ITEM 1. BUSINESS
OVERVIEW
Wall Data Incorporated ("Wall Data" or the "Company") is an enterprise software company providing products and services that allow organizations to integrate and deploy applications over corporate intranets, extranets and the Web. Using Wall Data solutions, organizations can extend their enterprise information systems to allow internal users, remote users, third-party partners and customers to access information and applications.
Wall Data operates two principal businesses: the RUMBA* business and the Cyberprise business. The RUMBA business consists of products that provide access to legacy corporate computer systems, and the Cyberprise business consists of products and services that enable companies to develop Enterprise Information Portals ("EIPs") that integrate applications, data and content within a Web browser interface.
Wall Data's RUMBA products were introduced in 1989 and have been sold to over 10,000 customers worldwide. The RUMBA product line was recently upgraded to take advantage of the emerging Web-to-host market by allowing users to access legacy systems from industry-leading browsers. The RUMBA family of host connectivity products operates in Microsoft's Windows 3.x, Windows 95 and Windows NT environments and supports the exchange of information between personal computer ("PC") applications and IBM compatible mainframe computing environments, including those manufactured by IBM, Hewlett Packard and Digital Equipment as well as a variety of client-server database applications.
The Company's Cyberprise products and services allow companies to build EIPs that provide their employees, customers, partners and suppliers with uniquely relevant enterprise information, applications, data and Internet content at a single point of access. The unique advantage Cyberprise brings to the market is the ability to link organizations' current information systems to the Web. The Cyberprise portal products incorporate rapid transformation technologies and include Web-to-host and business intelligence products. The first Cyberprise products were released in March of 1998.
Wall Data was incorporated in Washington in 1982 and has a 15-year history of extending corporate computing systems to users on new platforms and providing business solutions to customers worldwide.
CHANGE IN FISCAL YEAR END
On April 22, 1998, the Company's Board of Directors approved a change in the Company's fiscal year from a calendar year to a year beginning May 1 and ending April 30. The four-month transition period from January 1, 1998 through April 30, 1998 (the "1998 Four-Month Period") preceded the start of the fiscal year ended April 30, 1999 which will be referred to in this Form 10-K as Fiscal 1999. The prior periods ended
- ---------------
* "Wall Data," "RUMBA" and "ONESTEP" are registered trademarks of the Company and "Cyberprise" is a trademark of the Company. All other trademarks are the property of their respective owners.
December 31, 1997, 1996 and 1995 will be referred to herein as Fiscal 1997, Fiscal 1996 and Fiscal 1995 respectively.
RECENT DEVELOPMENTS
During the fourth quarter of fiscal 1999, the Company restructured its RUMBA host access business and its Cyberprise corporate portal business into two separate businesses, each with its own sales, service, development and marketing organizations to enable each business to address its own unique market dynamics, sales processes, growth rates and operating priorities. The Company continues to utilize centralized administrative and support organizations for both businesses to reduce costs and for efficiency purposes. There can be no assurance that the restructuring will improve the Company's performance or that the Company will be able to operate two separate business organizations successfully.
The Company also announced that it has engaged the investment banking firm of Bear Stearns & Company to evaluate strategic alternatives for the Company's two businesses. There can be no assurance that the Company will be able to identify or implement successful strategic alternatives for either the RUMBA business or the Cyberprise business. See "Important Factors Regarding Forward-Looking Statements."
PRODUCTS
The Company's software products provide computer users in business organizations with easy access to and use of computer applications and data residing on multiple host mainframes, minicomputers and servers in enterprise-wide information system networks and public information networks. Using Wall Data solutions, organizations can extend their enterprise information to allow their internal users, remote users, third-party partners and customers to access information and applications over corporate LAN/WAN systems, intranets, extranets and the Web.
CYBERPRISE
OVERVIEW
Wall Data's Cyberprise business (www.cyberprise.com) focuses on integrating and managing enterprise information assets through the Cyberprise Portal, a corporate portal for creating multiple online communities across a company's customers, partners and vendors. Cyberprise solutions have been sold to more than 180 customers in 18 industries.
Cyberprise solutions allow corporations to build EIPs that provide their employees, customers, partners and suppliers with uniquely relevant enterprise information, applications, data and Internet content at a single point of access. Wall Data's Cyberprise solutions accomplish this by creating virtual applications accessed through an EIP.
A virtual application integrates elements from multiple existing applications, data warehouses and the Internet and delivers the integrated information to the user through the EIP. Corporations use Cyberprise Rapid Transformation Technologies to create these virtual applications. Cyberprise Rapid Transformation Technologies allow customers to migrate existing solutions to the Web more rapidly and at a substantially lower cost than if they created new applications. The resulting virtual applications deliver integrated user- specific views of a broad range of corporate applications, information, and data, managed through the Cyberprise Corporate Portal. The breadth, integrated functionality and scalability of the Cyberprise solution uniquely differentiate the Company's position in this emerging market.
INDUSTRY BACKGROUND
Increasingly, business users rely on corporate intranets for basic information. These users are unable to take full advantage of the mission-critical data that reside in enterprise applications and databases due to the complexity of existing systems. Employees are expected to navigate by themselves through a number of other applications to access this information. Although they are mission-critical, legacy applications are often too
complex to be broadly accessible, too focused on narrow business functions and may be too difficult to learn. Moreover, legacy applications normally present single-purpose views, and rarely integrate with other relevant business information, whether from internal or external sources.
Wall Data's Cyberprise strategy addresses the emerging technology market now known as EIPs. There are three factors driving the growth of this market: (i) the corporate realization of the wealth of information currently stored in diverse enterprise information systems; (ii) the emergence of packaged information applications playing into the buy-versus-build trend; and (iii) the availability of affordable, ubiquitous information distribution channels in the form of intranets and extranets. Organizations are rapidly beginning to understand that the Internet represents an inexpensive and reliable distribution channel to provide their constituencies with essential business information. There can be no assurance that organizations will adopt solutions that are suitable for application of the Cyberprise technologies, or that the Cyberprise strategy will be successful.
PRODUCTS
The Company sells a number of products under the Cyberprise product family that enable its customers and partners to implement EIP solutions. Cyberprise EIP solutions allow organizations to access internally and externally stored information at a low cost, increase operational efficiency, lengthen the useful lives of legacy applications and maximize resource deployment.
Cyberprise Portal Server
The platform of the EIP solution is the Company's Cyberprise Portal Server. The Cyberprise Portal Server provides a single point of access and a common user interface across the enterprise, as well as rich functionality for content management and organization for each user, information publishing, Web-based administration, user license management, user load balancing across multiple servers, domain security and password management. These products run on the leading Web servers and operating systems including Microsoft NT and Unix systems from Sun and Hewlett-Packard.
The Cyberprise Portal Server allows browser users to access existing enterprise computing applications and information, as well as public information, through an easy-to-use channel interface that can be easily customized. The Cyberprise Portal Server also provides centralized management, security and scalability to permit IT to manage the delivery of the correct information and applications to each user.
Rapid Transformation Technologies
In support of the Cyberprise Portal Server, the Company sells a number of Rapid Transformation Technology products that are used to convert existing legacy applications, corporate data and information assets into virtual applications, delivering personalized information accessed over the Web. This is done automatically or with reduced development resources when customized solutions are required. There are two categories of Rapid Transformation Technologies: Automatic Web Enablement and Web Development Tools.
AUTOMATIC WEB ENABLEMENT includes Web-to-host products such as Cyberprise Host, Enterprise Edition available for both Microsoft Windows NT and the Sun and HP Unix Platforms, that automatically provide direct, persistent, browser-based access to host systems. Automatic Web Enablement also includes Business Intelligence products such as Cyberprise InfoPublisher to publish database queries, reports, data analysis cubes, and all forms of standard PC documents.
WEB DEVELOPMENT TOOLS enable internal developers, consultants and business users to extend the automatic capabilities of Cyberprise products to customized business solutions. Products such as Cyberprise Host Developer and Cyberprise DBApp Developer allow developers to build Web applications that connect host transaction applications, migrate client/server applications to the Web, create custom database queries and reports and customize user information presentation.
Cyberprise Rapid Transformation Technologies are a combination of DCOM, ActiveX, CORBA, Java and Java Bean components and tools that automatically transform applications and information to the World Wide Web or accelerate the transformation process for developers.
RUMBA BUSINESS -- HOST CONNECTIVITY SOFTWARE PRODUCTS
OVERVIEW
The RUMBA family of host connectivity software products (www.rumba.com) provides host connectivity in the PC-to-host, Web-to-host and server-based computing market. RUMBA products allow business users to access mission-critical applications and data by supporting the exchange of information between PC applications and host applications operating on IBM and IBM-compatible mainframe computers. RUMBA products implement PC-to-enterprise connections using an array of network and communication configurations over a wide range of communication hardware, multiple LAN operating systems and a broad range of communications servers and gateways. RUMBA software is designed for enterprise-wide implementation while leveraging customers' prior investments in host computers, applications, PCs, intranets, the Internet and a wide range of private networks. The Company has sold its RUMBA products to over 10,000 customers.
INDUSTRY BACKGROUND
The PC-to-host and Web-to-host industry is a successor to the terminal emulation market of the 1980's. The terminal emulation market developed due to users' needs to access mainframe computer applications without an additional terminal on the desktop. The computing industry changed with the introduction of the PC and the introduction of Microsoft Windows in 1989. These two events led the computer to spread throughout the business environment as well as to the consumer. However, much corporate data was still locked within the user-unfriendly mainframe. As a result, a new market for Windows-based PC-to-host connectivity software emerged to enable users to access this information easily through a familiar user interface.
PRODUCTS
Today's corporate workforce has come to expect computer applications to have the look and feel that is consistent with the Microsoft Windows environment. However, traditional host applications are still written to a dedicated terminal user interface instead of the graphical user interface of a Windows environment. Wall Data overcomes this difficulty with its RUMBA products. RUMBA products allow corporate users to operate existing applications through a Windows interface.
RUMBA software products fall into two categories: RUMBA client software products and RUMBA tool products. In 1989, the Company introduced RUMBA for the Mainframe, Windows Version, which allowed PC users to access and use host information and applications on IBM and IBM-compatible mainframes. Since then, the Company has introduced new client software products and features that allow PC users to access and use host applications and data in various enterprise-wide networks and public information networks. RUMBA tool products allow advanced users, developers and administrators to create custom applications to suit user needs. The component-based architecture of RUMBA products ensures robust, optimal performance and fast, flexible application development.
RUMBA Client Software Products
The Company recently released its latest generation of RUMBA client software products, the RUMBA 2000 product line, a full line of PC-to-host, Web-to-host and server-based computing solutions. In addition to traditional PC-to-host connectivity, the RUMBA 2000 product also includes a range of ActiveX, Java and Java Bean based Web-to-host technologies. The RUMBA 2000 product line was developed for organizations that are seeking to reduce the total cost of PC ownership that require robust host access functionality within their LAN/WAN infrastructure, and that have plans to adopt a Web-based computing
model. All RUMBA 2000 products include a browser-interface option allowing users to work with RUMBA software within their Microsoft Internet Explorer or Netscape Navigator browser environment using Active Document technology. By centrally installing RUMBA 2000 on a LAN server, an organization reduces the IT workload associated with supporting and maintaining multiple desktops. The RUMBA 2000 product also adds significant functionality and options that include: (i) TN5250E support that provides AS/400 users with printing and unique device names capabilities; (ii) AS/400 File Transfer which supports native TCP/IP; (iii) MPE Native File Transfer which provides HP3000 users with the ability to transfer files to a Windows application; and (iv) multi-file transfer to HP/UNIX hosts to increase user productivity.
RUMBA Office 2000, the successor to RUMBA Office, is a full, multi-host suite of solutions for users needing to access enterprise server or host systems that provides access to a vast range of character-based and client-server applications on business-critical systems and includes Web-to-host capabilities. The modular architecture of RUMBA Office integrates file and print management, database access, mail and messaging, and Internet features into a single universal client. In addition, features such as QuickAssist, which eliminates repetitive keystrokes, and Hotspots and QuickStep, which allow host applications to be operated by a mouse instead of the keyboard, help to provide customers with productivity-enhanced business tools. Wall Data has also introduced versions of its RUMBA products that support Citrix WinFrame and Microsoft Terminal Server environments providing customers with cost-efficient host access in server-based computing models.
