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 that May Affect Future Results,” “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 embeddable data management and agile integration software. The embeddable PSQL database engine allows organizations to successfully embrace new technologies while maintaining application compatibility and robust database reliability in a near-zero database administration environment. Pervasive’s agile, multi-purpose integration platform accelerates the sharing of information between multiple databases, applications, or hosted business systems and allows customers to re-use the same software for diverse integration scenarios. 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 to small to mid-sized enterprises (SMEs) through a well-developed channel of independent software vendors (ISVs), Software-as-a-Service (SaaS) vendors, value-added resellers (VARs) and system integrators.
Our flagship Pervasive PSQL® database, offering unparalleled data management technology combined with very low 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, Web and mobile 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 Microsoft Windows Server 2008.
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 small to mid-sized businesses and departments of large enterprises. 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 two-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.
Index to Financial Statements 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 international offices in Brussels; Frankfurt; London; and Paris; and a joint venture in Japan. Our website 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 website, 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 website 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 20 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 SaaS 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 a maturation and commoditization phase. The emergence of Linux and other open source software solutions is testament to this trend, as is the increasing demand for the affordability and rapid deployment provided by the SaaS delivery model. As markets mature and commoditize, having a “value” orientation-delivering the highest performance with the lowest TCO-becomes increasingly critical. We believe infrastructure software will be a key ingredient for small to mid-sized businesses and departments within enterprises that 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.
We believe that maturation and commoditization trends in the software market, increasing SaaS proliferation, trends in the SME market, and trends in the data and application integration market 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 maturing and cost-sensitive markets, and Pervasive, with its strengths in high-performance, low-cost data management and integration solutions, is well-positioned to benefit from the trends in these markets. 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 economic slowdown in the U.S. 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 and integration software, enabling businesses to capitalize on their data investments, while leveraging the inevitable transition from high cost to
Index to Financial Statements
high value. Pervasive’s family of low-cost, 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 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 most-recent version, Pervasive PSQL Summit™ v10.10, was first released in fiscal year 2008 as Pervasive PSQL V10 and delivers improvements in performance and increased simplicity of development, deployment and ease of use. In addition, this release features support for the Microsoft® Windows Vista™ desktop operating system and is certified compatible with the Microsoft Windows Server 2008 operating system.
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. ISVs, including Software-as-a-Service vendors and packaged software vendors, have two critical problems-once they sell a new customer on their solution, they need to help their customers migrate and then integrate legacy data to the new application. Today, customers expect migration and integration to be included in the solution. Combining our deep knowledge and more than 20 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 application into “integration-ready” solutions that are scalable from one-time data migration to ongoing application integration within and beyond organizational boundaries.
We intend to continue investing in product development, marketing and sales activities focused on enhancing and leveraging our integration product line through our existing channel of ISVs, as well as new ISVs, Software-as-a-Service vendors and systems integrators. Given the sales cycles for selling to an ISV with perhaps thousands of end user customers and given the development processes and schedules of our ISV customers, we
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see this as our longest-term investment in revenue opportunities associated with our integration products. In addition, we continue to benefit from new and existing direct end user accounts, many of which are sourced initially as referrals from existing channel partners. 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.
Our integration product revenues are generated predominantly in North America. However, we continue to market our expanding integration product line to our customer base across Europe, including recruiting market development partners. Further, we continue to work with market development partners in China, Japan and Korea to cover the marketing, sales and support of our integration products. International sales have typically represented less than 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 2009.
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 2007 and 2008 resulted in the introduction and further development of three new product and service offerings:
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Pervasive DataTools™-downloadable, subscription-based, functional subsets of our Pervasive Data Integrator™ product,
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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, and
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Pervasive DataRush™-our Java engine and library designed to enable software developers to capture the parallel processing capabilities of multi-core technologies for data-intensive applications, presently at Release Candidate phase and with initial lighthouse customer projects successfully completed.
We will continue to build our Pervasive DataSolutions and Pervasive DataRush businesses in fiscal year 2009, 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. Unlike certain of our competitors, we will not seek to acquire application providers, as doing so could cause us to be competitive with large portions of our very important partner channel.
Remain Focused on Profitability. Since March 2001, we have reported thirty 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 2009 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 coupled with
Index to Financial Statements
an absence of suitable acquisition targets would cause us to continue to be active with our Share Repurchase Program. In fiscal years 2006, 2007 and 2008, we acquired approximately 0.8 million, 2.7 million and 2.2 million shares, respectively, of our stock on the open market at a total cost of approximately $3.2 million, $10.8 million and $9.2 million, respectively. And, we began the new fiscal year with $9.3 million of authorized repurchase funds remaining under our most recent Board-approved $10.0 million repurchase program.
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, systems integrators 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 low TCO 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 deliver faster return on investment (ROI), greater business flexibility, enhanced revenue opportunities and proven accountability for data infrastructure investments at a lower 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 Summit™ v10.10, was first released in fiscal year 2008 as Pervasive PSQL V10 and delivers improvements in performance and increased simplicity of development, deployment and ease of use. In addition, this release features support for the Microsoft® Windows Vista™ desktop operating system and is certified on the Microsoft Windows Server 2008 operating system.
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 DataExchange solutions feature a combination of product and services customized for the business problem to be solved:
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Data high availability-provides a real-time backup of data to a secondary local or remote server for reliable protection and availability of application data;
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Data continuity-augments end-of-day tape backups by maintaining an up-to-date warm standby at an off-site location; and
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Data portal-bridges the gap between existing transactional systems and the Web portal or data warehouse, allowing system access for non-transactional activities, such as query and analysis, without disrupting, modifying or taxing the performance of the transactional system.
