INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
See accompanying notes.
PERVASIVE SOFTWARE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
1. The Company
Pervasive Software (NASDAQ: PVSW) helps companies get the most out of their data investments through agile, embeddable software including on-premises and cloud-based services for data management, data integration, B2B exchange and analytics. The embeddable Pervasive PSQL™ database engine provides robust database reliability in a near-zero database administration environment for packaged business applications. Pervasive’s multi-purpose data integration platform, available on-premises and in the cloud, accelerates the sharing of information between multiple data stores, applications, and hosted business systems and allows customers to re-use the same software for diverse integration scenarios. Pervasive DataRush™ is an embeddable parallel dataflow platform enabling data-intensive applications such as claims processing, risk analysis, fraud detection, data mining, predictive analytics, sales optimization and marketing analytics. For more than two decades, Pervasive products have delivered value to tens of thousands of customers in more than 150 countries with a compelling combination of performance, flexibility, reliability and low total cost of ownership. Through Pervasive Innovation Labs, the company also invests in exploring and creating cutting edge solutions for the toughest data analysis and data delivery challenges. In addition, significant portions of our database and integration flagship product lines are embeddable into commercial applications for sale through a well-developed channel of independent software vendors (ISVs), Software-as-a-Service (SaaS) vendors, value-added resellers (VARs) and system integrators (SIs).
The Company develops, markets, sells and supports its offerings worldwide through its principal office in Austin, Texas and through additional offices in Greenville, South Carolina; Brussels; Frankfurt; Paris and London and a joint venture in Japan. The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.
2. Summary of Significant Accounting Policies
Revenue Recognition
The Company licenses its software through original equipment manufacturer (OEM) license agreements with software developers, or ISVs and through shrink-wrap software licenses, sold through ISVs, VARs, systems integrators and distributors, or direct to end users. Revenues are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant Company obligations with regard to implementation remain, the fee is fixed or determinable and collectability is probable. Revenues related to OEM license agreements involving nonrefundable fixed minimum license fees are recognized upon delivery of the product master or first copy if no significant vendor obligations remain. Per copy royalties related to OEM license agreements in excess of a fixed minimum amount are recognized as revenue when such amounts are reported to the Company. Revenue from post contract support and the right to receive unspecified upgrades is recognized ratably over the contract term. The Company generally provides telephone support to customers and end users in the 30 days immediately following the sale at no additional charge and at a minimal cost per call. The Company accrues the cost of providing this support. Revenue from consulting services and training is recognized when the related services are performed. The Company enters into agreements with certain distributors that provide for certain stock rotation and price protection rights. These rights allow the distributor to return products in a non-cash exchange for other products or for credits against future purchases. The Company reserves for the cost of estimated sales returns, stock rotation and price protection rights as well as uncollectible accounts based on experience. Revenue from shipping and handling is recognized in product license revenue at the shipping date. Shipping and handling costs are included in Cost of product licenses in the Consolidated Statements of Income.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Where software licenses are sold with maintenance or other services, the Company allocates the total fee to the various elements based on the fair values of the elements. The Company determines the fair value of each element in the arrangement based on vendor-specific objective evidence (“VSOE”) of fair value. VSOE of fair value is based upon the normal pricing and discounting practices for those products and services when sold separately and, for support services, is additionally measured by the renewal rate. If the Company does not have VSOE for one of the delivered elements of an arrangement, but does have VSOE for all undelivered elements, the Company uses the residual method to record revenue. Under the residual method, the arrangement fee is first allocated to the undelivered elements based upon their VSOE of fair value; the remaining arrangement fee, including any discount, is allocated to the delivered element. If the residual method is not used, discounts, if any, are applied proportionately to each element included in the arrangement based on each element’s fair value without regard to the discount.
Sales Returns and Bad Debt Reserves
The Company reserves the cost of estimated sales returns, stock rotation and price protection rights as well as uncollectible accounts based on experience. The Company evaluates quarterly the adequacy of the reserve for sales returns, stock rotation and price protection. Because these reserves are based on judgments and estimates, actual results could differ from the estimates.
Software Development Costs
The Company expenses software development costs as incurred until technological feasibility has been established, at which time such costs are capitalized until the product is available for general release to customers. To date, the establishment of technological feasibility of its products has coincided with the general release of such software. As a result, the Company has not capitalized any such costs other than those recorded in connection with its acquisitions.