With the 1998 introduction of RUMBA Office, Cyberprise Edition, the Company also added browser-based host access within the extranet and Internet environments. RUMBA Office, Cyberprise Edition incorporates portions of the Company's Cyberprise Host technology to address the growing Web-to-host market. These Web-to-host features are now incorporated in the RUMBA product line. These products allow employees to access host applications using industry standard Internet browsers running the Microsoft Windows operating system.
RUMBA Tool Products
The Company's RUMBA software tools operate on client PCs and network servers to enable software developers and advanced users to customize or develop applications making use of host information. By supplying enterprise information access technology and implementing industry-standard architectures for custom solution development, including Microsoft's ActiveX component architecture, RUMBA tools give developers the ability to easily produce custom software solutions that meet specific user and enterprise needs.
RUMBA tools deliver a range of capabilities for enhancing the presentation of enterprise information on PCs and the Web and are designed for users and developers of varying proficiency. Developers can use RUMBA application tools in connection with industry-standard application programming interfaces and computer-aided software engineering tools to develop sophisticated applications and transaction programs interfacing with host applications. Advanced application users or developers can use RUMBA application tools to customize or develop specific applications designed to incorporate enterprise information. Advanced application users can use RUMBA application tools to present enterprise information in the format of familiar Windows applications on the Web.
SERVICE
Wall Data is committed to responsive, high-quality product support and timely upgrades for the Company's software products. In the RUMBA business, these services are marketed under the ONESTEP(R) brand, and in the Cyberprise business these services are marketed under the Cyberprise services brand.
RUMBA SERVICES -- ONESTEP. The Company's ONESTEP program is an optional annual subscription service program for the Company's RUMBA products, providing responsive, priority product support at predictable costs augmenting customers' support staff and maximizing user productivity. Customers can select the support options that best fit the size, structure and service requirements of their organization. Separate service offerings are available for various Wall Data products. Individual program options include: priority telephone access to Wall Data senior support engineers; electronic services on the Web that provide on-line case entry, privileged access to Wall Data's online support information database, and the ability to download
current product updates and fixes; and upgrade subscription, which keeps the customer's software current with the latest upgrades and updates.
CYBERPRISE SERVICES. Cyberprise Services include maintenance, support, consulting and specialized programs to facilitate moving corporate information and applications, including mission-critical systems to the Cyberprise environment.
Cyberprise Services are marketed under the Cyberprise Service brand in the form of a flexible annual maintenance program which provides responsive, priority product support at predictable costs, augments customers' support staff and maximizes user productivity.
The Company also offers consulting services for implementation of Cyberprise solutions. The Company has a small group of employees in the Cyberprise Services group to oversee implementation engagements using existing systems engineers as well as contracting with third party consulting partners to fulfill consulting engagements. As of July 1, 1999, the Company had 40 consulting partners available to serve as primary contractors or subcontractors on consulting engagements on deployments of Cyberprise solutions. To date, consulting revenue from customer engagements has not been significant. The Company recently assigned 24 additional people to the Cyberprise Consulting Group to further support customer implementation of Cyberprise solutions.
SALES, MARKETING AND DISTRIBUTION
OVERVIEW
The Company markets its products primarily to multinational and national business organizations with installed enterprise computer systems. These organizations vary in size, complexity and purchasing-decision structures. To address this range of sales and marketing opportunities, Wall Data uses a combination of direct sales, telesales, resellers, distributors and OEMs.
The direct sales force focuses on large enterprises and markets to the executive, management information systems, department/division and user levels within these organizations. The Company also sells its products through indirect channels, primarily consisting of distributors and national and regional resellers addressing the business market. The Company supports its resellers and distributors with experienced sales, marketing, systems engineering and technical support staff. In addition, the Company relies on resellers and distributors to market and support its products in certain geographic markets. There can be no assurance, however, that such resellers and distributors will be able to market the Company's products effectively or be qualified to provide timely and cost-effective customer support or service. See "-- Important Factors Regarding Forward-Looking Statements -- Reliance on Resellers and Distributors."
Wall Data sells its product lines through national distributors such as Ingram Micro Inc., Merisel, Inc. and Tech Data Corporation, which may in turn sell to other resellers, VARs and dealers. The Company's resellers include Corporate Software and Technology, Entex Information Systems, Shared Medical Systems, Softmart, Inc. and Software Spectrum, Inc. The Company's agreements with resellers and distributors typically are not exclusive and may be terminated by either party without cause. Many of the Company's resellers and distributors carry competing product lines. The Company's agreements with certain distributors and resellers permit them to exchange products under certain circumstances and permit returns from certain resellers subject to specific limitations; an accrual is recorded for estimated sales returns and exchanges. There can be no assurance that any resellers or distributors will continue to represent the Company's products or that additional resellers or distributors will agree, or continue, to represent the Company's products.
CYBERPRISE
The Company markets its Cyberprise products worldwide through a dedicated direct sales force. The Cyberprise direct sales force focuses on large enterprises and markets to the executive, management information systems, department/division and user levels within these organizations. The Company also sells its Cyberprise products through indirect channels, primarily consisting of the Cyberprise Partner Network and
other distributors and national and regional resellers addressing the business market. Sales efforts for Cyberprise products emphasize delivery and deployment of business solutions, rather than technology implementations or product sales.
RUMBA
The Company markets its RUMBA products worldwide, primarily to multinational and national business organizations with installed enterprise information systems. These organizations vary in size, complexity and purchasing-decision structures. To address this range of sales and marketing opportunities, the RUMBA business uses a combination of direct sales, telesales, resellers, distributors and OEMs.
The Company relies on its RUMBA direct sales force to generate demand by focusing on large enterprises and marketing to the executive, management information systems, department/division and user levels within these organizations. Fulfillment is completed by the Company or its resellers and distributors. The Company also sells its RUMBA products through indirect channels, primarily consisting of distributors and national and regional resellers addressing small and midsize organizations.
Wall Data has entered into OEM agreements with certain companies, pursuant to which these companies market derivatives of RUMBA products under various names. The OEM agreements generally provide nonexclusive licenses of specific versions of software and allow the OEMs to combine the specific version of software with their product-specific software and to distribute and market the derivative of the software product under their own names. The Company generally receives a license fee or royalty based on the number of copies of products or derivatives of the software distributed to end users or used internally. Sales pursuant to OEM agreements accounted for approximately 3.4% of the Company's net revenues in the Fiscal 1999. There can be no assurance, however, that OEMs will be able to market the Company's products effectively or that OEM revenues will continue at such levels.
INTERNATIONAL
The Company's international sales and marketing staff are located in Brazil, Canada, England, France, Germany, Ireland, Japan and Mexico. Currently, the Company's sales in Europe are made on both a direct basis and through local resellers and distributors. Agreements with local resellers and distributors generally provide for non-exclusive rights to sell the Company's products in a specified geographic area.
Approximately 26%, 35%, 30% and 29% of the Company's net revenues in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively, were attributable to sales made to customers outside North America. The Company expects that international sales will continue to be a significant portion of its business. The Company's international sales efforts are focused primarily on large business organizations with computing resources located throughout the world. The Company has sales and/or marketing staff located in Argentina, Australia, Brazil, Canada, England, France, Germany, Ireland, Italy, Japan, Mexico, Singapore and Spain. Currently, the Company's sales in Europe are made primarily through local resellers and distributors. Agreements with local resellers and distributors generally provide the resellers nonexclusive rights to sell the Company's products in a specified geographic area. Resellers are required to pay license fees for all products shipped to them and to market the products. Generally, the agreement may be terminated by the Company if the reseller breaches the agreement or fails to reach agreed-upon sales quotas and, after one year, may be terminated by either party with three months' notice. See Note 13 of Notes to Consolidated Financial Statements for more information regarding foreign operations and export sales.
The Company faces certain risks inherent in international business operations, including fluctuations in foreign currency exchange rates, the instability of certain overseas economic environments, longer accounts receivable payment cycles, difficulties in staffing and managing international operations, unexpected changes in regulatory requirements, tariffs and other trade barriers, potentially adverse tax consequences, repatriation of earnings and the burdens of complying with a wide variety of foreign laws. There can be no assurance that such factors will not have a material adverse effect on the Company's future international sales and, consequently, on the Company's results of operations. See "-- Important Factors Regarding Forward-Looking Statements -- International Operations."
MARKETING
The Company's marketing programs are designed to create user awareness and generate sales opportunities for its direct sales force and telesales, as well as its resellers, distributors and OEMs. These programs include press releases, press and industry analyst relations, advertising in trade and business publications, direct mail advertising, participation in regional conferences, seminars, trade shows and industry conferences and provision of ongoing customer communication programs. In addition, the Company provides demonstration disks and trial versions of the software to promote the products and provide product information. Additional sales support is provided to resellers through product literature and promotional programs. The Company also assists the marketing efforts of certain of its resellers and distributors by providing funds for promotional and educational purposes.
PRODUCT DEVELOPMENT
The Company intends to enhance and expand its product lines in connection with evolving customer requirements, industry standards and technologies. The Company believes its future success will depend on its ability to do so and any failure by the Company to anticipate or respond adequately to changes in technology and customer preferences, or any significant delay in product development or introduction, could have a material adverse effect on the Company's results of operations. Historically, the Company generally has developed new products internally but, from time to time, has acquired or licensed technologies from third parties. Although there can be no guarantee that product development efforts will result in commercially viable products, Wall Data intends to continue to make substantial investments in product development. See "-- Important Factors Regarding Forward-Looking Statements -- New Products; Technological Change; Uncertain Acceptance of the Company's New Products." Wall Data's product development expenses totaled $25.8 million, $9.0 million, $26.6 million and $30.7 million in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively.
COMPETITION
The enterprise software market is intensely competitive and subject to rapidly changing technology and standards incorporated into PCs, the Internet, networks, host computers and enterprise servers.
The market for the Company's products is also characterized by significant price competition, and the Company expects it will face increasing pricing pressures. There can be no assurance that the Company will be able to maintain its historic prices, and an inability to do so could materially adversely affect the Company's results of operations.
The principal competitive factors affecting the market for the Company's products include product functionality, ease of use, price, quality, performance and reliability; quality of customer service and support; product availability; vendor credibility; and ability to keep pace with technological change. There can be no assurance that the Company will continue to compete successfully in the face of increasing competition from new products and enhancements introduced by existing competitors and new companies entering the market.
The RUMBA business competes with providers of PC-to-host and Web-to-host connectivity products, including, without limitation, IBM, Attachmate Corporation and WRQ, Inc. In addition, the Company competes with providers of software products for TCP/IP networks such as Novell, Inc. ("Novell"), NetManage, Inc. and Hummingbird Communications, Limited.
In general, customers and prospective customers of the Company's RUMBA products also have competitors' connectivity products installed, and the Company competes with these vendors for customer orders. IBM sells products that compete with those of the Company and can exercise significant customer influence and technology control in the IBM PC-to-host connectivity market. The Company also competes with providers of LAN systems and software products that can provide PC-to-host connectivity. Microsoft currently incorporates limited PC-to-host connectivity technology in Windows. The Company expects that Microsoft will continue to include and expand this capability in its future products and product enhancements. The introduction by Microsoft of a client software connectivity product or formation of a significant
relationship with a competitor of the Company could materially adversely affect sales of the Company's products.
The Cyberprise business competes with providers of software products for Internet and corporate intranet information publishing products, including IBM. In addition, a significant number of competitors offer products that compete directly with the Cyberprise EIP solutions. Moreover, many potential customers may choose to build their own EIPs or engage consulting firms to build customized EIPs. There can be no assurance that the Company's EIP solutions will be able to compete successfully in the EIP market.
Many of the Company's competitors have substantially greater financial, technical, sales and marketing and other resources, as well as greater name recognition and a larger installed base, than the Company. The Company believes that competition will increase in the future.
PROPRIETARY RIGHTS
The Company regards its software as proprietary and relies on a combination of patent, trademark and copyright laws, trade secrets, confidentiality procedures and contractual provisions, including employee and third-party nondisclosure and proprietary rights agreements, to protect its proprietary rights. The Company has registered and filed applications to register its trademarks "WALL DATA," "RUMBA," "ONESTEP," "SALSA" and "ARPEGGIO" and their associated logos in the United States and other countries and has pending trademark applications in the United States and other countries for "Cyberprise" and "The Power of Cyberprise." The laws of some foreign countries may not protect the Company's proprietary rights to the same extent as do the laws of the United States.
Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information the Company regards as proprietary. Policing unauthorized use of the Company's products is difficult, and while the Company is unable to determine the extent to which piracy of its software products exists, it expects software piracy to be a persistent problem.
The Company typically distributes its products to users under nonexclusive, nontransferable licenses, which restrict use of the product solely for the customer's internal operations. In licensing some of its products, the Company relies on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable. In other circumstances, the Company makes available enterprise-wide licenses, which permit use and copying of the product for internal purposes only and typically are for limited terms. In addition, the Company has entered into certain agreements pursuant to which it has licensed object code for specific products and, in certain cases, has entered into source code escrow agreements. Pursuant to these escrow agreements, the Company deposits the source code for the licensed product and related materials with an escrow agent or trustee who must maintain the confidentiality of the source code and may release the source code and materials to the licensee only in the event of insolvency or dissolution of, or reasonably certain nonperformance by, the Company. Upon such release, the licensee may use the released source code and materials only in accordance with the restrictions under the terms of its license or OEM agreement with the Company.
In September 1998, the Company filed an action for declaratory judgment in Federal District Court for the Western District of Washington against OpenConnect Systems ("OCS") of Dallas, Texas seeking a judicial determination that the Company does not infringe on Patent No. 5,754,830 (the "'830 Patent") held by OCS. Also in September 1998, OCS filed suit in Federal District Court for the Eastern District of Texas against the Company claiming that the Company infringes the '830 Patent. The OCS complaint seeks unspecified damages. The Company has answered the OCS complaint by denying infringement and asserting that the '830 patent is invalid and unenforceable. The Federal District Court for the Western District of Washington has stayed the action for declaratory judgment pending a ruling from the Federal District Court for the Eastern District of Texas on a motion by the Company to transfer the action. Because the complaint seeks unspecified damages, it is impossible to predict the impact of a negative outcome in the litigation; however, an adverse outcome could have a material adverse impact on the Company's liquidity, operating
results or financial condition. The Company intends to defend against the action vigorously. See "Legal Proceedings."
No other material claims have been made against the Company for infringement of proprietary rights of third parties. There can be no assurance, however, that other third parties will not assert infringement claims against the Company in the future.
As the number of software products in the industry increases and the functionality of these products further overlaps, the Company believes that software programs will become increasingly subject to infringement claims. The cost of responding to any such assertion may be material, whether or not the assertion is valid. See "-- Important Factors Regarding Forward-Looking Statements -- Intellectual Property and Proprietary Rights."
SEASONALITY
The Company's business is seasonal. A substantial portion of the Company's annual net revenues and operating income typically have occurred in the fourth calendar quarter, and in each of the last five years, the first calendar quarter revenues have been down sequentially compared with revenues for the immediately preceding fourth calendar quarter. In addition, the third calendar quarter of each year typically is characterized by more difficult sales cycles, particularly in Europe, as customers tend to procure more slowly during the summer months. The change in the Company's fiscal year end was made to improve the Company's ability to manage operations in light of seasonal buying patterns. There can be no assurance, however, that the change in the fiscal year end will improve the Company's ability to manage its operations.
EMPLOYEES
As of April 30, 1999, the Company's headcount totaled 758 persons, including employees and contractors. The Company believes that its future success continues to depend on its ability to attract and retain skilled technical, marketing and management personnel. Competition for such personnel in the computer industry is intense, and the Company has experienced periods of significant turnover. The Company believes its relations with its employees are good.
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
The following important factors, among others, could cause the Company's actual results to differ materially from those expressed in the forward-looking statements in this Form 10-K and presented elsewhere by management from time to time.
Recent Restructuring. During the fourth quarter of fiscal 1999, the Company restructured its RUMBA business and its Cyperprise business into two separate businesses, each with its own sales, service, development and marketing organizations to enable each business to address its own unique market dynamics, sales processes, growth rates and operating priorities. The Company experienced significant disruptions in sales in connection with the restructuring. There can be no assurance that such disruptions will not occur in the future. The Company's future success depends on its ability to operate the two businesses independently. There can be no assurance that the Company will successfully be able to operate the two businesses independently.
New Products; Technological Change; Uncertain Acceptance of the Company's New Products. The market for the Company's products is characterized by rapidly changing technology, evolving industry standards, changes in customer needs and frequent new product introductions. The Company's future success will depend on its ability to enhance its current products, to develop new products on a timely and cost-effective basis that meet changing customer needs and to respond to emerging industry standards and other technological changes. In particular, the Company must be able to modify its products to maintain compatibility with IBM and IBM-compatible mainframe computers, IBM AS/400 midrange computers, Digital VAX computers, Novell LAN operating systems, Microsoft Windows, and industry-standard PCs, hosts and communications interfaces. In addition, the Company must adapt its current products, and develop
new ones, to address the rapidly evolving Internet and corporate intranet market. Any failure by the Company to anticipate or respond adequately to changes in technology and customer preferences or industry standards, or any significant delays in product development or introduction, would have a material adverse effect on the Company's results of operations. There can be no assurance that the Company will be successful in developing new products or enhancing its existing products on a timely basis, or that such new products or product enhancements will achieve market acceptance. See "-- Product Development" and "-- Competition."
Software products as complex as those offered by the Company may contain undetected errors or failures when first introduced or as new versions are released. There can be no assurance that, despite significant testing by the Company and by current and potential customers, errors will not be found in new products after commencement of commercial shipments, resulting in loss of or delay in market acceptance. Furthermore, from time to time the Company and others may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that announcements of currently planned or other new products will not cause customers to defer purchasing existing Company products or cause distributors to return products to the Company. Delays or difficulties associated with new product introductions or product enhancements could have a material adverse effect on the Company's results of operations.
New Markets; Longer Sales Cycle. The Company's initial software products provided client-based software that operated in a LAN/WAN environment. The Company has now announced products that allow organizations to extend their enterprise applications and information beyond the LAN/WAN environment to their corporate intranet, extranets and the Internet. As the Company increases its focus on providing leading Internet-based enterprise solutions for its customers, the Company's business is expected to be characterized by longer sales cycles and more complex use of its software. These sales generally include increased involvement by application developers, integrators or other consultants and involve a significant commitment of capital by prospective customers, with attendant delays. The Company has relatively limited experience with sales of Internet-based server software products or licensing models used in that environment. There can be no assurance that the Company will be able to successfully manage its new product line, and the failure to do so could have a material adverse effect on the Company's business, operating results and financial condition.
Variability in Quarterly Performance. The Company's results of operations have historically varied substantially from quarter to quarter, and the Company expects that they will continue to do so. The timing and amount of the Company's quarterly net revenues depend on a number of factors, such as the size and timing of customer orders or license agreements, the timing of the introduction and customer acceptance of new products or product enhancements by the Company or its competitors, changes in computer operating systems introduced by Microsoft, IBM or other companies, changes in pricing policies by the Company or its competitors, product returns or rotations, fluctuations in foreign exchange rates, customers postponing purchases of software products while expending funds to be year 2000 compliant and changes in general economic conditions. Products generally are shipped as orders are received. Accordingly, the Company historically has operated with little or no backlog. In addition, the Company's operating expenses are relatively fixed in the short term, and a significant portion of the revenues for each quarter typically is received in the months of March, June, September and December due to customer buying patterns. As a result, variations in timing of revenues can cause significant variations in quarterly results of operations. The Company does not generally take measures that are specifically designed to limit fluctuations in the Company's quarterly results of operations. There can be no assurance that the Company will be profitable on a quarter-to-quarter basis in the future.
The growth in net revenues and operating income experienced by the Company in past years is not necessarily indicative of future results. In view of the significant growth of the Company's operations in past years, the Company believes that period-to-period comparisons of its financial results are not necessarily meaningful and should not be relied on as an indication of future performance.
Competition. The "enterprise software market" is intensely competitive and subject to rapidly changing technology and evolving standards incorporated into PCs, networks, host computers and enterprise servers. In
general, customers and prospective customers of the Company's products also have competitors' connectivity products installed, and the Company competes with these vendors for customer orders. The introduction by Microsoft of a client software connectivity product or formation of a significant relationship with a competitor of the Company could adversely affect sales of the Company's products. Also, the introduction of Internet and corporate intranet technology by the Company's traditional competitors or by any other company in the Internet/intranet technology market could reduce the demand for the Company's products. Many of the Company's competitors have substantially greater financial, technical, sales and marketing and other resources, as well as greater name recognition and a larger installed base, than the Company. The Company believes that competition will increase in the future. The market for the Company's products is also characterized by significant price competition, and the Company expects that it will face increasing price pressures. There can be no assurance that the Company will be able to maintain its historic prices, and an inability to do so could materially adversely affect the Company's results of operations. There can be no assurance that the Company will continue to compete successfully in the face of increasing competition from new products and enhancements introduced by existing competitors and new companies entering the market.
Dependence on a Single Product Line. The Company has derived a substantial portion of its net revenues to date from sales of its RUMBA client software connectivity products, and the RUMBA product line and related enhancements are expected to continue to account for a substantial portion of the Company's net revenues for the foreseeable future. Some of the features of the Company's Cyberprise products deliver, through a Web browser, similar access to enterprise information and applications to the access delivered by RUMBA Web-to-host and client software products. As a result, acceptance of the Company's Cyberprise products may have a negative impact on RUMBA sales. A decline in demand for RUMBA products as a result of competition, technological change or otherwise would have a material adverse effect on the Company's results of operations. See "-- Products" and "-- Competition."
Dependence on Host Computers. The Company's products are designed for use with IBM and IBM-compatible mainframe computers, IBM AS/400 midrange computers and Digital VAX computers. If business organizations were to reduce their use of these host computers, the market for the Company's products would be materially adversely affected. In addition, because the Company's products operate in conjunction with IBM and Digital system software, the Company must adapt its products to technological changes by IBM and Digital. Any failure by the Company to do so in a timely manner would materially adversely affect the Company's results of operations. See "-- Products" and "-- Competition."
Dependence on Microsoft Windows. Substantially all the Company's net revenues are derived from the sales of products designed to achieve host connectivity within a Microsoft Windows environment and are marketed primarily to Windows users. As a result, sales of the Company's products could be materially adversely affected by market developments adverse to Windows. In addition, the Company's strategy of developing products using the Windows environment is substantially dependent on its ability to gain access to, and to develop expertise in, current and future Windows developments by Microsoft in a timely fashion. See "-- Products" and "-- Competition."
Dependence on the Internet. As the Company focuses on delivering Internet-based solutions for its customers' enterprise application needs, sales of the Company's products will increasingly depend on adequate access to the Internet. The Internet also may develop more slowly than expected for a variety of reasons, such as inadequate development of the necessary infrastructure or complementary products. There can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on it by potential growth. If the necessary infrastructure or complementary products are not developed, or if the Internet develops more slowly than expected, the Company's business, operating results and financial condition will be materially adversely affected.
Reliance on Resellers and Distributors. The Company expects to continue to rely, in part, on resellers and distributors for sales of its products. There can be no assurance, however, that such resellers and distributors will be able to market the Company's products effectively. The Company's agreements with resellers and distributors are not exclusive and may be terminated by either party without cause. Many of the Company's resellers and distributors carry competing product lines. There can be no assurance that any
resellers or distributors will continue to represent the Company's products. In addition, the Company will be increasingly dependent on the continued viability and financial stability of resellers and distributors, which, in turn, are substantially dependent on the PC industry. The inability to recruit, or the loss of, important resellers or distributors could materially adversely affect the Company's results of operations. See "-- Sales, Marketing and Distribution."
The Company also expects to rely increasingly on resellers and distributors to support its products. There can be no assurance, however, that the Company will be able to attract resellers and distributors qualified to provide timely and cost-effective customer support or service. Any deficiencies in the service or support provided by such entities could have a material adverse effect on the Company's results of operations. See "-- Sales, Marketing and Distribution."