Index to Financial Statements 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 and the Health Insurance Portability and Accountability Act (HIPAA). Pervasive AuditMaster provides data access accountability by means of three modules:
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Capture-The Capture module is an easily installed database plug-in. It provides a real-time monitoring Capture agent that records every event in the database in a detailed trail. It is installed at the database level, so when the database is running, AuditMaster captures and records to a secure log record of events in the database;
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Report-Once the Capture module establishes the audit trail, the Report module allows for the activity log to be queried enabling a security administrator to perform audits on the activity within the application by verifying past activities or analyzing patterns and trends; and
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Alert-While Reports are historical in nature, the Alert module offers proactive surveillance of future data activity. Once defined in AuditMaster, alert triggers wait for specified events of interest based on the entire range of user actions, including creating, updating and deleting data, or even simply reading it. When a watched-for event occurs, AuditMaster immediately triggers an Alert, which can take the form of an email to one or more recipients, a call to another application, or the start-up of a new application.
Data and Application Integration Product Line
Our integration and data quality analysis product line augments our low-TCO data management software offerings. Our data integration products have been developed on a single, 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 mid-sized businesses and departments of large enterprises to create and fine-tune their solutions for frequently changing business 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™ is available in Universal, Professional, Standard and SaaS editions. Pervasive Data Integrator aggregates and integrates data quickly and cost-effectively for legacy migrations as well as high volume, 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
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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 low-cost adoption by non-programmers for small data volumes all the way to complex, high-volume multi-processor implementations that handle millions of transactions. Pervasive Data Integrator provides a 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 Salesforce, NetSuite, Microsoft Dynamics (CRM, GP and AX), SAP, HIPAA, SWIFT, EDI, message queues (JMS and Websphere MQ) and enterprise service buses. The product is offered in both perpetual and subscription-based licensing models.
In addition, we recently introduced the Data Mediation Services (DMS) framework and SDK that can be used by Pervasive or partners to build specific Pervasive Data Integration connectors for additional commercially available or custom applications.
Pervasive Data Profiler™ reduces 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. This information enables our customers to make faster, more accurate decisions.
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.
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 directed by our Chief Technology Officer and 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 years 2007 and 2008 resulted in the introduction of three new product and service offerings: Pervasive DataTools, Pervasive DataSolutions and Pervasive DataRush.
Pervasive DataTools™ is our fast, affordable and powerful answer for all kinds of data challenges. Aggressively and conveniently priced via monthly subscriptions, these downloadable data tools put the power of 20+ years’ experience directly in the hands of our customers. Pervasive DataTools represent specific functional and connector subsets of our Pervasive Data Integrator product, delivered via a fully automated website.
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 Use with QuickBooks and Salesforce. Made available in June 2007 via salesforce.com’s AppExchange website, Pervasive DataSynch automatically synchronizes customer, product and order information between Salesforce and QuickBooks. Pervasive has since
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introduced a Microsoft Dynamics CRM-QuickBooks edition of DataSynch, the second of many possible application-specific synchronization solutions to be provided by Pervasive and just one of many anticipated data services-based offerings, which could range from data profiling to data auditing to any number of additional data services-based solutions from Pervasive.
Pervasive DataRush™ is our 100% Java engine and library that allows software developers to quickly build highly parallel, data intensive applications that take full advantage of multicore, SMP platforms. Semiconductor leaders such as Intel, AMD, Sun and IBM are delivering CPUs with an increasing number of cores on each chip. Today, consumers and businesses alike can purchase quad-core or even eight-core computers for what only a short time ago was the price of a single core computer. However, for the full processing capacity of multi-core computers to be captured, software developers must change the way software applications are written. The Pervasive DataRush engine and library are designed to allow software developers to help close this hardware-software technology gap. Pervasive is presently engaged with lighthouse customers and prospective partners to define optimal go-to-market strategies for execution in fiscal 2009.
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 SME organizations with limited IT resources, as well as departments of larger enterprises, 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 client/server, Web and mobile applications and systems integrators, consultants and value-added resellers (VARs) 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 client/server, Web and mobile 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.
Index to Financial Statements 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/mail campaigns, specifically targeting IT departments and business managers as well as vertical marketing initiatives aimed at the Financial Services and Healthcare sectors. While our primary focus is on small to mid-sized enterprises and departments within larger businesses, our products often scale to satisfy the needs of large enterprises resulting in direct sales to these organizations. The primary goal of these marketing campaigns is to direct potential customers back to our corporate Web site 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 products. Through our press and industry analyst relationships, the marketing team seeks industry endorsements that drive target customer buying within the integration segment.
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 enjoy 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 Internet for presentation, often with a specific problem from the customer, shown as a proof of concept, is produced. By using the Internet 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 Internet, 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
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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.
Professional Services
The Professional Services Group (PSG) is focused primarily on accelerating and maximizing integration ROI for customers. This group, consisting of Implementation Services 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 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. 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.
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 applications to the Web, 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 our DataExchange or 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.
Index to Financial Statements Research and Development
We have made substantial investments in research and development through both internal development and technology acquisition. As of June 30, 2008, we had 66 employees in research and development and our research and development expenditures for fiscal year 2008 were $10.2 million. We will continue to invest heavily in focused research and development resources to further our vision of the future of embedded data infrastructure software, enabling businesses to capitalize on their data investments, while accelerating the inevitable transition from high cost to high value.
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 to simplify development with our products, deployment and use of our products, and the on-going investment in emerging platform opportunities.
Our research and development investments in fiscal 2009 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 ISV’s, VARs and consultants who serve them.
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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 Web-based applications, enabling us to partner with application vendors and participate in market segments that are experiencing rapid growth.
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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. This includes existing 32-bit support and a planned fiscal 2009 offering of 64-bit support which includes HP-UX on the Intel® Itanium® architecture. 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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Application-specific integration solutions-We continue to invest in the creation of additional application-specific, service-based integration solutions to leverage recent investments in our Pervasive DataSynch product line.