Advertising Costs
The Company expenses costs of producing advertising-related and sales-related collateral materials as incurred. Other production costs associated with direct mail programs, placement costs associated with magazine or other printed media and all direct costs associated with trade shows and other sales-related events are expensed when the related direct mail is sent, advertising space is used or the event is held. These expenses in 2008, 2009 and 2010 were approximately $1.7 million, $1.5 million and $1.4 million, respectively.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
The Company estimates its income taxes in each of the jurisdictions in which it operates as part of the process of preparing the consolidated financial statements. This process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes and net operating loss and tax credit carryforwards. These differences result in deferred tax assets and liabilities. The Company then assesses the likelihood that deferred tax assets will be recovered from future taxable income and to the extent the Company believes that recovery is not more likely than not, it
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
establishes a valuation allowance. The Company concluded that a valuation allowance was required for all periods presented prior to 2007. The Company considered future taxable income in assessing the need for the valuation allowance, and was able to determine that it would be able to realize a portion of deferred tax assets in the future in excess of its net recorded amount, resulting in an adjustment to the deferred tax asset valuation allowance. Additionally, the valuation allowance was reduced by Canada net operating loss carryforwards that expired prior to utilization and were previously offset by a valuation allowance.
The Company is subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining the worldwide provision for income taxes and recording the related assets and liabilities. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. The Company is occasionally under audit by tax authorities in various jurisdictions. Although the Company believes it has appropriate support for the positions taken on its tax returns, the Company has recorded a liability for its best estimate of the probable loss on certain of these positions. The Company believes that its accruals for tax liabilities are adequate for all open years, based on its assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter, which matters result primarily from intercompany transfer pricing. Although the Company believes its recorded assets and liabilities are reasonable, tax regulations are subject to interpretation and tax litigation is inherently uncertain; therefore assessments can involve both a series of complex judgments about future events and rely heavily on estimates and assumptions. Although the Company believes that the estimates and assumptions supporting its assessments are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in historical income tax provisions and recorded assets and liabilities. Based on the results of an audit or litigation, a material effect on its income tax provision, net income, or cash flows in the period or periods for which that determination is made could result. Due to the complexity involved, the Company is not able to estimate the range of reasonably possible losses in excess of amounts recorded.
A reconciliation of the change in our unrecognized tax benefits for the year ended June 30, 2010 is as follows (in thousands):
As of June 30, 2010, $30,000 of unrecognized tax benefits are attributed to uncertain tax positions that, if recognized, would affect the effective tax rate. We accrue and recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of June 30, 2010, the balance of accrued interest and penalties related to unrecognized tax benefits was approximately $13,000. We do not believe that it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within twelve months of June 30, 2010.
With few exceptions, the Company and all of its major filing subsidiaries are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before fiscal year 2006.
Cash, Cash Equivalents and Short-term Investments
The Company considers all highly liquid investment securities with an original maturity of three months or less at the date of purchase to be cash equivalents.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Marketable securities are classified as “available for sale”, excluding cash equivalents as described above, and are recorded at estimated fair value with any unrealized gains or losses included in other comprehensive income (loss). Realized gains and losses are computed based on the specific identification method. Realized gains and losses were not material for the periods presented.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The inputs used to measure fair value are classified into the following hierarchy:
1. Level 1 Inputs-quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to obtain at the measurement date. This level provides the most reliable evidence of fair value.
2. Level 2 Inputs-inputs other than quoted prices included within Level 1 that are directly or indirectly observable for the asset or liability. Level 2 assets consist of marketable debt and equity instruments with quoted market prices that are traded in less active markets or priced using a quoted market price for similar instruments. Examples of assets currently utilizing Level 2 inputs are U.S. agency securities, commercial paper and municipal bonds.
3. Level 3 Inputs-Used to measure fair value of assets and liabilities that little, if any, market activity exists at the measurement date. These inputs reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.
Short-term investments consisted of the following (in thousands):
Property and Equipment
Property and equipment are stated at cost and are being depreciated over their estimated useful lives (3 to 7 years) using the straight-line method. Leasehold improvements are amortized over the life of the lease or the estimated useful life, whichever is shorter.