International Operations. The Company expects that international sales will continue to account for a significant portion of its business. An increase in the value of the U.S. dollar relative to foreign currencies could make the Company's products less competitive in those markets in which the Company's products are sold. The Company engages in some foreign currency hedging transactions, although it does not hedge all of its foreign currency positions. Operating expenses relating to foreign offices also are subject to the effects of fluctuations of foreign currency exchange rates. The Company faces certain risks inherent in international business operations, including fluctuations in foreign currency exchange rates, the instability of certain overseas economic environments, longer accounts receivable payment cycles, difficulties in staffing and managing international operations, unexpected changes in regulatory requirements, tariffs and other trade barriers, potentially adverse tax consequences, repatriation of earnings and the burdens of complying with a wide variety of foreign laws. There can be no assurance that such factors will not have a material adverse effect on the Company's future international sales and, consequently, on the Company's results of operations.
Risks Related to the Year 2000. The Company has developed plans to address issues related to the impact on its products and systems of the year 2000. Products have been modified, financial and operational systems have been assessed and plans have been developed to address modification requirements. If the Company or its vendors or distributors are unable to resolve such issues in a timely manner or if the Company's products are used in conjunction with the software of other suppliers that have not adequately addressed year 2000 issues, it could result in a material adverse impact to the Company. Accordingly, the Company plans to continue to devote the necessary resources to resolve significant year 2000 issues in a timely manner. In addition, prospective customers for the Company's products may delay purchase decisions as they assess the impact of the year 2000 on their systems, or as they are required to dedicate all available IT budgets to year 2000 remediation. Such delays may have a material adverse impact on the Company's sales and, consequently, on the Company's results of operations.
Dependence on Key Personnel; Management of Growth. The Company's success depends to a significant extent on a number of senior management personnel, including the Chief Executive Officer, John R. Wall, and the President of the RUMBA business, Kevin B. Vitale. The loss of the services of these key persons would have a material adverse effect on the Company. The Company has employment agreements with Messrs. Wall and Vitale. The Company's success also depends in part on its ability to continue to attract and retain skilled technical, marketing and management personnel. Competition for such personnel in the computer industry is intense. There can be no assurance that the Company will be successful in attracting and retaining the personnel it requires to develop new and enhanced products and to conduct its operations successfully. The ability of the Company to grow will depend in part on the ability of its officers and key personnel to manage growth successfully through implementation of appropriate management systems and controls. The Company's results of operations could be materially adversely affected if the Company were unable to attract, hire, assimilate, train and manage these personnel, or if revenues failed to increase at a rate sufficient to absorb the resulting increase in expenses. See "-- Sales, Marketing and Distribution" and "-- Employees."
Intellectual Property and Proprietary Rights. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information the Company regards as proprietary. Policing unauthorized use of the Company's products is difficult, and while the Company is unable to determine the extent to which piracy of its software products
exists, it expects software piracy to be a persistent problem. In licensing some of its products, the Company relies on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable. In addition, the laws of some foreign countries may not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that these protections will be adequate or that the Company's competitors will not independently develop similar technology. There can be no assurance that third parties will not assert infringement claims against the Company in the future. As the number of software products in the industry increases and the functionality of these products further overlaps, the Company believes that software programs will become increasingly subject to infringement claims. The cost of responding to any such assertion may be material, whether or not the assertion is valid. See "-- Proprietary Rights."
ITEM 2.
ITEM 2. PROPERTIES
The Company's headquarters is located in Kirkland, Washington, where it leases approximately 65,000 square feet for its principal executive, administrative, sales and marketing, customer support and service and product development activities. The Company also leases approximately 12,500 square feet of office space in London, England and 3,000 square feet of office space in Dublin, Ireland and leases space for its other national and international offices.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In September 1998, the Company filed an action for declaratory judgment in Federal District Court for the Western District of Washington against OpenConnect Systems ("OCS") of Dallas, Texas seeking a judicial determination that the Company does not infringe on Patent No. 5,754,830 (the "'830 Patent") held by OCS. Also in September 1998, OCS filed suit in Federal District Court for the Eastern District of Texas against the Company claiming that the Company infringes the '830 Patent. The OCS complaint seeks unspecified damages. The Company has answered the OCS complaint by denying infringement and asserting that the '830 patent is invalid and unenforceable. The Federal District Court for the Western District of Washington has stayed the action for declaratory judgment pending a ruling from the Federal District Court for the Eastern District of Texas on a motion by the Company to transfer the action. Because the complaint seeks unspecified damages, it is impossible to predict the outcome in the litigation; however, an adverse outcome could have a material adverse impact on the Company's liquidity, operating results or financial condition. The Company intends to defend against the action vigorously.
The Company may be subject to other legal proceedings or claims, either asserted or unasserted, that arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that any pending legal matters will have a material adverse effect on the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS
The executive officers of the Company and their ages as of April 30, 1999 are as follows:
BOARD OF DIRECTORS AT APRIL 30, 1999
The directors of the Company at April 30, 1999 are as follows:
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market (symbol "WALL"). The number of shareholders of record of the Company's Common Stock at July 1, 1999 was 316.
The Company has never declared or paid any cash dividends on its Common Stock. The Company currently anticipates that it will retain all future earnings for use in the expansion and operations of its business and does not anticipate paying cash dividends in the foreseeable future.
High and low sales prices for the Company's Common Stock for each quarter in Fiscal 1997, the 1998 Four Month Period, and Fiscal 1999 are as follows:
ITEM 6.
ITEM 6.SELECTED FIVE-YEAR FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
- --------------- * Excludes non recurring gain in 1995 of $14.0 million ($8.7 million, or $0.87 per share on a diluted basis, after income taxes) and restructuring and other non recurring charges in 1999, 1997, 1996, 1995 and 1994 of $2.4 million ($0.24 per share), $11.5 million ($7.3 million, or $0.74 per share on a diluted basis, after income taxes), $3.1 million ($2.0 million, or $0.20 per share on a diluted basis, after income taxes), $6.8 million ($4.2 million, or $0.42 per share on a diluted basis, after income taxes) and $4.0 million ($2.5 million, or $0.25 per share on a diluted basis, after income taxes), respectively. See Notes 7 and 12 of Notes to Consolidated Financial Statements.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
OVERVIEW
Wall Data is an enterprise software company providing products and services that allow organizations to integrate and deploy applications over corporate intranets, extranets and the Internet. Since its inception in 1982, Wall Data has enabled more than 10,000 companies to extend their enterprise systems to new platforms, while maximizing their technology investments. Wall Data products support platforms from leading technology companies including Microsoft, Hewlett-Packard, SUN Microsystems, Informix, Sybase, Oracle, IBM and Netscape.
Effective April 30, 1998, the Company changed its fiscal year end from December 31 to April 30. As a result, the Company has reported a transition period of four months ended April 30, 1998 (the "1998 Four Month Period") in its previous filing. The fiscal year ended April 30, 1999 will be referred to as Fiscal 1999, and prior periods ended December 31, 1997 and 1996 will be referred to as Fiscal 1997 and Fiscal 1996, respectively. The 1998 Four Month Period will be compared to the unaudited results for the four months ended April 30, 1997 (the "1997 Four Month Period").
The results of operations for Fiscal 1999 reflect a loss. During Fiscal 1999, operating expenses increased to $122.3 million as compared to the prior period of $118.3 million due to the launch of the Cyberprise business. In the fourth quarter revenues fell, as compared to the previous quarters, to a level that did not support the operating expenses. The Company believes that the revenue decline to be primarily a result of the disruptions associated with the restructuring of Wall Data into separate RUMBA and Cyberprise businesses. However, market conditions, including customer deferment of purchases as attention and resources are dedicated to year 2000 preparedness, are also believed to be factors. In the fourth quarter, the Company determined that the RUMBA and Cyberprise businesses had differing sales processes and other operational aspects. The Company separated all of the line functions of the business including technical support, services, product development, field sales and marketing in order to increase the focus on the specific needs of each business. In May 1999, the Company announced that it has engaged the investment-banking firm of Bear Stearns & Co. to assist in evaluating strategic alternatives for the RUMBA and Cyberprise businesses.
The Company's results of operations have historically varied substantially from quarter to quarter, and the Company expects that they will continue to do so. The timing and amount of the Company's quarterly net revenues are dependent on a number of factors, such as the size and timing of customer orders or license agreements, the timing of the introduction and customer acceptance of new products or product enhancements by the Company or its competitors, changes in PC operating systems introduced by Microsoft, IBM or other companies, changes in pricing policies by the Company or its competitors, product returns or rotations, fluctuations in foreign exchange rates, customers postponing purchases of software products while expending funds to be year 2000 compliant and changes in general economic conditions. Products generally are shipped as orders are received and, accordingly, the Company historically has operated with little or no backlog. The Company's operating expenses are relatively fixed in the short term. In addition, a significant portion of revenues for each quarter typically is received in the last month of each fiscal quarter due to customer buying patterns and sales incentives. As a result, variations in timing of revenues can cause significant variations in quarterly results of operations.
The Company expects to experience fluctuations in future net revenues and operating income that may be caused by the competitive nature of its industry and market acceptance of the Company's new Cyberprise products, among other factors. As a result, the Company believes that period-to-period comparisons of its financial results are not necessarily meaningful and should not be relied upon as an indication of future performance.
The Company's business is seasonal, with a substantial percentage of its annual net revenues and operating income typically occurring in the last quarter of the calendar year. Since 1991, the Company has frequently incurred higher operating expenses in each sequential quarter primarily due to an increase in the
number of employees. Operating expenses declined in the fourth quarter of Fiscal 1999 as the Company has reduced the number of employees to 758 at April 30, 1999 from a high of 886 at October 31, 1999.
Certain reclassifications have been made to prior year financial statements to conform to the current year presentation (see Note 1 of Notes to Consolidated Financial Statements).
REVENUES
TOTAL NET REVENUE. Net revenues increased 5% in Fiscal 1999 to $139.7 million from $133.6 million in the prior comparable period. The increase was primarily due to a 23% increase in service revenues. Net revenues decreased 16% in the 1998 Four Month Period to $39.1 million from $46.4 million in the 1997 Four Month Period. The decrease was primarily due to declining license fees, principally for RUMBA for the Mainframe and RUMBA OFFICE. Net revenues in Fiscal 1997 of $140.9 million were flat as compared to Fiscal 1996 of $139.4 million.
Net international revenues related to sales of the Company's products and services represented $36.0 million, or 26% of net revenues, during Fiscal 1999 compared to $45.2 million, or 34% of net revenues, in the prior comparable period. Revenue in Europe decreased $8.7 million in Fiscal 1999 as compared the same period in the prior comparable period. This decline in Europe was impacted by a large transaction during the prior comparable period and a late launch of the Company's Cyberprise products in Europe. Net international revenues related to sales of the Company's products and services represented $13.5 million, or 35% of net revenues during the 1998 Four Month Period, $42.4 million, or 30% of net revenues in Fiscal 1997 and $40.0 million, or 29% of net revenues in Fiscal 1996. The increases in international net revenues in the 1998 Four Month Period and Fiscal 1997 were primarily due to increased acceptance of RUMBA products and increased sales and marketing activities in Europe, particularly in the United Kingdom. Most of the Company's international revenues in the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996 were generated through its indirect distribution channels. In Fiscal 1999, international revenues derived from direct sales to end users increased to 37% of total international revenues from 14% in the prior year. The increase in direct sales is primarily attributed to the purchase of First Service Computer Dienstleistungs-GmbH (First Service), a German distribution company. The Company's international sales are denominated in U.S. dollars and local currencies.
Operating expenses incurred in local currencies relating to the Company's offices in Europe, Japan, Australia, Singapore and Latin America are also subject to the effects of fluctuations of foreign currency exchange rates. Foreign currency exchange rate changes did not have a significant effect on net revenues in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, but exchange rate fluctuations could have an adverse effect on future net revenues. The Company has experienced difficulties in hiring, training and retaining management-level staff abroad and in selecting international resellers with technological and sales personnel to distribute the Company's products. In Fiscal 1999, the Company has experienced higher employee turnover in Germany primarily as a result of merger integration issues related to the First Service acquisition. Additional risks inherent in the Company's international business activities, which have not materially affected the Company's business to date, generally include unexpected changes in regulatory requirements, tariffs and other trade barriers, longer accounts receivable payment cycles, difficulties in
managing international operations, potentially adverse tax consequences, repatriation of earnings and the burdens of complying with a wide variety of foreign laws.
In January 1998, the Company adopted the American Institute of Certified Public Accountants ("AICPA") Statement of Position (SOP 97-2), "Software Revenue Recognition," as amended. SOP 97-2 provides guidance on recognizing revenue on software transactions. The adoption of SOP 97-2 did not have a material impact on the Company's current licensing or revenue recognition practices.