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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. Our goal is to offer the most scalable and easy-to-use 100% Java engine and library that allows software developers to quickly build highly parallel, data intensive applications that take full advantage of the parallel processing capabilities of emerging multi-core chip technologies.
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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.
Index to Financial Statements Competition
We encounter competition for our embedded database products primarily from large, public companies, including Microsoft, Oracle, Sybase, 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 ETL (extract, transform and load) software vendors and data warehousing and application integration software providers. Such competitors include Ascential/IBM, Business Objects/SAP, Informatica, and Information Builders. In addition, we compete or may compete against database vendors that currently offer, or may develop, products with functionalities that compete with our solutions. These products typically operate specifically with these competitors’ proprietary databases. Such competitors include IBM, Microsoft, Sybase and Oracle. Competition also comes in the form of custom code, where potential customers have sufficient internal technical resources to develop solutions in-house without the aid of our products or those of our competitors. 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 database 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 segment 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 could have a material adverse impact on our database business.
Software-as-a-Service (SaaS) vendors may 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.
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, 2008, Pervasive employed 219 full-time employees, including 87 in sales and marketing, 66 in research and development, 34 in professional services, customer service and technical support, and 32 in general and administrative. We are not subject to any collective bargaining agreement, and we believe that our relationships with our employees are good.
Index to Financial Statements Facilities
Our leased headquarters facility in Austin, Texas, consists of approximately 91,000 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 international offices in Brussels, Frankfurt, London and Paris.
Index to Financial Statements 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 due to a variety of factors. Many of these factors 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.SQL 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 independent software vendors, or ISVs who embed our products or value-added resellers, 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 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.
Index to Financial Statements 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 economic climate 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. There can be no assurance that we will be able to effectively promote revenue growth rates in all economic conditions.
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 that this pattern may occur in the future.
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 substantially dependent on orders booked and shipped throughout that quarter.
Our Performance Depends on Market Acceptance of Pervasive.SQL
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 (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 year 2008 relative to fiscal year 2007 and decreased in fiscal year 2007 relative to fiscal year 2006. We believe the decrease in fiscal year 2007 was due to a variety of factors, including but not limited to, competition and what we believe to be the negative impact of general economic conditions on our ISV customers who build applications utilizing our database software and reduced demand for the ISVs’ software applications themselves. In addition, the decrease in fiscal year 2007 was due in part to reduced customer demand within our installed base of customers for the then current version of our database product (Version 9 released in March 2005). In September 2007, we released the latest version of our database product, PSQL Summit v10 and revenue from this product has increased in fiscal year 2008 relative to fiscal 2007. Regardless, a continued reduction in our embedded database business, or our inability to grow the integration products business we acquired as a result of our acquisition of Data Junction Corporation in fiscal year 2004, 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
Index to Financial Statements
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 related expenses, 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.
We May Face Problems in Connection With Past Acquisitions, Joint Ventures or Licensing Arrangements
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 that 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 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.
Index to Financial Statements 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.
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, 2008, one distributor (our joint venture partner in Japan, AG-TECH Corporation) accounted for an aggregate of approximately 13% of our revenues, as compared to 11% in the fiscal year ended June 30, 2007. Additionally, sales related to accounting software applications has, at various times, represented as much as 20% of our revenues. Furthermore, there is currently 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 and ACCPAC International Inc., three of our ISVs. The Sage Group family of companies has, at various times, represented as much as 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 independent software vendors, value-added resellers, systems integrators, consultants and distributors. Our sales channel could be adversely affected by a number of factors including:
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the failure of independent software vendors to develop, and the failure of value-added resellers to sell, products based on emerging platforms supported by us;
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pressures placed on the sales channel to sell competing products;
Index to Financial Statements
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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 partners. In addition, we cannot be certain our competitors will not attempt to recruit certain of our current or future partners. Such competitive actions may have an adverse effect on our ability to attract and retain partners.
We May Not Be Able to Develop Strategic Relationships
Our current collaborative relationships may not prove to be beneficial to us, and they may not be sustained. We may not be able to enter into successful new strategic relationships in the future, which could have a material adverse effect on our business, operating results and financial condition. From time to time, we have collaborated with other companies in areas such as product development, marketing, distribution and implementation. However, many of our current and potential strategic partners are either actual or potential competitors with us. In addition, many of our current relationships are informal or, if written, terminable with little or no notice.
We Depend on Third-Party Technology in Our Products
We rely upon certain software that 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.
Index to Financial Statements 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. We may not be successful in:
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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;
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avoiding difficulties that could delay or prevent the successful development, introduction or marketing of these products; or
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achieving market acceptance for our new products and product enhancements.
Our Software May Contain Errors or Defects
Errors or defects in our products may result in loss of revenues or delay in market acceptance, and could materially adversely affect our business, operating results and financial condition. 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. Product errors can put us at a competitive disadvantage and can be costly and time-consuming to correct.
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 Pervasive. 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 represent competitive pressure. We believe that Microsoft will continue to incorporate SQL Server
Index to Financial Statements
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 continues to grow 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 Pervasive.
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, 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 ETL (extract, transform and load) software vendors and data warehousing and application integration software providers. Such competitors include Ascential/IBM, Business Objects/SAP, Informatica, and Information Builders. In addition, we compete or may compete against database vendors that currently offer, or may develop, products with functionalities that compete with our solutions. These products typically operate specifically with these competitors’ proprietary databases. Such competitors include IBM, Microsoft, Sybase and Oracle. Competition also comes in the form of custom code, where potential customers have sufficient internal technical resources to develop solutions in-house without the aid of our products or those of our competitors. 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 database 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 may 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.
Index to Financial Statements 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, IBM, Progress, MySQL/Sun, 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 that 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. 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 that 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 Software-as-a-Service 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 that 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, 2008, we derived 38% of our revenues outside North America. Our international operations are generally subject to a number or 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;
Index to Financial Statements
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difficulties with financial reporting in foreign countries;
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quality control of certain development, translation or localization activities; and
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political and economic instability.