Long-Lived Assets
The Company periodically reviews the carrying amounts of long-lived assets, to determine whether current events or circumstances warrant adjustment to such carrying amounts. In reviewing the carrying amounts of long-lived assets, the Company considers, among other factors, the future cash inflows expected to result from the use of the asset and its eventual disposition less the future cash outflows expected to be necessary to obtain those inflows.
Goodwill and Other Intangible Assets
The Company assesses whether goodwill and indefinite-lived intangibles are impaired on an annual basis and reviews for triggering events on an ongoing basis. Upon determining the existence of goodwill and/or
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
indefinite-lived intangibles impairment, the Company measures that impairment based on the amount by which the book value of goodwill and/or indefinite-lived intangibles exceeds its fair value. The fair value of an asset is the amount at which that asset could be bought or sold in a current transaction between willing parties in an orderly transaction between market participants. Additional impairment assessments may be performed on an interim basis if the Company encounters events or changes in circumstance that would indicate that, more likely than not, the book value of goodwill and/or indefinite-lived intangibles has been impaired.
Foreign Currency Transactions
For the Company’s foreign subsidiaries, the functional currency has been determined to be the local currency, and therefore, assets and liabilities are translated at year-end exchange rates, and income statement items are translated at average exchange rates prevailing during the year. Such translation adjustments are recorded in aggregate as a component of stockholders’ equity. Gains and losses from foreign currency denominated transactions are included in other income and were not significant in 2008, 2009 or 2010.
Financial instruments, principally forward pricing contracts, are used by the Company from time to time in the management of its foreign currency exposures. The fair value associated with these forward pricing contracts at June 30, 2009 and 2010 is not significant. Gains and losses on foreign currency transaction hedges are recognized in income when realized and offset the foreign exchange gains and losses on the underlying transactions. The Company does not hold or issue derivative financial instruments for trading purposes.
Fair Value of Financial Instruments
Cash equivalents, marketable securities, accounts receivable, accounts payable, accrued liabilities and other liabilities are stated at cost which approximates fair value due to the short-term maturity of these instruments.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentrations of credit risk consist of short-term investments, including marketable securities, and trade receivables. The Company’s short-term investments, which are included in cash and cash equivalents and in marketable securities for reporting purposes, are placed with high credit quality financial institutions and issuers. The Company performs periodic credit evaluations of its customers’ financial condition and generally does not require collateral. Estimated credit losses are provided for in the financial statements.
In July 2001, we formed a business venture with AG-TECH Corporation, a company developing, selling and importing packaged software, to sell and support certain of our products in Japan. In connection with the new business venture, we obtained a less than 20% ownership interest in AG-TECH and the ability to elect one director to the AG-TECH Board of Directors. We do not have the ability to significantly influence or control the operations of AG-TECH and therefore, account for our investment in AG-TECH on the cost method of accounting. AG-TECH Corporation is one of the Company’s distribution partners in Japan and accounted for approximately 13%, 10% and 11% of the Company’s revenue during the years ended June 30, 2008, 2009 and 2010 respectively. The AG-TECH distribution agreement has been renewed twice, most recently for an additional five-year term which expires on June 30, 2012.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Stock-Based Compensation
Employee share-based compensation expense, which includes stock options and restricted stock, is recognized on a straight-line basis over the vesting period of the underlying awards, which is generally four years for stock options and three years for restricted stock, based on the grant date fair value. The Company utilizes the Black-Scholes option pricing model to estimate the grant date fair value, which requires the input of highly subjective assumptions, including expected volatility and expected life. Historical volatility was used in estimating the fair value of share-based awards rather than implied volatility, while the expected life was estimated to be four years based on historical trends since the Company’s initial public offering. The Company now estimates forfeitures for options granted, which are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options having no vesting restrictions and being fully transferable. Accordingly, the estimate of fair value may not represent the value assigned by a third-party in an arms-length transaction. While the estimate of fair value and the associated charge to earnings materially impacts the Company’s results of operations, it has no impact on its cash position.
The Company has elected the alternative transition method described in FASB Staff Position No. FAS 123R-3 for purposes of calculating the pool of excess tax benefits (“APIC pool”) available to absorb tax deficiencies recognized subsequent to the adoption of Statement 123R for employee awards.