LICENSE FEES. License fees for Fiscal 1999, the twelve months ended April 30, 1998, the 1998 Four Month Period, the 1997 Four Month Period, Fiscal 1997 and Fiscal 1996 were $109.8 million, $109.2 million, $30.2 million, $40.0 million, $118.9 million and $124.8 million, respectively. Total license fees were relatively flat in Fiscal 1999 as compared to the prior comparable period. Fiscal 1999 was the first full year of revenue from the Company's Cyberprise products which represented $18.9 million or 17% of the total license fees. The Company's Cyberprise products are designed to enable companies to move existing mission-critical systems and public information to the Web and extend those systems to remote users, vendors and customers. In Fiscal 1999, all products that are Web enabled were reported as Cyberprise revenue. License fees for RUMBA products declined 16% in Fiscal 1999 to $90.9 million from $108.7 million in the prior comparable period. RUMBA license fees represent all revenue from PC to host products. Most of the decrease in license fees in Fiscal 1999 compared to the prior year resulted from decreased sales of RUMBA OFFICE, RUMBA AS/400 and OEM products. Approximately 87% and 13% of the RUMBA license fees in Fiscal 1999 related to products containing 32-bit technology and 16-bit technology, respectively.
License fees for the 1998 Four Month Period declined to $30.2 million as compared to $40.0 million in the 1997 Four Month Period as a result of decreased sales of RUMBA for the Mainframe and RUMBA OFFICE. A RUMBA license to one customer accounted for approximately 18% of the net revenues in the 1997 Four Month Period. Approximately 82% and 18% of license fees in the 1998 Four Month Period related to products containing 32-bit technology and 16-bit technology, as compared to 65% and 35% of license fees in the 1997 Four Month Period related to products containing 32-bit technology and 16-bit technology, respectively. License fees in Fiscal 1997 declined 5% from Fiscal 1996. The Company believes that the license fees revenues in Fiscal 1997 were lower than in prior years due to lengthening sales cycles for its core products as its customers continue to evaluate Internet technology strategies for future mission-critical systems. Approximately 67% and 33% of license fees in Fiscal 1997 related to products containing 32-bit technology and 16-bit technology, respectively. In March 1996, the Company released commercial versions of a number of RUMBA software products, incorporating the ActiveX component architecture designed for the Windows 95 and Windows NT 32-bit operating systems. Approximately 32% and 68% of net revenues in Fiscal 1996 related to products containing the 32-bit technology and 16-bit technology, respectively.
The Company has derived the majority of its net revenues to date from licenses of its RUMBA client software products, which accounted for 65%, 76%, 84% and 90% of net revenues in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively. The RUMBA product line and related enhancements are expected to account for a majority of the Company's net revenues during the next year. A decline in demand for RUMBA products as a result of competition, technological changes or otherwise would have a material adverse effect on the Company's results of operations. As the Cyberprise products have certain similar functionalities as RUMBA products, the acceptance of the Company's Cyberprise products will have a negative effect on RUMBA sales. With the evolution of the Cyberprise vision, management plans to differentiate the Cyberprise business from RUMBA as an EIP solution beginning in Q1 of FY2000. As a result, prior periods will be restated to eliminate all RUMBA/Cyberprise edition revenues from Cyberprise and reflect it as RUMBA business. In Fiscal 1999, the Company reported approximately $8.9 million of RUMBA/Cyberprise edition revenue as Cyberprise license fees. There can be no assurance that the Cyberprise strategy will be successful. See "Important Factors Regarding Forward-Looking Statements."
SERVICE REVENUE. Service revenues for Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996 were $29.9 million, $8.9 million, $21.9 million and $14.5 million, respectively. Increases in revenue from ONESTEP customer support contracts is correlated with license fees to new customers and renewal contracts of previous license customers. As license fees of RUMBA products decline, the Company expects that the
service revenues will be flat or decline in the future. Cyberprise service revenue in Fiscal 1999 was $1.2 million and represented 4% of the total service revenue.
COST OF REVENUE
COST OF LICENSE FEES. Cost of license fees consists primarily of software publishing costs, which include labor, product media, packaging and documentation, publishing, royalties and licensing costs, amortization of product localization costs and provisions for obsolete inventory, and reseller rebates. Cost of license fees decreased 6% to $16.5 million in Fiscal 1999 from $17.6 million in the prior comparable period. The decline in cost of license fees is a result of reduced expenses related to material costs, amortization of localization costs and material fulfillment and processing. These declines were partially offset by increases in royalty expenses of approximately $1.2 million. Cost of license fees for the 1998 Four Month Period increased as a percentage of license fees to 17% as compared to 15% in the 1997 Four Month Period primarily due to increases in amortization of localization costs and product quality assurance costs. The amortization of localization costs for the 1998 Four Month Period increased primarily due to third-party localization costs incurred in Fiscal 1997 relating to certain RUMBA products for various European countries. The Company amortizes third-party localization costs over a 24-month period. Software publishing costs decreased in Fiscal 1997 due to the conversion of all product media from diskettes to compact disks and the adoption of simplified, uniform product packaging. Royalties and licensing costs decreased in Fiscal 1997 due to lower RUMBA software license revenues and lower costs for third-party technology. Expenses for royalties and amortization of prepaid licenses will increase in the future if the Company introduces more products incorporating software licensed from third parties, and amortization of product localization costs will increase as the Company introduces new products in international markets.
COST OF SERVICE REVENUES. Cost of service revenues consists primarily of technical support, post-sales engineering and consulting services. Cost of service revenues has increased in absolute dollars from Fiscal 1996 through Fiscal 1999 primarily due to increases in staffing levels related to technical support and consulting associated with increased service.
OPERATING EXPENSES
All internal software development costs are expensed as incurred. Product development expenses are primarily associated with the enhancement of existing products, the development of new software products and costs related to quality assurance and technical publications for all products. During Fiscal 1999 the Company has released RUMBA 2000, RUMBA Cyberprise Edition and other related web to host products. In fiscal 1997, Cyberprise Server products, Cyberprise Host products, Cyberprise Tools products and RUMBA OBJECTX were developed and released. RUMBA 95/NT, SALSA and ARPEGGIO were developed in Fiscal 1995 and Fiscal 1996 and released in the first half of Fiscal 1996. Development costs in absolute dollars were relatively flat in Fiscal 1999 and the 1998 Four Month Period as compared to the prior periods. In Fiscal 1997, various technologies were consolidated into the Company's Cyberprise products. In Fiscal 1999 and the 1998 Four Month Period approximately 46% and 44% of the product development
expenses related to Cyberprise products, respectively. Product development expenses decreased in Fiscal 1997 due to lower average headcount, arising from the completion of initial versions of RUMBA 95/NT and SALSA products in Fiscal 1996.
During Fiscal 1996 through Fiscal 1999, the Company generally expanded its sales and marketing operations by increasing staffing levels coupled with increases in the amount and breadth of its cooperative advertising programs with resellers and distributors, other marketing programs and trade show activities. The increase in sales and marketing in Fiscal 1999 and the 1998 Four Month Period as compared to the same periods in the prior year is primarily due to increases in sales management and staff related to the new Cyberprise products. The number of sales offices maintained by the Company totaled 69, 57, 49 and 57 at April 30, 1999, 1998, December 31, 1997 and 1996, respectively. At April 30, 1999, the total sales offices included ten offices in Europe, two offices in Canada, two offices in Latin America and one office each in Australia and Japan. Sales and marketing expenses as a percentage of net revenues increased in Fiscal 1997 compared to Fiscal 1996 primarily due to the lower revenue growth rate in Fiscal 1997.
General and administrative expenses include general administrative, finance and accounting, legal and human resources costs. General and administrative expenses increased 24% to $14.8 million in Fiscal 1999 from the prior comparable period of $12.0 million. The increase resulted primarily from administrative expenses from Software Development Tools, Inc. (SDTI), acquired in November 1997, and First Service, acquired in March 1998 (see Note 7 of Notes to Consolidated Financial Statements), and legal costs related to defense of the Company's technologies (see "Legal Proceedings"). General and administrative expenses increased in the 1998 Four Month Period as compared to the 1997 Four Month Period from increases in staffing related to the SDTI and First Service acquisitions. The increases in general and administrative expenses in Fiscal 1997 and Fiscal 1996 resulted primarily from increased staffing and associated expenses necessary to manage and support the Company's growth. The Company intends to continue to maintain its general and administrative expenses as necessary to support its operations. The amortization of goodwill and other intangible assets increased in Fiscal 1999 and the 1998 Four Month Period as a result of the Company's acquisition of SDTI and First Service.
In October 1998, the Company recorded a $2.4 million charge to restructure operations in Asia-Pacific and Latin America (APLA) markets. The restructuring charge includes $0.8 million severance and lease termination costs, $1.0 million for the write down of certain localization costs and other assets and $0.6 million for the write down of a minority investment in a Korean distributor. As of April 30, 1999, the Company has made cash payments totaling $0.5 million in connection with the $0.8 million accrued severance and lease termination costs. The Company estimates that expense savings from the restructuring charge, on an annual basis, to be approximately $1.0 million. During Fiscal 1997, the Company recorded nonrecurring charges totaling $11.5 million ($7.3 million, or $0.74 per share on a diluted share basis, after tax). In June 1997, the
Company agreed to settle the shareholders' class action lawsuit for $9.1 million, including related legal fees. (See Notes 7 and 12 of Notes to Consolidated Financial Statements.) The Company also recorded nonrecurring charges in Fiscal 1997 of $1.0 million for the restructuring of the SALSA business unit, $0.6 million for retirement payments to the Company's former Chairman, President and CEO, and $0.7 million for the write-off of in process research and development resulting from the acquisition of Software Development Tools Inc. (See Note 7 of Notes to Consolidated Financial Statements). During Fiscal 1996, the Company resolved to streamline its business operations and recorded nonrecurring charges totaling $3.1 million ($2.0 million, or $0.21 per share on a diluted basis, after tax) primarily relating to the write-off of technology investments and prepaid royalties no longer relevant to the Company's ongoing product offerings and programs.
OTHER INCOME (EXPENSE)
Interest income decreased in Fiscal 1999 compared to the prior comparable period due to lower investment balances. Interest income did not fluctuate from the 1997 Four Month Period to the 1998 Four Month Period. Interest income increased in Fiscal 1997 compared to Fiscal 1996 due to higher investment balances. Other income, net of other expenses, includes interest expense, foreign currency transaction gains and losses and miscellaneous income and expenses. Foreign currency transactions resulted in net exchange losses of $0.1 million in Fiscal 1999, $0.8 million in Fiscal 1997 and $0.6 million in Fiscal 1996 and a net exchange gain of $0.2 million in the 1998 Four Month Period. During Fiscal 1999, the Company engaged in currency hedging by purchasing and selling options on certain foreign currencies. All options are purchased at the beginning of each quarter and expire at the end of the same quarter. The options are intended to hedge against foreign exchange positions on intercompany balances with subsidiaries.
INCOME TAXES
The provision for income taxes includes U.S. federal, state and international taxes currently payable and deferred taxes arising from temporary differences in determining income for financial statement and tax purposes. The income tax provision for Fiscal 1999 and the 1998 Four Month Period relates primarily to taxes payable on income in the Company's foreign subsidiaries. No tax benefit has been recognized for tax purposes for U.S. losses. Such benefits are available to offset future taxable income in the U.S. The decrease in the Company's effective tax rate in Fiscal 1997 as compared to Fiscal 1996 resulted primarily from Foreign Sales Corporation tax benefits and from operating losses incurred in higher tax rate jurisdictions combined with significant operating profits earned in jurisdictions with lower tax rates. As of April 30, 1999, the Company reviewed its current risks and uncertainties regarding the ultimate realizability of its deferred tax assets and believes that it is more likely than not that future operations and tax planning relating to the strategic alternatives that are currently being considered would allow for the recognition of its deferred tax assets. The Company will review the realizability of these deferred tax assets each quarter to determine if operating results and business conditions have changed such that the carrying value of the assets requires adjustment.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and marketable securities totaled $65.5 million, or 52% of total assets at April 30, 1999, $57.5 million, or 41% of total assets, at April 30, 1998, $70.8 million, or 52% of total assets, at December 31, 1997, and $62.5 million, or 49% of total assets, at December 31, 1996. The increase in cash, cash equivalents and marketable securities is primarily a result of collection of accounts receivable and reduced balances. The reduction on cash, cash equivalents and marketable securities from December 31, 1997 to April 30, 1998 resulted primarily from the acquisition of First Service for $9.8 million, net of cash acquired. Cash, cash equivalents and marketable securities are expected to decline in the first quarter of Fiscal 2000 as a result of the operating loss in the fourth quarter of Fiscal 1999.