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 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 employees, either of which could materially and adversely affect our business, results of operations and financial condition.
Index to Financial Statements We Have Anti-Takeover Provisions
Our Restated Certificate of Incorporation and 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. It includes 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 whereby one preferred share purchase right was distributed for each outstanding share of our common stock. The rights are designed to assure that all of our stockholders receive fair and equal treatment in the event of any proposed takeover and to guard against partial tender offers, open market accumulations and other tactics designed to gain control without paying all stockholders a fair price. The rights were not being distributed in response to any specific effort to acquire us.
The rights become exercisable if a person or group hereafter acquires 15% or more of our common stock or announces a tender offer for 15% or more of our common stock. Such events, or if we are acquired in a merger or other business combination transaction after a person acquires 15% or more of our common stock, would entitle the right holder to purchase, at an exercise price of $18.00, a number of shares of common stock having a market value at that time of twice the right’s exercise price. Rights held by the acquiring person would become void. The Board of Directors can choose to redeem the rights at one cent per right at any time before an acquiring person hereafter acquires 15% or more of the outstanding common stock. The Rights Plan may have the effect of discouraging, delaying or preventing a change in control or unsolicited acquisition proposals.
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 that 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 nine fiscal quarters ending June 30, 2008, the Company has acquired approximately 5.6 million shares of its common stock on the open market at a total cost of approximately $22.5 million, or approximately $4.02 price per share. The Company’s Board of Directors has approved a new stock repurchase plan effective March 25, 2008, whereby the Company may repurchase additional shares of its common stock with a value of up to $10 million, $9.3 million of which is still available as of June 30, 2008. Depending on market conditions and
Index to Financial Statements
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.
Index to Financial Statements 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 That May Affect Future Results,” “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,” “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 2008 fiscal year that remained unresolved.
ITEM 2.
ITEM 2. PROPERTIES
Our leased headquarters facility in Austin, Texas, consists of approximately 91,000 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 international offices in Brussels, Frankfurt, London and Paris.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The company is not a party to any material legal proceeding.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
The Company did not submit any matters to a vote of security holders during the fourth quarter of fiscal year ended June 30, 2008.
Index to Financial Statements 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, 2008.
As of August 31, 2008, there were approximately 240 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
In March 2008, we announced the authorization of a new $10.0 million stock repurchase plan which became effective on March 25, 2008. During the three months ended June 30, 2008, we repurchased 164,421 shares of common stock at a cost of approximately $0.7 million under the stock repurchase plan approved in March 2008. The transactions occurred in open market purchases. The repurchase program may be suspended or discontinued at any time without prior notice.
Index to Financial Statements
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, 2006, 2007 and 2008 and the consolidated balance sheet data at June 30, 2007 and 2008 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, 2004 and 2005 and the consolidated balance sheet data at June 30, 2004, 2005 and 2006 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 and $1.8 million for the years ended June 30, 2006, 2007 and 2008, respectively, which are not included in years prior to fiscal year 2006. See Note 2 Summary of Significant Accounting Policies.
Index to Financial Statements
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.
Overview
Pervasive Software (NASDAQ: PVSW) helps companies get the most out of their data investments through embeddable data management and agile integration software. The embeddable PSQL database engine allows organizations to successfully embrace new technologies while maintaining application compatibility and robust database reliability in a near-zero database administration environment. Pervasive’s agile, multi-purpose integration platform accelerates the sharing of information between multiple databases, applications, or hosted business systems and allows customers to re-use the same software for diverse integration scenarios. 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 to small to mid-sized enterprises (SMEs) through a well-developed channel of independent software vendors (ISVs), Software-as-a-Service (SaaS) vendors, value-added resellers (VARs) and system integrators.
Our flagship Pervasive PSQL® database, offering unparalleled data management technology combined with very low 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, Web and mobile 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 Microsoft Windows Server 2008.
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 small to mid-sized businesses and departments of large enterprises. 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 two-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.
Our customer base is both large and diverse; we serve 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. Founded in 1994, Pervasive is headquartered in Austin, Texas, with international offices in Brussels, Frankfurt, London, Paris and a joint venture in Japan.
In July 2001, we formed a business venture with AG-TECH Corporation, a company developing, selling and importing packaged software, to sell and support our products in Japan. AG-TECH has been engaged in the sales
Index to Financial Statements
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. 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. Pervasive’s revenues from Japan were $6.8 million, $4.6 million and $5.4 million for the fiscal years ended June 30, 2006, 2007 and 2008, respectively. This agreement has been renewed twice, most recently for an additional five-year term which expires on June 30, 2012.
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, value-added resellers, or 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
Index to Financial Statements
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. 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. 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 Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment” (“SFAS 123R”) and Staff Accounting Bulletin No. 107, “Share-Based Payment.” 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, as required under SFAS 123R, we now 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-Under the liability method of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“Statement 109”), 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
Index to Financial Statements
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 fiscal years 2006, 2007 and 2008, we again considered future taxable income in assessing the need for a valuation allowance, and 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 in the cumulative amount of $2.9 million. Further, our foreign net operating loss and state tax credit carryforwards are subject to potential expiration if not utilized by certain dates in the future.
On July 1, 2007 the Company adopted the Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement of Financial Accounting Standards (SFAS 109), “Accounting for Income Taxes”. This interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. The Company did not have an adjustment to report in conjunction with the adoption of FIN 48.
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 frequently under audit by tax authorities in various jurisdictions. Prior to July 1, 2007, accruals for tax contingencies were provided for in accordance with the requirements of SFAS No. 5, Accounting for Contingencies. 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.