Cash received from option exercises under all share-based payment arrangements for the years ended June 30, 2008, 2009 and 2010, was $0.4 million, $0.2 million and $0.4 million, respectively. The estimated tax benefit realized for the tax deductions from option exercises of the share-based payment arrangements was approximately $0.1 million for the year ended June 30, 2008, and nil for the years ended June 30, 2009 and June 30, 2010.
Total compensation cost recognized in income for stock-based employee compensation awards was approximately $1.8 million, $1.7 million and $1.8 million for the fiscal years ending June 30, 2008, 2009 and 2010, respectively.
During fiscal 2008, 2009 and 2010, the fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model, assuming no dividends and the following weighted average assumptions:
The weighted average estimated grant date fair value for options granted under the Company’s stock option plan during the years ended June 30, 2008, 2009 and 2010 was $1.56, $1.12 and $1.36 per share, respectively.
During fiscal years 2008, 2009 and 2010 the Company issued 138,000, 774,000 and 223,000 shares, respectively, of restricted stock with a weighted average fair value of $4.10, $3.79 and $5.06 per share, respectively. During fiscal year 2008, 2009 and 2010, the Company issued 25,000, 8,000 and 27,000 restricted stock units, respectively. The shares and units are being expensed over their expected lives of three to four years.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
As of June 30, 2010, $1.6 million, $1.0 million, $0.3 million and $0.1 million of unrecognized compensation cost related to non-vested awards is expected to be recognized in fiscal years 2011, 2012, 2013 and 2014, respectively, with a weighted average period of approximately 2.4 years.
Net Income Per Share
Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share includes the weighted average number of common shares outstanding and the number of common equivalent shares which would be issued related to options and restricted shares using the treasury method, unless such additional shares are anti-dilutive.
Segments
The Company considers its business activities to be a single segment.
Recently Issued Accounting Standards
In December 2007, the FASB issued guidance on Business Combinations, which was incorporated into ASC 805 (formerly Statement No. 141(R)) that establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. This guidance was adopted by the Company on July 1, 2009 and will apply prospectively to business combinations completed on or after that date, which includes the ChanneLinx acquisition discussed in Note 8.
In December 2007, the FASB issued guidance on Non-controlling Interests in Consolidated Financial Statements, which was incorporated into ASC 810-10-65-1 (formerly Statement No. 160), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a parent’s ownership interest and the valuation of retained non-controlling equity investments when a subsidiary is deconsolidated. This guidance also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. This guidance was adopted by the Company on July 1, 2009 and did not have a significant impact on its consolidated financial statements.
In April 2008, the FASB issued guidance on Determination of the Useful Life of Intangible Assets, which was incorporated into ASC 350-30-65-1 (formerly FSP FAS 142-3), that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance was adopted by the Company on July 1, 2009 and did not have a significant impact on its consolidated financial statements.
In June 2009, the FASB issued ASU 2009-01, Topic 105-Generally Accepted Accounting Principles (formerly SFAS No. 168), which establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with generally accepted accounting principles. ASU 2009-01 explicitly recognizes rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws as
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
authoritative GAAP for SEC registrants. ASU 2009-01 was adopted by the Company on July 1, 2009 and did not have a significant impact on its consolidated financial statements.
In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force to amend certain guidance in FASB Accounting Standards Codification™ (ASC) 605, Revenue Recognition, 25, “Multiple-Element Arrangements”. The amended guidance in ASC 605-25 (1) modifies the separation criteria by eliminating the criterion that requires objective and reliable evidence of fair value for the undelivered item(s), and (2) eliminates the use of the residual method of allocation and instead requires that arrangement consideration be allocated, at the inception of the arrangement, to all deliverables based on their relative selling price. The amended guidance becomes effective for the Company on July 1, 2010. The Company does not expect the amended guidance to have a significant impact on its consolidated financial statements.
The FASB also issued ASU 2009-14, Certain Revenue Arrangements That Include Software Elements-a consensus of the FASB Emerging Issues Task Force, to amend the scope of arrangements under ASC 985, Software, 605, “Revenue Recognition” to exclude tangible products containing software components and non-software components that function together to deliver a product’s essential functionality.