The Company's expenditures for property and equipment for Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996 totaled $5.7 million, $1.8 million, $3.9 million and $5.1 million, respectively. The decrease in expenditures in Fiscal 1997 compared to Fiscal 1996 primarily resulted from reduced growth in average staffing levels. The Company does not currently have any specific commitments with regard to capital expenditures. Because the Company has reduced the number of employees, it expects to acquire less capital equipment in Fiscal 2000 than in Fiscal 1999. Purchases of prepaid software technology totaled $3.3 million, $1.3 million, $2.4 million and $1.3 million in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively. Capitalized third-party localization expenditures totaled $1.5 million in Fiscal 1999, $0.2 million in the 1998 Four Month Period and $3.0 million in both Fiscal 1997 and Fiscal 1996. The decrease in capitalized localization costs in Fiscal 1999 as compared to Fiscal 1997 and Fiscal 1996 resulted from the significant increase in the volume of new product introductions in Fiscal 1997 and Fiscal 1996 compared to Fiscal 1999 and the expansion of sales operations into new international markets.
In April 1995, the Board of Directors authorized a stock repurchase program of up to $10.0 million. Through December 31, 1995, the Company had repurchased 488,200 shares with a total cost of $8.5 million. No shares have been repurchased since Fiscal 1995.
On March 12, 1998, the Company acquired First Service for $11.0 million. Of the $11.0 million cash payment, $2 million remains in escrow to cover claims, if any. In October 1997, the Company acquired a 15% interest in Suntek Information System Co. Ltd. for approximately $0.9 million. In November 1997, the Company acquired SDTI for approximately $3.0 million. Also, in November 1997, the Company acquired a ten percent equity interest in DataChannel, Inc. for approximately $1.7 million. In April 1995, the Company acquired Concentric Data Systems, Inc. for approximately $7.8 million. See Note 7 of Notes to Consolidated Financial Statements. The Company will consider, from time to time, joint ventures, additional acquisitions or investments in other businesses or third-party technology. The Company believes that existing cash and cash equivalents, together with funds from operations, will provide the Company with sufficient funds to finance its operations through Fiscal 2000.
During the first half of Fiscal 2000, the Company will be evaluating its operations after the significant decline in sales experienced during the fourth quarter of Fiscal 1999. Planned reductions of the number of employees have already been made and it is possible that further reductions will be necessary if the fourth quarter sales declines in Fiscal 1999 are not viewed as temporary. It is possible that the Company may elect to record a restructuring charge in the future in connection with employee reductions and other downsizing activities. The Company's business has been and will be impacted by uncertainties as they relate to restructuring of the Company's business into two separate businesses. See "Business -- Important Factors Regarding Forward-Looking Statements."
YEAR 2000
The Year 2000 problem arises from the common practice in software development in the past of using two digits rather than four to designate the calendar year (e.g., DD/MM/YY). This practice can lead to incorrect results whenever computer systems, software or microchips perform arithmetic operations, comparisons or data field sorting involving years later than 1999. The Company has been assessing the impact of the Year 2000 issues for some time and has developed and implemented plans to address these issues related to its products, its internal business systems and its distributors and partners.
The Company has tested its products for Year 2000 compliance and has made modifications to certain of its products to make them Year 2000 compliant. Year 2000 compliant means that neither performance nor functionality of the products or services is materially affected by dates prior to, during and after the year 2000. The Company believes that all of its Cyberprise products are Year 2000 compliant and that nearly all of its currently supported RUMBA, ARPEGGIO and R&R Report Writer products are Year 2000 compliant as is or with available patches. Because most of the work associated with testing and modification of the Company's products has occurred in the ordinary course of product development, the cost of Year 2000 compliance for the Company's products has not been material.
The Company is assessing its internal systems, including financial and operational systems, for Year 2000 compliance. The Company is currently in the process of reviewing all affected Information Technology ("IT") processes, applications, hardware, operating systems and databases, as well as critical non-IT areas (such as facilities and building equipment) where Year 2000 issues may exist. The assessment of the Company's critical internal IT systems was completed before December 31, 1998. The Company continues to assess all remaining internal systems and external relationships. The Company's goal is to complete all assessment and mitigation tasks for all internal systems and external relationships by September 1, 1999. The Company has incurred approximately $178,000 in costs to date related to the assessment and mitigation of internal system Year 2000 issues and estimates that total related costs will approximate $500,000. These costs are primarily fees paid to third-party consultants and vendors and exclude internal costs, which the Company does not track separately and which the Company does not believe will be material. The Company believes that the costs required to remedy internal Year 2000 issues will not have a material effect on the Company's operations or financial results.
The Company is also evaluating external relationships with distributors, resellers, vendors and partners for Year 2000 issues. The Company is currently in the process of surveying its external vendors and partners. None of the Company's resellers or distributors is individually responsible for a material amount of the Company's total revenues.
Although the Company is not aware of material operational issues or costs associated with preparing for the Year 2000, the Company may experience serious adverse impacts or material costs if the Company or its vendors or distributors fail to resolve Year 2000 issues in a timely manner or if the Company's products are used in conjunction with the software of other suppliers that have not adequately addressed Year 2000 issues. The Company has not yet completed all contingency plans to address problems that may result if the Company, its vendors, or its distributors fail to achieve Year 2000 readiness. The Company's goal is to complete all contingency plans by September 1, 1999. The Company plans to continue to devote the necessary resources to resolve significant Year 2000 issues and develop contingency plans.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE'S ABOUT MARKET RISK
INTEREST RATE RISK. The Company has exposure to changes in interest rates in its marketable securities which consist primarily of corporate bonds. The Company's exposure to market risk for changes in interest rates relates primarily to its short-term investments and short-term obligations, thus, fluctuations in interest rates would not have a material impact on the fair value of these securities. The Company does not use derivative financial instruments in its investment portfolio to manage interest rate risk. The Company does, however, limit its exposure to interest rate and credit risk by establishing and strictly monitoring clear policies and guidelines for its fixed income portfolios. The guidelines also establish credit quality standards, limits on exposure to one issue, issuer, as well as the type of instrument. Due to the limited duration and credit risk
criteria established in the Company's guidelines, the exposure to market and credit risk is not expected to be material.
FOREIGN CURRENCY RISK. Approximately 26%, 35%, 30% and 29% of the Company's net revenues in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively, were attributable to sales made to customers outside North America. Because the Company invoices certain of its foreign sales in local currency (British Pound Sterling, German Marks, and other currencies) and does not hedge these transactions, fluctuations in exchange rates could adversely affect the translated results of operations of the Company's foreign subsidiary. Therefore, foreign exchange fluctuation could have a material adverse effect on the Company's future international sales and, consequently, on the Company's results of operations.
The Company also maintains intercompany balances with subsidiaries with different local currencies. These intercompany balances are at risk of foreign exchange losses if exchange rates fluctuate. To hedge against foreign exchange losses on intercompany balances, the Company engaged in currency hedging in Fiscal 1999 by purchasing and selling options on certain foreign currencies. All options are purchased at the beginning of each quarter and expire at the end of the same quarter.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted in Item 14 of this Form 10-K.
ITEM 9.
ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item regarding the Company's directors is incorporated by reference to the Company's definitive Proxy Statement for its 1999 Annual Meeting of Shareholders to be held on September 22, 1999.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the Proxy Statement.
PART IV.
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
(1) The following financial statements are filed as a part of this report:
(2) Financial statement schedules -- Schedule II Valuation and Qualifying Accounts
The independent auditors' report with respect to the financial statement schedules appears on page of this Report. All other financial statements and schedules not listed are omitted because either they are not applicable or not required, or the required information is included in the consolidated financial statements.
(3) Exhibits
- --------------- + Management contract or compensatory plan
* Included herewith
(b) Reports on Form 8-K: None.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders Wall Data Incorporated
We have audited the accompanying consolidated balance sheets of Wall Data Incorporated as of April 30, 1999 and 1998 and December 31, 1997, and the related consolidated statements of income, shareholders' equity and cash flows for the year ended April 30, 1999, the four months ended April 30, 1998 and for the years ended December 31, 1997 and 1996. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Wall Data Incorporated at April 30, 1999 and 1998 and December 31, 1997, and the consolidated results of its operations and its cash flows for the year ended April 30, 1999, the four months ended April 30, 1998 and for the years ended December 31, 1997 and 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statement taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Seattle, Washington May 18, 1999
WALL DATA INCORPORATED
CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of these consolidated financial statements.
WALL DATA INCORPORATED
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
The accompanying notes are an integral part of these consolidated financial statements.
WALL DATA INCORPORATED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
WALL DATA INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOW (IN THOUSANDS)
The accompanying notes are an integral part of these consolidated financial statements.
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS APRIL 30, 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Wall Data Incorporated ("Wall Data" or the "Company") develops and markets enterprise software products and associated application tools and provides comprehensive support and services for its products. The Company's products deliver access to existing corporate computing systems, including various host, database, client/server and public information, to users in a browser or Windows-based environment. Using Wall Data solutions, organizations can extend their enterprise information systems to allow internal users, remote users, third party partners and customers to access information and applications over corporate intranets, extranets, the Internet, Local Area Networks and Wide Area Networks.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation.
Foreign Currency Translation
Assets and liabilities denominated in foreign currencies are translated to U.S. dollars at the exchange rate on the balance sheet date. Revenues, costs and expenses are translated at the average rates of exchange prevailing during the period. Translation adjustments resulting from this process are shown separately in shareholders' equity. Gains and losses from foreign currency transactions are included in other income.
Revenue Recognition
In January 1998, the Company adopted the American Institute of Certified Public Accountants ("AICPA") Statement of Position (SOP 97-2), "Software Revenue Recognition," as amended. SOP 97-2 provides guidance on recognizing revenue on software transactions. The adoption of SOP 97-2 did not have a material impact on the Company's licensing or revenue recognition practices.
The Company licenses software under non-cancelable license agreements and provides post-contract customer services (including maintenance, support and periodic upgrades/enhancements) and other services (including installation, training and consulting). License fee revenues are recognized when a non-cancelable license agreement has been signed, the product has been delivered, there are no uncertainties surrounding product acceptance, the fees are fixed, collection is considered probable, and vendor-specific objective evidence exists to allocate the total fee to elements of the arrangement. Vendor-specific objective evidence is typically based on the price charged when an element is sold separately, or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. Elements included in multiple element arrangements could consist of software products, upgrades, enhancements, customer support services, or consulting services. The Company's agreements with certain distributors and resellers permit them to exchange products under certain circumstances and permit returns form certain resellers subject to specific limitations; an accrual is recorded for estimated sales returns and exchanges. Revenues from post-contract customer services are recognized ratably over the related term, which is generally one year. Other revenues are recognized as performed.
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
Income Taxes
The provision for income taxes includes U.S. federal, state and international taxes currently payable and deferred taxes arising from temporary differences between income tax and financial reporting. Deferred tax benefits from operating losses are not recognized until they can be used to offset taxable income.
Cash and Cash Equivalents
For purposes of the consolidated financial statements, the Company considers all highly liquid instruments with a maturity of three months or less at the date of purchase to be cash equivalents. Cost approximates market value for all cash and cash equivalents. All cash equivalents are classified as available-for-sale.
Marketable Securities
The Company accounts for its marketable securities under the provisions of Statement of Financial Accounting Standards ("SFAS") Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities." All marketable securities are classified as available-for-sale and are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity.
Fixed Assets
Fixed assets are stated at cost. Depreciation is computed by the straight-line method over estimated useful lives ranging from two to ten years for financial reporting purposes and by different methods approved for income tax purposes.
Long-term Investments
Long-term equity investments in non-public companies are recorded at cost due to the lack of significant influence and readily determinable fair value. For investments in companies that are quoted on an exchange, investments are classified as available-for-sale and carried at market value with unrealized gains and losses included in shareholders' equity. Investments are regularly reviewed for possible impairment of value and downward adjustments are made as deemed appropriate.