Index to Financial Statements 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 year 2008 relative to fiscal year 2007 after decreasing in fiscal year 2007 relative to fiscal year 2006. We believe the current year increase was due to the release of our latest version of Pervasive PSQL version 10. The prior year decrease was due to a variety of factors, including but not limited to, competition and what we believe to be the negative impact of general economic conditions on our ISV customers who build applications utilizing our database software and reduced demand for the ISVs’ software applications themselves. In addition, the decrease in fiscal year 2007 was due in part to reduced customer demand within our installed base of customers for the prior version of our database product (version 9 released March 2005). Our embedded database and related products represented approximately 66% of our revenue in fiscal year 2008. 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 revenue synergies and opportunities presented by the acquired business, combined with our historical database business and channels. Our integration products represented approximately 34% of our revenue in fiscal year 2008. 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 $45.6 million, $40.8 million and $42.5 million for the fiscal years ended June 30, 2006, 2007 and 2008, respectively, which represents a decrease of 11% from fiscal 2006 to 2007, and an increase of 4% from fiscal 2007 to 2008. Our product license revenues were $33.8 million, $28.9 million and $29.3 million for the fiscal years ended June 30, 2006, 2007 and 2008, respectively, which represents a decrease of 14% from fiscal 2006 to 2007, and an increase of 2% from fiscal 2007 to 2008. Our service and other revenues were $11.8 million, $11.9 million and $13.1 million for the fiscal years ended June 30, 2006, 2007 and 2008, respectively, which represents an increase of 1% from fiscal 2006 to 2007, and an increase of 10% from fiscal 2007 to 2008.
Index to Financial Statements International revenues, consisting of all revenue from customers located outside of North America, were $16.8 million, $14.9 million and $16.2 million in fiscal 2006, 2007 and 2008, representing 37%, 37% and 38% of total revenue, respectively. The decrease in international revenue in fiscal year 2007 is primarily attributed to a decline in our embedded database revenue in Japan. The increase in international revenue in fiscal year 2008 is primarily attributed to an increase in our embedded database revenue in both Europe and Japan. 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 $2.4 million, $3.4 million and $2.2 million in fiscal 2006, 2007 and 2008, representing 5%, 8% and 5% of total revenues respectively. The increase in cost of product licenses revenue in fiscal year 2007 is primarily the result of the write off of various purchased technologies during the year in the amount of $1.1 million. We anticipate that cost of product licenses revenue in fiscal year 2009 will decrease as compared to fiscal year 2008 due to a reduction in amortization expense when the purchased technology related to the fiscal year 2004 acquisition of Data Junction becomes fully amortized.
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 $5.6 million, $4.4 million and $4.2 million in fiscal 2006, 2007 and 2008, representing 12%, 11% and 10% of total revenues, respectively. Cost of services and other revenues decreased in fiscal year 2007 as compared to fiscal year 2006 primarily as a result of a reduction in costs related to support and professional service personnel. We anticipate cost of services and other in fiscal year 2009 will be consistent with fiscal year 2008.
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 $18.7 million, $15.3 million and $17.9 million in fiscal 2006, 2007 and 2008, representing 41%, 38% and 43% of total revenues, respectively. Sales and marketing expenses decreased in fiscal 2007 primarily due to a reduction in costs related to sales and marketing personnel and a reduction in marketing program costs. Sales and marketing expenses increased in fiscal 2008 primarily due to an increase in costs related to sales and marketing personnel and increased investment in marketing programs in support of new and upgraded product releases. We anticipate sales and marketing expenses will increase during fiscal year 2009 as we increase our sales and marketing personnel and invest in marketing programs 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 $10.3 million, $9.8 million and $10.2 million in fiscal 2006, 2007 and 2008, representing 23%, 24% and 24% of total revenues, respectively. Research and development expenses decreased in fiscal year 2007 primarily due to the closing of our India subsidiary at the end of fiscal 2006. Research and development expenses increased in fiscal year 2008 primarily due to increased investment in innovation of extensions to existing products as well as new products and services. We anticipate our research and development spending will increase in fiscal year 2009 as we continue to invest in existing products as well as new products and services.
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 $6.5 million, $5.5 million and $5.1 million in fiscal year 2006, 2007 and 2008, representing 14%, 14% and 12% of total revenues, respectively. General and administrative expenses decreased in dollar amount in
fiscal year 2007 primarily as a result of a reduction in costs associated with executive management personnel and
Index to Financial Statements
a corresponding reduction in FAS 123R stock option expense. General and administrative expenses decreased in dollar amount in fiscal year 2008 primarily due to the full-year effect of reductions of executive management personnel during fiscal year 2007. We believe our general and administrative expenses in fiscal year 2009 will be consistent with fiscal year 2008.
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 SFAS 123(R). (See Notes 2 and 6 to the Consolidated Financial Statements.) Share-based compensation expense was included in costs and expenses as follows:
The decrease in share-based compensation expenses in 2007 and 2008 resulted primarily from reductions in senior management positions in 2006 and 2007. We believe our share-based compensation expense in fiscal year 2009 will be consistent with fiscal year 2008.
Management Restructuring Charges. We announced certain senior management changes effective January 24, 2006, including the replacement of our former President and Chief Executive Officer, David Sikora, with John Farr, who previously served as our Chief Financial Officer. Our Vice President of Corporate Development and Vice President of Marketing also left the company during the quarter. We incurred severance and legal expenses associated with these changes during the quarter ending March 31, 2006 in the amount of $0.8 million.
Interest and Other Income. Interest and other income consists primarily of interest earned on various investments and was approximately $1.4 million, $2.3 million and $1.7 million in fiscal years 2006, 2007 and 2008, respectively. The increase in interest and other income in fiscal 2007 as compared to fiscal 2006 resulted from higher cash balances and higher yields on invested funds. The decrease in interest and other income in fiscal 2008 as compared to fiscal 2007 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 $0.4 million and $1.4 million in fiscal 2007 and 2008, respectively. Income tax benefit was approximately $2.2 million in fiscal 2006. The income tax benefit in fiscal 2006 consists primarily of the effect of a change in our valuation allowance related to our deferred tax asset in the amount of $2.3 million, offset partially by provision for income taxes related to foreign operations. The provision for income taxes in fiscal years 2007 and 2008 consist of income taxes related to both our foreign and domestic operations, offset by a change in our valuation allowance.