The amended guidance in ASC 605-25 and ASC 985-605 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early application and retrospective application permitted. The Company expects to prospectively apply the amended guidance in ASC 985-605, concurrently with the amended guidance in ASC 605-25, beginning on July 1, 2010. The Company is in the process of evaluating the impact the amendments to ASC 605-25 and ASC 985-605 will have on its consolidated financial statements.
3. Property and Equipment
Property and equipment consists of the following (in thousands):
Depreciation expense was approximately $0.8 million, $0.8 million and $0.8 million for fiscal years ending June 30, 2008, 2009 and 2010, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
4. Income Taxes
The components of income before income taxes consist of the following (in thousands):
Significant components of income tax expense (benefit) are as follows (in thousands):
The Company’s provision for income taxes differs from the expected provision computed by applying the statutory federal income tax rate of 34% to income from continuing operations before income taxes for 2008, 2009 and 2010 as a result of the following (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The components of deferred income taxes at June 30, 2009 and 2010 are as follows (in thousands):
As of June 30, 2010, the Company expects that upon filing of its domestic tax return for fiscal year 2010 it will have state research and development credit carryforwards of approximately $0.5 million and a state temporary credit for business loss carryforwards of approximately $0.2 million. These carryforwards will begin to expire in fiscal 2021 and 2027, respectively, if not utilized.
At June 30, 2010, the Company has a valuation allowance of $0.2 million, which is primarily related to the Texas research and development carryforwards and the determination that these assets will likely expire prior to utilization.
As of June 30, 2009 and 2010, the Company had a Federal income tax receivable of $0.3 million and $0.4 million, respectively.
5. Employee Benefits
The Company’s employees are offered health coverage under a partially self-funded plan in which the Company purchases specific stop-loss insurance coverage at $50,000 per year, per employee. The Company has also purchased an aggregate stop-loss insurance coverage to limit its maximum annual exposure to claims funded. Based on the policy census at July 1, 2010, such maximum annual exposure for the policy year ending June 30, 2011 is approximately $2.9 million. The Company pays a fixed fee per covered individual for administrative costs of the administrator and the cost of the stop-loss insurance purchased on the Company’s behalf. The Company contributes 100% toward the cost to insure each employee and more than 75% toward the cost to insure dependents for which coverage is requested by the employee. Expenses for the partially self-funded plan including premiums and claims funded for the years ended June 30, 2008, 2009 and 2010 were approximately $1.1 million, $1.3 million, and $1.7 million, respectively.
The Company has a 401(k) retirement plan which is available to all domestic, full-time employees. The Company’s expenses related to the plan were not significant in the years ended June 30, 2008, 2009 or 2010. In fiscal years 2008, 2009 and 2010, the Company funded a matching contribution of 10% of participant contributions made during calendar years 2007, 2008 and 2009 for all participants employed by the Company on
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2007, 2008 and 2009. The amount expensed related to the match was approximately $100,000, $111,000 and $122,000 for the fiscal years ended June 30, 2008, 2009 and 2010, respectively.
6. Common Stock and Stock Options
The Company’s 2006 Equity Incentive Plan as amended (the 2006 Plan) was adopted by the Board of Directors on September 21, 2006, and approved by the stockholders on November 14, 2006, as the successor to the 1997 Stock Incentive Plan (the 1997 Plan). Outstanding options under the 1997 Plan have been incorporated into the 2006 Plan and no further option grants will be made under the 1997 Plan. The incorporated options will continue to be governed by their existing terms, unless the Plan Administrator elects to extend one or more features of the 2006 Plan to those options.
Incentive stock options may be granted to employees of the Company entitling them to purchase shares of common stock for a maximum of ten years (five years in the case of options granted to a person possessing more than 10% of the combined voting power of the company as of the date of grant). The exercise price for incentive stock options may not be less than fair market value of the common stock on the date of the grant (110% of fair market value in the case of options granted to a person possessing more than 10% of the combined voting power of the Company). Nonqualified stock options may be granted to employees, officers, directors, independent contractors and consultants of the Company. The exercise price for nonqualified stock options may not be less than 85% of the fair market value of the common stock on the date of the grant (110% of fair market value in the case of options granted to a person possessing more than 10% of the combined voting power of the Company). The vesting period for stock options is generally a four-year period. Options are generally exercisable by the holder only for the vested portion of each grant. The Company may also award Restricted Stock, Restricted Stock Units and Stock Appreciation Rights subject to provisions in the 2006 Plan.