Prepaid Software Technology Fees
Prepaid software technology license fees, included in Other Assets on the Consolidated Balance Sheets, are amortized to cost of revenue using the shorter of the straight-line method over periods not to exceed 24 months or fees based on actual product shipments.
Product Development Costs
The Company accounts for software development costs in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," under which certain software development costs incurred subsequent to the establishment of technological feasibility are capitalized and amortized over the estimated lives of the related products. Technological feasibility is established upon completion of a working model. To date, costs incurred subsequent to the establishment of technological feasibility have not been significant, and all software development costs have been charged to product development expense in the accompanying statements of operations. Internal product development costs are expensed as incurred. External costs incurred to localize software products into local market languages are capitalized and amortized to cost of revenue using the straight-line method over periods not to exceed 24 months. WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
Intangible Assets
Excess of cost over fair market value of net identifiable assets of acquired companies and other intangible assets are amortized on a straight-line basis over various periods between four and ten years. The carrying value of intangible assets is periodically reviewed by the Company based on the expected future undiscounted operating cash flows of the related business unit. Based upon its most recent analysis, the Company believes that no material impairment of intangible assets exists at April 30, 1999.
Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation" encourages, but does not require companies to record compensation expense for stock-based employee compensation based on a prescribed method for determining fair value. The Company has elected to continue to account for stock option grants to employees in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes compensation expense for stock options only when the exercise price is less than the quoted market price at the date of grant.
Advertising Costs
All advertising costs are expensed as incurred. Total advertising expenses approximated $3.5 million, $1.5 million, $5.7 million and $6.9 million in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively.
Earnings per Share
Basic earnings per share is based on the weighted average number of shares of Common Stock outstanding during the period. Diluted earnings per share includes the effect of dilutive Common equivalent shares from stock options, using the treasury stock method.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 requires companies to recognize all derivatives as assets or liabilities measured at their fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. Management does not expect this Statement to have a material impact on our consolidated financial statements. This Statement is effective for fiscal years beginning after June 15, 1999 and cannot be applied retroactively. The Company will adopt this accounting standard beginning May 1, 2000.
Use of Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Accordingly, actual results may differ from those estimates. Estimates are used when accounting for allowance for doubtful accounts, accrued costs, taxes and contingencies.
Reclassifications
Certain reclassifications have been made to prior year financial statements to conform to the current year presentation. Previously, the Company included Software Quality and Technical Publications expenses in Cost of Revenue and Sales and Marketing, respectively. To more closely conform to standard industry practices, Software Quality and Technical Publications expenses are now classified as Product Development. WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
Also, costs for the management information systems were allocated from General and Administrative to functional areas.
2. CHANGE IN YEAR-END
In April 1998, the Company's Board of Directors approved a change in the Company's fiscal year-end from December 31 to April 30, beginning with the four months ended April 30, 1998 ("1998 Four Month Period"). Prior periods ended December 31, 1997 and 1996 will be referred in these notes to the consolidated financial statements as Fiscal 1997 and Fiscal 1996, respectively. This change is being made to improve the Company's ability to manage operations in light of seasonal customer buying patterns. Comparative information for the four months ended April 30, 1998 and 1997 is as follows:
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
3. COMPREHENSIVE INCOME (LOSS)
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," in January 1998. This standard requires disclosure of total non-owner changes in stockholders' equity, which is defined as net income plus direct adjustments to stockholders' equity such as unrealized gains and losses on equity investments adjustments and cumulative translation adjustments. The balances of the components of the Company's total comprehensive income were as follows:
4. MARKETABLE SECURITIES
Marketable securities consist primarily of corporate bonds. Unrealized gains and losses are shown as a component of stockholders' equity. As of April 30, 1999, corporate bonds totaled $47.7 million at estimated fair value and had an adjusted cost of $47.8 million with gross unrealized losses of $0.1 million. The corporate bonds will mature by December 2000.
Marketable debt securities with original maturity dates of less than three months totaled $42 million and $45 million at cost as of April 30, 1998 and December 31, 1997, respectively, and are included in cash and cash equivalents. The estimated fair value of the commercial paper approximates cost.
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
5. FIXED ASSETS
6. OTHER ASSETS
Royalties and amortization of prepaid licenses totaled $2.8 million, $0.6 million, $1.7 million and $4.1 million in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively, and are included in cost of revenues. Amortization of external product localization costs totaled $1.9 million, $1.0 million, $2.2 million and $0.6 million in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively, and are included in cost of revenues.
In April 1999, the Company loaned $860,000 to its Chief Executive Officer under the terms of a promissory note. The unpaid principal balance accrues interest at the rate of 5.28%. All principal amounts and unpaid interest are payable on April 15, 2003 and is included in other assets.
Other assets and long-term investments are regularly reviewed for possible impairment and are written off if, in the opinion of management, their value has been impaired.
7. INVESTMENTS, DISPOSITIONS AND OTHER NON-RECURRING ITEMS
In October 1998, the Company recorded a $2.4 million charge to restructure its operations in the Asia-Pacific and Latin America (APLA) markets. The adverse economic conditions in the APLA markets and declining sales have led the Company to eliminate an administrative layer and two of its smallest sales offices. The restructuring charge includes $0.8 million for severance and lease terminations costs, $1.0 million for the write down of certain product localization costs and other assets and $0.6 million for the write down of a minority investment in a Korean distributor. These charges increased the net loss for Fiscal 1999 by $2.4 million or $0.24 per share.
In March 1998, the Company acquired all of the outstanding shares of First Service Computer Dienstleistungs-GmbH ("First Service") of Hattingen, Germany and related companies for $11 million cash. First Service distributes and supports a range of connectivity software solutions to major corporations
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
throughout Germany and had been selling and supporting Wall Data's products and technologies for more than seven years. The acquisition, accounted for using the purchase method, included a cash payment of $11 million of which $2 million remains in escrow to cover claims, if any. As a part of this transaction, the Company recorded approximately $14.3 million of goodwill and other intangible assets and approximately $3.3 million in long-term deferred taxes. The goodwill and other intangible assets are being amortized over a ten-year period. Pro forma information has not been presented due to immateriality.
In October 1997, the Company acquired a fifteen percent equity interest in Suntek Information Systems Co., Ltd. ("Suntek") for approximately $0.9 million. Suntek distributes and supports software products in Korea. In October 1998, the Company evaluated the realizability of the asset and recorded a $0.6 million restructuring charge (included in the $2.4 million charge discussed above) to write down its investment in Suntek to the estimated fair value of $0.3 million. Based on negative changes in the economic and business environments in Korea, the Company calculated an impairment of its investment in Suntek using estimated future cash flows.
In November 1997, the Company and Data Channel, Inc. ("DataChannel") entered into an agreement under which DataChannel licensed its ChannelManager technology to the Company. DataChannel is a software development company which creates tools that streamline the presentation and management of information over corporate intranets. Pursuant to the licensing agreement, the Company recorded guaranteed royalties to DataChannel of $5.0 million. The Company paid $3.0 million and $2.0 million in Fiscal 1999 and in the 1998 Four Month Period, respectively. In addition, the Company acquired a ten percent equity interest in DataChannel for approximately $1.7 million.
In November 1997, the Company acquired all of the outstanding shares of Software Development Tools, Inc. ("SDTI") for $3.0 million. SDTI was a privately held developer of Windows development tools designed to provide a graphical interface to host applications and to migrate IBM AS/400 and mainframe applications to client/server environments. The acquisition has been accounted for under the purchase method of accounting. As a result of this transaction, the Company recorded non-recurring charges of approximately $741,000 ($667,000, or $0.07 per share on a diluted basis, after income taxes) for the write-off of in-process research and development. Approximately $2.3 million of the total purchase price was allocated to developed technology, goodwill and other intangible assets. The intangible assets are being amortized on a straight-line basis over periods ranging from four to ten years. Pro forma information relating to the acquisition of SDTI has not been presented due to immateriality.
During the second quarter of 1997, the Company recorded other non-recurring charges totaling $9.7 million ($6.7 million, or $0.67 per share on a diluted basis, after income taxes). Approximately $9.1 million represents a charge for the settlement of the shareholders' class action lawsuit. The remaining charges represent retirement payments to the Company's former Chairman and Chief Executive Officer. In July 1997, the Board of Directors also voted to accelerate the vesting of certain stock options to the former Chairman. The related compensation expense, which was not material, was recorded as an expense in the third quarter. The Company also recorded restructuring charges of approximately $1.0 million for the write-off of inventories, technology investments and severance payments relating to the SALSA business line.
During the fourth quarter of 1996, the Company recorded non-recurring charges totaling $3.1 million ($2.0 million, or $0.20 per share on a diluted basis, after income taxes) resulting from decisions to streamline operations and improve operating efficiencies. The charges primarily related to the write-off of technology investments and prepaid royalties no longer relevant to the Company's ongoing product offerings and programs.
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
8. INCOME TAXES
(Loss) income before income taxes consists of the following:
The provision for income taxes consists of the following:
In Fiscal 1999, the Company recorded a benefit of approximately $300,000 to reduce its deferred income tax liability as a result of a tax rate change affecting one the Company's international subsidiaries.
The effective rate differs from the U.S. federal statutory rate as follows:
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
The Company received compensation deductions in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996 for income tax purposes of $0.7 million, $0.6 million, $0.8 million and $1.0 million, respectively, resulting from the exercise of nonqualified stock options and from disqualifying dispositions of Common Stock received through exercise of incentive stock options. As required by generally accepted accounting principles, the resulting tax benefits for the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996 of $0.2 million, $0.3 million and $0.4 million, respectively, are reported as additions to shareholders' equity rather than as a reduction of income tax expense. Because of the Company's net operating loss, no tax benefit was recorded in Fiscal 1999.
Net deferred tax assets consist of the following:
The Company's deferred tax assets at April 30, 1999 were $6.1 million. The Company is no longer adding amounts to the deferred tax asset balance because of its operating losses. As of April 30, 1999, the Company reviewed its current risks and uncertainties regarding the ultimate realizability of its deferred tax assets and believes that it is more likely than not that future operations and tax planning relating to the strategic alternatives that are currently being considered would allow for the recognition of its deferred tax assets. The Company will review the realizability of these deferred tax assets each quarter to determine if operating results and business conditions have changed such that the carrying value of the assets requires adjustment.
The Company has recorded a valuation allowance to reflect the estimated amount of deferred tax assets that may not be realized. The increase in the valuation allowance in Fiscal 1999, the 1998 Four Month Period and Fiscal 1997 resulted from additional net operating losses and the uncertainty as to the realization of other deferred tax assets. As of April 30, 1999, the Company and its foreign subsidiaries have unused net operating
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
loss carryforwards, for income tax purposes, of $8.7 million and $11.4 million, respectively. The Company and the foreign subsidiary net operating losses expire through 2018 and 2002, respectively.
Income taxes paid in Fiscal 1999, the 1998 Four Month Period and Fiscal 1997 totaled $1.2 million, $0.1 million and $0.7 million, respectively. In Fiscal 1996, the Company received net refunds of $0.5 million.
9. SHAREHOLDERS' EQUITY
In April 1995, the Board of Directors authorized the repurchase of the Company's Common Stock up to an aggregate purchase price of $10 million. As of December 31, 1995, the Company had repurchased 488,200 shares of Common Stock for approximately $8.5 million. The Company has not repurchased any shares since Fiscal 1995.
The Company has a shareholder rights agreement, designed to protect shareholders from certain takeover tactics, and declared a dividend of one preferred share purchase right for each outstanding share of the Company's Common Stock to stockholders of record as of July 31, 1995. The rights entitle the holder (a) to purchase one one-hundredth of a share of Series A Junior Participating Preferred Stock, no par value per share, of the Company at a price of $110, subject to adjustment to prevent dilution, upon the occurrence of triggering events, or (b) in certain circumstances, to purchase Wall Data Common Stock (or stock of the acquiring entity, as the case may be) at a 50% discount from its then current market value. Such events would include the acquisition of Wall Data shares through open market purchases or a tender offer that, in the aggregate, equals or exceeds 20% of outstanding shares. At the option of the Board of Directors, the rights may be exchanged for one share of Wall Data Common Stock for each right. Such rights do not extend to any holder whose action triggered the rights. The rights expire in August 2005 and may be redeemed prior to that time at the option of the Board of Directors for nominal consideration. Until a triggering event occurs, the rights will not trade separately from the related Wall Data Common Stock.