Index to Financial Statements 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
Index to Financial Statements
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 That May Affect Future Results.”
Liquidity and Capital Resources
Cash provided by operations was $8.2 million, $11.9 million and $7.9 million for fiscal 2006, 2007 and 2008, respectively. Cash provided by operations increased in fiscal 2007 as compared to fiscal year 2006 primarily due to an increase in income before taxes, non-cash amortization and write-offs of purchased technology intangible assets, a decrease in trade accounts receivable and an increase in deferred revenue. Cash provided by operations decreased in fiscal 2008 as compared to fiscal year 2007 as our trade receivables remained at normalized levels compared to revenues following significant collections experience in fiscal 2007 and our income tax expenses increasingly resulted in cash payments to taxing jurisdictions.
We invested, net, $9.1 million and $2.4 million in marketable securities in fiscal 2006 and 2007, 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 $0.6 million, $0.7 million and $0.7 million in fiscal 2006, 2007 and 2008, respectively. This property consisted primarily of computer hardware and software for general upgrade requirements for all fiscal years.
During fiscal years 2006, 2007 and 2008, we repurchased 763,700 shares, 2,697,531 shares and 2,248,394 shares, respectively, of common stock at a cost of approximately $3.2 million, $10.8 million and $9.2 million, respectively. In March 2008, we announced the authorization of a new $10.0 million stock repurchase plan which became effective on March 25, 2008, of which $9.3 million remains available as of June 30, 2008. 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, 2006, 2007 and 2008, we received approximately $1.8 million, $2.6 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 658,000, 861,000 and 144,000 for the fiscal years ending June 30, 2006, 2007 and 2008, 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, 2008, we had $41.1 million in working capital including $44.9 million in cash, cash equivalents and marketable securities, compared to working capital of $43.5 million at June 30, 2007.
Summary Disclosures About Contractual Obligations
The following table summarizes our operating lease obligations, net of subtenant offsets, at June 30, 2008, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:
Index to Financial Statements Recently Issued Accounting Standards
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which establishes a framework for measuring fair value under other accounting pronouncements that require fair value measurements and expands disclosures about such measurements. SFAS No. 157 does not require any new fair value measurements, but rather it creates a consistent method for calculating fair value measurements to address non-comparability of financial statements containing fair value measurements utilizing different definitions of fair value. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 157 on July 1, 2008 did not have a significant impact on its consolidated financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). SFAS 159 provides a “Fair Value Option” under which a company may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. This Fair Value Option will be available on a contract-by-contract basis with changes in fair value recognized in earnings as those changes occur. The effective date for SFAS 159 is the beginning of each reporting entity’s first fiscal year end that begins after November 15, 2007. SFAS 159 also allows an entity to early adopt the statement as of the beginning of an entity’s fiscal year that begins after the issuance of SFAS 159, provided that the entity also adopts the requirement of SFAS No. 157. The adoption of SFAS 159 on July 1, 2008 did not have an impact on the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) 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. SFAS 141R is effective for the Company beginning July 1, 2009 and will apply prospectively to business combinations completed on or after that date.
In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements-an amendment of Accounting Research Bulletin No. 51” (“SFAS 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. The Statement 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. SFAS 160 is effective for the Company beginning July 1, 2009 and will apply prospectively, except for the presentation and disclosure requirements, which will apply retrospectively. The Company does not believe this pronouncement will impact its 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 2006, the result would have been an increase in revenue and operating income of approximately $0.3 million. If the U.S. dollar to Japanese yen rate had remained unchanged throughout fiscal 2007, the result would have been an increase in revenue and operating income of approximately $0.1 million. 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
Index to Financial Statements
euro rate had remained unchanged throughout fiscal 2006, the result would have been an increase in operating income of less than $0.1 million. If the U.S. dollar to euro rate had remained unchanged throughout fiscal 2007, the result would have been an increase in operating income of approximately $0.1 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. The impact of fluctuations in the relative value of all other currencies for fiscal 2006, 2007 and 2008 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, 2006, 2007, and 2008 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, 2008, 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.
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 generally accepted accounting principles.
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.
Index to Financial Statements Management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2008. 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, 2008, 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 generally accepted accounting principles.
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.
Index to Financial Statements PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information regarding directors, executive officers and corporate governance 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 11, 2008. The Proxy Statement is anticipated to be filed within 120 days after the end of the registrant’s fiscal year ended June 30, 2008.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company, and their ages as of August 31, 2008, 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 in various capacities as CFO, Executive Vice President, interim CEO and Board Member 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.
Index to Financial Statements
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.
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.
Index to Financial Statements 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, 2007 and 2008
Consolidated Statements of Income for each of the three years in the period ended June 30, 2008
Consolidated Statements of Changes in Stockholders’ Equity for each of the three years in the period ended June 30,
Consolidated Statements of Cash Flows for each of the three years in the period ended June 30,
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.
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.
(c)
Exhibits
Index to Financial Statements
+
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 9, 2006.
++++
Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed February 5, 2007.
+++++
Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed May 9, 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.
Index to Financial Statements 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.
PERVASIVE SOFTWARE INC.
(Registrant)
By:
/S/ JOHN E. FARR
John E. Farr
President and Chief Executive Officer
September 8, 2008
Date
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.