During fiscal year 2008, 2009 and 2010 the Company issued 138,000, 774,000 and 223,000 shares, respectively, of restricted stock with a weighted average fair value of $3.83, $3.79 and $5.06 per share, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
A summary of changes in common stock options during the year ended June 30, 2008, 2009 and 2010 is as follows:
The following is additional information relating to options outstanding at June 30, 2010:
The aggregate intrinsic value (the amount by which market price exceeds the option exercise price) for options as of June 30, 2010 is as follow:
At June 30, 2010, 3,862,014 shares of common stock were reserved for future exercise of stock options and restricted stock awards. As part of the 2006 Plan, shareholders approved a share reserve of 5,396,725 for future exercise of stock options and restricted stock awards. The share reserve includes 4,396,725 shares that were subject to outstanding awards under the 1997 Plan (determined as of June 30, 2006) and which, if forfeited, cancelled or otherwise terminated are returned to the 2006 Plan share reserve and made available for subsequent issuance.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
7. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share from operations (in thousands, except per share data):
At June 30, 2008, 2009 and 2010 approximately 789,000, 849,000 and 795,000 shares, respectively, were not included in the diluted earnings per share calculation since the shares are anti-dilutive.
8. Goodwill, Business Acquisition and Other Intangible Assets
As of June 30, 2010, Pervasive had goodwill in the amount of $38.5 million associated with the acquisition of Data Junction. The Company assesses the impairment of goodwill and other intangible assets with indefinite lives annually in the fourth quarter, or more frequently if other indicators of impairment arise. The Company has determined no impairment of existing goodwill exists as of June 30, 2010.
On July 31, 2009, the Company completed the purchase of assets from Greenville, SC-based ChanneLinx, Inc. for total consideration of approximately $2.6 million in cash. Amortization expense for intangible assets related to ChanneLinx was approximately $0.5 million in fiscal year ended June 30, 2010.
Other intangible assets, classified as Purchased Intangibles on the balance sheet, amounted to $2.1 million (net of accumulated amortization of $6.8 million) as of June 30, 2010. These intangible assets consist of developed technology, including the $6.3 million value assigned to amortizable intangible assets related to developed technology in connection with the acquisition of Data Junction during the second quarter of fiscal 2004 and $2.6 million related to the acquisition of ChanneLinx in the first quarter of fiscal 2010.
The Company is amortizing the intangible assets on a straight-line basis over their estimated useful lives, generally five years. Amortization expense for the years ended June 30, 2008, 2009 and 2010 was approximately $1.5 million, $0.6 million and $0.5 million, respectively. Amortization expense for intangible assets is anticipated to be approximately $0.5 million for each of the years ended June 30, 2011 through June 30, 2014.
PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Purchased technology consists of the following (in thousands):
9. Commitments and Contingencies
The Company leases its headquarters and international office space and, in some cases, is obligated for its proportionate share of utilities and other defined operating expenses of the related building. The Company has executed a $175,000 letter of credit as required under the headquarters office lease. Office rent expense, net of subtenant offsets, for the Company’s domestic and international offices for the years ended June 30, 2008, 2009 and 2010, was approximately $1.8 million, $1.8 million, and $1.7 million, respectively.
Future minimum lease payments, net of subtenant offsets, at June 30, 2010 under the operating leases for worldwide office space are as follows (in thousands):
The Company is involved in various legal proceedings which arise from time to time in the normal course of business. While the ultimate results of such matters generally cannot be predicted with certainty, management does not expect any such matters to have a material adverse effect on the consolidated financial position and results of operations as of June 30, 2010.
PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
10. Segments of Business and Geographic Area Information
The Company is engaged in the design, development and marketing of data infrastructure software. The Company considers its business activities to constitute a single segment of business.
A summary of the Company’s operations by geographic area follows (in thousands):
(A) Operating income (loss) for Europe, Japan and Rest of World do not include any allocation of marketing, product development, technical support and administrative costs incurred in the United States.
11. Statements of Cash Flows
The changes in current assets from operations reflected in the consolidated statements of cash flows are comprised of the following (in thousands):
PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The changes in accounts payable and accrued liabilities from operations reflected in the consolidated statements of cash flows are comprised of the following (in thousands):