The Company has several stock-based compensation plans that are described below. The Company has elected to continue to apply APB Opinion No. 25 in accounting for its plans and, accordingly, recognizes compensation expense for employee stock options only when the exercise price is less than the quoted market price at the date of grant; stock compensation expense was not material in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996. Had stock-based compensation been determined based on the prescribed method for estimating fair value under SFAS No. 123, the Company's pro forma net income (loss) and earnings (loss) per share in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996 would have been $(13.8) million, or $(1.38) per share, $(5.8) million, or $(0.60) per share, $0.2 million, or $0.02 per share on a diluted basis, and $2.7 million, or $0.28 per share on a diluted basis, respectively. The pro forma effects on net income (loss) for these periods are not indicative of the pro forma effects in future years because SFAS No. 123 does not apply to grants prior to 1995 and additional grants in future years are anticipated. The pro forma amounts have been determined using the Black-Scholes option pricing model with the following weighted average assumptions for Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively: risk-free interest rates of 5.3%, 5.7%, 5.9% and 6.5%; volatility factors of 80%, 80%, 79% and 74%; expected life of five years and a zero dividend yield for each period.
The Company has stock option plans that provide for nonqualified and incentive stock options for officers, employees and consultants. A committee of the Board of Directors determines the terms and conditions of options granted under the plans, including the exercise price; however, the exercise price for incentive stock options shall not be less than the fair market value at the date of grant. Options granted under the plans generally become exercisable, cumulatively, at a rate of 25% per year from the date of grant, and expire 10 years from the date of grant. The Company also has a stock option plan for non-employee directors providing for grants of nonqualified options at an exercise price that is not less than the fair market value at the date of grant. WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
In July 1995 and January 1996, the Compensation Committee of the Board of Directors authorized the exchange of new options for certain previously granted stock options. Approximately 818,000 shares, ranging in price from $17.00 to $54.25 per share, were exchanged for new options with an exercise price ranging from $15.32 to $18.75 per share.
Stock option activity and option price information for all option plans is as follows:
The weighted average fair value of options granted in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, as determined under the method prescribed in SFAS No. 123, is $10.29, $10.45, $11.12 and $11.10, respectively.
Additional information concerning outstanding stock options and exercisable stock options as of April 30, 1999 is set forth below:
Approximately 672,000 shares were available for future grants as of April 30, 1999. At April 30, 1998 options for the purchase of approximately 665,000 shares were exercisable at a weighted average exercise price of $15.98 per share. At December 31, 1997, options for the purchase of approximately 1,148,000 shares were exercisable at a weighted average exercise price of $9.38 per share. At December 31, 1996, options for the
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
purchase of approximately 827,000 shares were exercisable at a weighted average exercise price of $6.33 per share.
The Company has an employee stock purchase plan for all eligible employees. Under the plan, employees may purchase shares of Common Stock having a total value not exceeding 10% of gross compensation, at a price per share equal to 85% of the lower of fair market value of the Common Stock on the first or last business day of each six-month offering period. As of April 30, 1999, approximately 278,000 shares had been issued under the plan, and 122,000 shares are reserved for future issuance.
10. RECONCILIATION OF EARNINGS PER SHARE
The following table presents a reconciliation of basic earnings per share to earnings per share -- assuming dilution (income and shares in thousands):
Certain options to purchase shares of Common Stock were not included in the computation of diluted EPS in Fiscal 1997 and Fiscal 1996 because the options' exercise price was greater than the average market price of the Common shares. The total shares that were thus excluded approximated 1,650,000 and 1,513,000 in Fiscal 1997 and Fiscal 1996, respectively.
11. EMPLOYEE BENEFITS
The Company has a Retirement Savings Plan to provide for voluntary salary deferral contributions on a pretax basis in accordance with Section 401(k) of the Internal Revenue Code of 1986, as amended. Effective January 1, 1998, the Retirement Savings Plan was amended to require the Company to make matching contributions in an amount equal to 100% of employee pretax contributions but subject to a maximum of 5% of eligible compensation contributed to the plan. Employees receive vesting credit in the Company's contribution of 25% for each year of employment. During Fiscal 1999 and the 1998 Four Month Period, the Company incurred expenses of $2.0 million and $0.7 million, respectively, related to the Company's contribution to the Retirement Savings Plan. No Company contributions were made in prior periods.
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
12. LITIGATION
In September 1998, the Company filed an action for declaratory judgment in Federal District Court for the Western District of Washington against OpenConnect Systems, Inc. ("OCS") of Dallas, Texas seeking a judicial determination that the Company does not infringe on patent No. 5754,830 (the "830 Patent") held by OCS. Also in September 1998, OCS filed suit in Federal District Court for the Eastern District of Texas against the Company claiming that the Company infringes the '830 Patent. The OCS complaint seeks unspecified damages. The Company has answered the OCS complaint by denying infringement and asserting that the '830 patent is invalid and unenforceable. The Federal District Court for the Western District of Washington has stayed the action for declaratory judgement pending a ruling from the Federal District Court for the Eastern District of Texas on a motion by the Company to transfer the action. Because the complaint seeks unspecified damages, it is impossible to predict the outcome; however, an adverse outcome could have a material impact on the Company's liquidity, operating results or financial condition. The Company intends to defend against the action vigorously.
In July 1997, the Company agreed to settle a class action lawsuit for $11.25 million, of which $3.0 million was paid by the Company's insurance carrier. Included in non-recurring expenses in the second quarter of 1997 is a charge of $9.1 million for the Company's share of the settlement plus related fees and expenses. The Company paid its share of the settlement in July 1997. Wall Data denied the allegations of the plaintiffs' claims, but agreed to the settlement to avoid any further expense and the distraction of continued legal proceedings.
13. OPERATING SEGMENT, GEOGRAPHIC SEGMENT AND CONCENTRATION OF CREDIT RISK
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which changed the method for determining and reporting business segment information. SFAS No. 131 is effective for financial statements for fiscal years beginning after December 15, 1997 and, therefore, the Company has adopted the new requirements retroactively in Fiscal 1999.
Operating Segment Information
Wall Data is organized based on the products and services that it offers. Under this organizational structure, the Company has two reportable segments, RUMBA and Cyberprise. The RUMBA segment consists of products and services that connect the PC to host systems. RUMBA products include RUMBA OFFICE, RUMBA Mainframe, RUMBA AS/400 and others. The Company's Cyberprise products are designed to enable companies to move existing mission-critical systems and public information to the Web and extend those systems to remote users, vendors and customers. In Fiscal 1999, all products that are Web enabled were reported as Cyberprise revenue. Cyberprise products include Cyberprise Server, Cyberprise Host, RUMBA/Cyberprise edition, Cyberprise Tools DBApp Developer and others. With the evolution of the Cyberprise vision, management plans to differentiate the Cyberprise business from RUMBA as an EIP solution beginning in Q1 of FY2000. As a result, prior periods will be restated to eliminate all RUMBA/ Cyberprise edition revenues from Cyberprise and reflect it as RUMBA business. In Fiscal 1999, the Company reported approximately $8.9 million of RUMBA/Cyberprise edition revenue as Cyberprise license fees.
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
The Company's chief operating decision maker utilizes revenue and operating income (loss) information in assessing performance and making overall operating decisions and resource allocations. Restructuring charges and other nonrecurring charges are excluded from each segment's operating income (loss). The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. Information about the Company's segments is as follows:
The Company does not specifically identify or allocate assets among its reportable segments. However, for management reporting purposes, depreciation and amortization expenses for equipment, furniture and fixtures and intangible assets, respectively, are included with other operating expenses and allocated to each segment based upon each segment's proportion of operating expenses. Depreciation and amortization expenses for each reportable segment are as follows:
Geographic Segment Information
Information regarding the Company's operations in different geographic areas in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996 is set forth below. Amounts presented for North America include revenues from customers in North America and certain international revenues, primarily Japan and Latin America; such international revenues equaled 4%, 5%, 4% and 4% of consolidated net revenues in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively. Total international revenues equaled 26%, 35%, 30% and 29% of consolidated net revenues in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively. Foreign currency exchange transactions, which are included in other income (expense), resulted in net exchange gains (losses) of $(0.1) million, $0.2 million, $(0.8) million and
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
$(0.6) million in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively. During Fiscal 1999, the Company engaged in currency hedging by purchasing and selling options on certain foreign currencies. All options are purchased at the beginning of each quarter and expire at the end of the same quarter. The options are intended to hedge against foreign exchange positions on intercompany balances with subsidiaries.
Intercompany sales are at prices intended to provide a profit for the selling entity after coverage of product development, marketing, support and general and administrative expenses. The identifiable assets by geographic area are those used in the Company's operations in each area.
Credit Risk
Sales to any one customer did not exceed 10% of net revenues in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 or Fiscal 1996.
14. COMMITMENTS
The Company rents office facilities under operating lease agreements. Future minimum lease payments at April 30 under non-cancelable operating leases with terms in excess of one year are as follows (in thousands):
WALL DATA INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) APRIL 30, 1999
Rental expenses under operating leases amounted to approximately $5.9 million, $1.5 million, $5.2 million and $5.4 million in Fiscal 1999, the 1998 Four Month Period, Fiscal 1997 and Fiscal 1996, respectively.
In May 1997, the Company entered into an agreement with a third party to provide the Company with information technology services for a ten-year period. The Company has options to terminate the agreement on the fourth, sixth and eighth anniversaries of the effective date of the agreement. The minimum commitment for the year ending April 30, 2000 is approximately $5.1 million. Annual commitments will increase each year thereafter based on the growth of the Company and inflation.
WALL DATA INCORPORATED
SELECTED QUARTERLY FINANCIAL DATA AND MARKET INFORMATION (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- - Wall Data's Common Stock has been traded on the Nasdaq National Market under the symbol "WALL" since March 15, 1993, the effective date of the Company's initial public offering.
- - The market prices of a share of Common Stock reflect the high and low trading prices, as reported by the Nasdaq National Market.
- - The Company has not paid cash dividends on its Common Stock.
- - As of July 1, 1999, there were 316 holders of record of the Company's Common Stock. - --------------- (1) In October 1998, the Company recorded a $2.4 million charge to restructure its operations in the Asia-Pacific and Latin America (APLA) markets. The restructuring charge includes $0.8 million for severance and lease terminations costs, $1.0 million for the write down of certain product localization
costs and other assets and $0.6 million for the write down of a minority investment in a Korean distributor. See Note 7 of Notes to Consolidated Financial Statements.
(2) In the fourth quarter of Fiscal 1999 revenues fell, as compared to the previous quarters. The revenue decline is believed to be primarily a result of the disruptions associated with the restructure of Wall Data into separate RUMBA and Cyberprise businesses. However, market conditions, including customer deferment of purchases as attention and resources are dedicated to year 2000 preparedness, are also believed to be factors. In the fourth quarter, the Company determined that the RUMBA and Cyberprise businesses had differing sales processes and other operational aspects. The Company separated all of the line functions of the business including technical support, services, product development, field sales and marketing in order to increase the focus on the specific needs of each business.
(3) During the quarter ended June 30, 1997, the Company recorded non-recurring charges totaling $10.7 million before income taxes, consisting of $9.1 million for the settlement of the shareholders' class action lawsuit, $1.0 million for the restructuring of the SALSA business unit, and $0.6 million for a retirement payment to the Company's former chairman. See Notes 7 and 12 of Notes to Consolidated Financial Statements.
(4) During the quarter ended December 31, 1997, the Company recorded non-recurring charges of $0.7 million before income taxes, for the write-off of in-process research and development resulting from the acquisition of Software Development Tools, Inc. See Note 7 of Notes to Consolidated Financial Statements.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
WALL DATA INCORPORATED
Date: July 27, 1999 By: /s/ JOHN R. WALL
------------------------------------ John R. Wall Chief Executive Officer
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 indicated below on the 27th day of July, 1999.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS WALL DATA INCORPORATED
- --------------- (A) Deductions consist of write-offs of uncollectible accounts, reseller rebates and product returns.
EXHIBIT INDEX
- --------------- + Management contract or compensatory plan
* Included herewith