Index to Financial Statements SCHEDULE II
PERVASIVE SOFTWARE INC.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
S-1
Index to Financial Statements PERVASIVE SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at June 30, 2007 and 2008
Consolidated Statements of Income for each of the three years in the period ended June 30, 2008
Consolidated Statements of Changes in Stockholders’ Equity for each of the three years in the period ended June 30,
Consolidated Statements of Cash Flows for each of the three years in the period ended June 30,
Notes to Consolidated Financial Statements.
Index to Financial Statements REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pervasive Software Inc:
We have audited Pervasive Software Inc. and subsidiaries (the “Company”) internal control over financial reporting as of June 30, 2008, 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, 2008, 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, 2008 and 2007 and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the three years in the period ended June 30, 2008, and our report dated September 8, 2008 expressed an unqualified opinion on those financial statements.
/s/ Grant Thornton LLP
Dallas, Texas
September 8, 2008
Index to Financial Statements 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. and subsidiaries (the “Company”) as of June 30, 2008 and 2007, 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, 2008. 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. as of June 30, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2008 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, 2008, 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 8, 2008 expressed an unqualified opinion on the effective operation of the Company’s internal control over financial reporting.
/s/ Grant Thornton LLP
Dallas, Texas
September 8, 2008
Index to Financial Statements PERVASIVE SOFTWARE INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
Index to Financial Statements PERVASIVE SOFTWARE INC.
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes.
Index to Financial Statements PERVASIVE SOFTWARE INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
See accompanying notes.
Index to Financial Statements PERVASIVE SOFTWARE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
1. The Company
Pervasive Software Inc. (the “Company”) helps companies get the most out of their data investments through embeddable data management and agile integration software. The embeddable PSQL database engine allows organizations to successfully embrace new technologies while maintaining application compatibility and robust database reliability in a near-zero database administration environment. Pervasive’s agile, multi-purpose integration platform accelerates the sharing of information between multiple databases, applications, or hosted business systems and allows customers to re-use the same software for diverse integration scenarios. 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 to small to mid-sized enterprises (SMEs) through a well-developed channel of independent software vendors (ISVs), Software-as-a-Service (SaaS) vendors, value-added resellers (VARs) and system integrators.
The Company develops, markets, sells and supports its offerings worldwide through its principal office in Austin, Texas and through international offices in 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 Costs of product licenses in the Consolidated Statements of Income.
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
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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 2006, 2007 and 2008 were approximately $2.1 million, $1.7 million and $1.7 million, respectively.
Income Taxes
Under the liability method of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“Statement 109”), 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 establishes a valuation allowance. The Company concluded that a valuation allowance was required for all periods presented. 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 in the amount of $2.3 million, $0.5 million, and $66,000 in fiscal years 2006, 2007, and 2008, respectively.
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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 frequently under audit by tax authorities in various jurisdictions. Prior to fiscal year 2008, accruals for tax contingencies are provided for in accordance with the requirements of SFAS No. 5, Accounting for Contingencies. 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 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, the Company is not able to estimate the range of reasonably possible losses in excess of amounts recorded.
On July 1, 2007 the Company adopted the Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement of Financial Accounting Standards (SFAS 109), “Accounting for Income Taxes”. This interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. The Company did not have an adjustment to report in conjunction with the adoption of FIN 48.
A reconciliation of the change in our unrecognized tax benefits for the year ended June 30, 2008 is as follows (in thousands):
As of June 30, 2008, $133,000 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, 2008, the balance of accrued interest and penalties related to unrecognized tax benefits was approximately $74,000. We do not believe that it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of June 30, 2008.
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 2004.
Cash and Cash Equivalents
Cash and cash equivalents include cash, certificates of deposit, and securities with original maturities less than ninety days when purchased.
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Marketable Securities
Marketable securities have been classified as available-for-sale and such designation is reevaluated as of each balance sheet date. While the Company’s intent is to hold debt securities to maturity, they are classified as available-for-sale because the sale of such securities may be required prior to maturity. Realized gains and losses are recorded on the specific identification method and are included in other income. Realized and unrealized gains and losses have been insignificant for all periods presented.
The majority of the Company’s marketable securities mature on or before June 30, 2009. All are stated at fair market value as of June 30, 2007 and 2008, and consist 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. Upon determining the existence of goodwill and/or 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. 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 2006, 2007 or 2008.
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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, 2007 and 2008 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 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 15%, 11% and 13% of the Company’s revenue during the years ended June 30, 2006, 2007 and 2008 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.
Stock-Based Compensation
The Company accounts for employee share-based compensation costs, which include stock options and restricted stock, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment” (“SFAS 123R”) and Staff Accounting Bulletin No. 107, “Share-Based Payment”, using the modified prospective application method. The Company utilizes 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 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. Further, as required under SFAS 123R, 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
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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, 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, 2006, 2007 and 2008, was $1.8 million, $2.5 million and $0.4 million, respectively. The estimated net 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, 2006, $0.3 million for the year ended June 30, 2007 and $0.1 million for the year ended June 30, 2008.
Total compensation cost recognized in income for stock-based employee compensation awards was approximately $3.0 million, $2.1 million and $1.8 million for the fiscal years ending June 30, 2006, 2007 and 2008, respectively and the total recognized tax benefit related thereto was approximately $0.2 million, nil and nil, respectively.
During fiscal 2006, 2007 and 2008, 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, as defined by SFAS 123R, for options granted under the Company’s stock option plan during the years ended June 30, 2006, 2007 and 2008 was $2.83, $2.14 and $1.56 per share, respectively.
During fiscal year 2006, 2007 and 2008 the Company issued 600,000, 195,000 and 138,000 shares, respectively, of restricted stock with a weighted average fair value of $4.23, $4.21 and $3.83 per share, respectively. During fiscal year 2007 and 2008, the Company issued 5,000 and 25,000 restricted stock units, respectively. The shares and units are being expensed over their expected lives of three to four years.
As of June 30, 2008, $1.2 million, $0.7 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 2009, 2010, 2011 and 2012, respectively.
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.
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Segments
In accordance with Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company considers its business activities to be a single segment.
Recently Issued Accounting Standards
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which establishes a framework for measuring fair value under other accounting pronouncements that require fair value measurements and expands disclosures about such measurements. SFAS No. 157 does not require any new fair value measurements, but rather it creates a consistent method for calculating fair value measurements to address non-comparability of financial statements containing fair value measurements utilizing different definitions of fair value. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 157 on July 1, 2008 did not have a significant impact on its consolidated financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). SFAS 159 provides a “Fair Value Option” under which a company may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. This Fair Value Option will be available on a contract-by-contract basis with changes in fair value recognized in earnings as those changes occur. The effective date for SFAS 159 is the beginning of each reporting entity’s first fiscal year end that begins after November 15, 2007. SFAS 159 also allows an entity to early adopt the statement as of the beginning of an entity’s fiscal year that begins after the issuance of SFAS 159, provided that the entity also adopts the requirement of SFAS No. 157. The adoption of SFAS 159 on July 1, 2008 did not have an impact on the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) 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. SFAS 141R is effective for the Company beginning July 1, 2009 and will apply prospectively to business combinations completed on or after that date.
In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements-an amendment of Accounting Research Bulletin No. 51” (“SFAS 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. The Statement 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. SFAS 160 is effective for the Company beginning July 1, 2009 and will apply prospectively, except for the presentation and disclosure requirements, which will apply retrospectively. The Company does not believe this pronouncement will impact its financial statements.
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3.
Property and Equipment
Property and equipment consists of the following (in thousands):
Depreciation expense was approximately $1.3 million, $0.9 million and $0.8 million for fiscal years ending June 30, 2006, 2007 and 2008, respectively.
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):
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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 2006, 2007 and 2008 as a result of the following (in thousands):
The components of deferred income taxes at June 30, 2007 and 2008 are as follows (in thousands):
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
As of June 30, 2008, the Company expects that upon filing of its domestic tax return for fiscal year 2008 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. The Company also has Canadian net operating loss carryforwards of $8.0 million, a portion of which expires on an annual basis.
The valuation allowance decreased by approximately $0.8 million during the year ended June 30, 2008, which substantially relates to the expiration of Canadian net operating loss carryovers not previously benefited. At June 30, 2008, the Company has a valuation allowance of $2.9 million, which is primarily related to the Canadian net operating loss carryforwards and the determination that these assets will not be able to be utilized due to the uncertainty of generating sufficient taxable income in Canada in the near future.
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 $35,000 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, 2008, such maximum annual exposure for the policy year ending June 30, 2009 is approximately $2.1 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 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, 2006, 2007 and 2008 were approximately $0.8 million, $0.8 million, and $1.1 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, 2006, 2007 or 2008. In fiscal years 2006, 2007 and 2008, the Company funded a matching contribution of 10% of participant contributions made during calendar years 2005, 2006 and 2007 for all participants employed by the Company on December 31, 2005, 2006 and 2007. The amount expensed related to the match was approximately $94,000, $79,000 and $100,000 for the fiscal years ended June 30, 2006, 2007 and 2008, 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
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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 2006, 2007 and 2008 the Company issued 600,000, 195,000 and 138,000 shares, respectively, of restricted stock with a weighted average fair value of $4.23, $4.21 and $3.83 per share, respectively.
A summary of changes in common stock options during the year ended June 30, 2006, 2007 and 2008 is as follows:
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following is additional information relating to options outstanding at June 30, 2008:
The aggregate intrinsic value (the amount by which market price exceeds the option exercise price) for options as of June 30, 2008 is as follow:
At June 30, 2008, 4,678,539 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.
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):
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
At June 30, 2006, 2007 and 2008 approximately 1,469,000, 1,534,000 and 789,000 shares, respectively, were not included in the diluted earnings per share calculation since the shares are anti-dilutive.
8.
Management Restructuring Charges
The Company announced certain senior management changes effective January 24, 2006, including the replacement of the former President and Chief Executive Officer, David Sikora, with John Farr, who previously served as the Company’s Chief Financial Officer. The Vice President of Corporate Development and Vice President of Marketing also left the company during the quarter. The Company incurred severance and legal expenses associated with these changes during the quarter ending March 31, 2006 in the amount of $0.8 million.
9.
Goodwill and Other Intangible Assets
As of June 30, 2008, Pervasive had goodwill in the amount of $38.5 million associated with the acquisition of Data Junction. The Company previously determined, in accordance with Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets, that it would assess 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. Other intangible assets, classified as Purchased Technology on the balance sheet, amounted to $0.6 million (net of accumulated amortization of $5.9 million) as of June 30, 2008. 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. During fiscal year 2007, the Company filed amended tax returns related to Data Junction that resulted in approximately $0.4 million of federal research and development and Alternative Minimum Tax Credit carryforwards. Since the credits relate to periods prior to the Company’s acquisition of Data Junction, the benefit of these credit carryforwards was used to reduce goodwill.
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, 2006, 2007 and 2008 was approximately $1.6 million, $1.5 million and $1.5 million, respectively. During fiscal year 2007, the Company determined various purchased technologies were not likely to provide significant future economic benefit and therefore the remaining assets were written off in the amount of $1.1 million. Amortization expense for intangible assets is anticipated to be approximately $0.6 million for the year ended June 30, 2009.
Purchased technology consists of the following (in thousands):
10.
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, 2006, 2007 and 2008, was approximately $2.2 million, $2.2 million, and $1.8 million, respectively.
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Future minimum lease payments, net of subtenant offsets, at June 30, 2008 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, 2008.
11.
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 for Europe, India and Japan do not include any allocation of marketing, product development, technical support and administrative costs incurred in the United States.
Index to Financial Statements PERVASIVE SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
12. 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):
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):