Pervasive Software 10-Q 2012
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended December 31, 2011
COMMISSION FILE NUMBER: 000-23043
PERVASIVE SOFTWARE INC.
(Exact name of registrant as specified in its charter)
12365 Riata Trace Parkway, Bldg. B
Austin, Texas 78727
(Address of principal executive offices) (Zip code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15d of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer or a smaller reporting company. See definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of January 20, 2012 there were 16,178,266 shares of the Registrants common stock outstanding.
PERVASIVE SOFTWARE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying notes.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
See accompanying notes.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011
1. General and Basis of Financial Statements
The condensed balance sheet as of June 30, 2011, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements include the accounts of Pervasive Software Inc. and its majority-owned subsidiaries (collectively, the Company or Pervasive). All intercompany accounts and transactions have been eliminated in consolidation.
The financial statements included herein reflect all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary to fairly state the Companys financial position, results of operations and cash flows for the periods presented. These financial statements should be read in conjunction with the Companys consolidated financial statements and notes thereto for the year ended June 30, 2011, which are contained in the Companys Annual Report filed on Form 10-K on September 13, 2011 (File No. 000-23043). The results of operations for the three and six month periods ended December 31, 2011 and 2010 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year.
2. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
As of the six months ended December 31, 2011 and 2010 options representing approximately 376,000 and 853,000 shares, respectively, were not included in the diluted earnings per share calculation since the shares are anti-dilutive.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3. Cash, Cash Equivalents and Short-term Investments
The Company considers all highly liquid investment securities with an original maturity of three months or less at the date of purchase to be cash equivalents.
Marketable securities are classified as available for sale, excluding cash equivalents as described above, and are recorded at estimated fair value with any unrealized gains or losses included in other comprehensive income (loss). Realized gains and losses are computed based on the specific identification method. Realized gains and losses were not material for the periods presented.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The inputs used to measure fair value are classified into the following hierarchy:
Marketable securities consisted of the following (in thousands):
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4. Comprehensive Income
The components of comprehensive income are as follows:
5. Stock Compensation
Stock-based compensation expense is computed using the fair value of stock-based awards measured at the grant date, recognized over the relevant service period, and is adjusted each period for anticipated forfeitures. The grant date fair value of stock option awards is estimated using the Black-Scholes option pricing model, assuming no expected dividends and the following weighted average assumptions:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Share-based compensation expense reflects non-cash compensation expense associated with restricted stock purchase rights and employee stock options. Share-based compensation expense is included in costs and expenses as follows:
As of December 31, 2011, $3.7 million of unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 1.7 years.
The vesting period for restricted stock is generally a three year period. Stock will remain restricted until the full vesting period has expired. A summary of changes in restricted stock awards during the year ended June 30, 2011 and the six month period ended December 31, 2011 is as follows:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The vesting period for stock options is generally a four-year period. Options are generally exercisable by the holder only for the vested portion of each grant. A summary of changes in common stock options during the year ended June 30, 2011 and the six month period ended December 31, 2011 is as follows:
The following is additional information relating to outstanding options:
6. Stock Repurchase Program
In July 2010, we announced the authorization of a $10.0 million stock repurchase plan which became effective on July 27, 2010. During the three months ended December 31, 2011, we repurchased 82,134 shares of common stock at a cost of approximately $0.5 million under the stock repurchase plan approved on July 27, 2010. The transactions occurred in open market purchases. The repurchase program may be suspended or discontinued at any time without prior notice. As of December 31, 2011, approximately $2.6 million remained available for repurchase under this program.
7. Goodwill and Other Intangible Assets
As of December 31, 2011, Pervasive had goodwill in the amount of $38.5 million associated with the acquisition of Data Junction. The Company evaluates intangible assets for potential impairment annually in the fourth quarter, or more frequently if other indicators of impairment arise.
On July 31, 2009, the Company completed the purchase of assets from Greenville, SC-based ChanneLinx, Inc., a Web-based electronic data interchange (Web DI) technology company, for total consideration of approximately $2.6 million in cash.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Other intangible assets, classified as purchased intangibles on the balance sheet, amounted to $1.3 million (net of accumulated amortization of $7.6 million) as of December 31, 2011. These intangible assets consist of developed technology, including the $6.3 million value assigned to amortizable intangible assets related to developed technology in connection with the acquisition of Data Junction during the second quarter of fiscal 2004 and $2.6 million related to the acquisition of ChanneLinx in the first quarter of fiscal 2010.
The Company amortizes intangible assets with definite useful lives on a straight-line basis over their estimated useful lives, generally five years. Amortization expense for the three and six months ended December 31, 2011 was $0.1 million and $0.3 million, respectively. Amortization expense for intangible assets is anticipated to be approximately $0.5 million for each of the years ended June 30, 2012 through June 30, 2014.
8. Recently Issued Accounting Standards
In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2011-08, IntangiblesGoodwill and Other (Topic 350): Testing Goodwill for Impairment, (ASU 2011-08), which allows companies to waive comparing the fair value of a reporting unit to its carrying amount in assessing the recoverability of goodwill if, based on qualitative factors, it is not more likely than not that the fair value of a reporting unit is less than its carrying amount. ASU 2011-08 will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this standard is not expected to have a material impact on our consolidated statement of earnings, financial condition, statement of cash flows or earnings per share.
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (ASU 2011-05), which allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-05 will not have a material impact on our consolidated statement of earnings, financial condition, statement of cash flows or earnings per share.
In May 2011, the FASB issued Accounting Standards Update 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU 2011-04). The amendments in this ASU generally represent clarification of Topic 820, but also include instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). The amendments are effective for interim and annual periods beginning after December 15, 2011 and are to be applied prospectively. Early application is not permitted. The adoption of ASU 2011-04 will not have a material impact on our consolidated statement of earnings, financial condition, statement of cash flows or earnings per share.
PERVASIVE SOFTWARE INC.
The statements contained in this Report on Form 10-Q that are not purely historical statements are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding the Companys expectations, beliefs, hopes, intentions or strategies regarding the future. In some cases, you can identify forward-looking statements by terminology such as may, will, should, could, expects, plans, anticipates, believes, estimates, predicts, potential, or continue or the negative of such terms or other comparable terminology. These forward-looking statements involve risks and uncertainties. See Risk Factors in Part II, Item 1A of this Report on Form 10-Q for a more detailed discussion of these risks and uncertainties. Actual results may differ materially from those indicated in such forward-looking statements. We are under no duty to update any forward-looking statements after the date of this filing on Form 10-Q to conform these statements to actual results, except as required by law.
Our Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) includes the following sections:
You should read this MD&A in conjunction with the Consolidated Financial Statements and related Notes.
Pervasive is a global data innovation leader, delivering software to manage, integrate and analyze data, in the cloud or on-premises, throughout the entire data lifecycle. Our Pervasive PSQL database products generated approximately 58% of our revenue during fiscal year 2011. Channel adoption trends for version 11 of our Pervasive PSQL database have been good since its launch in September 2010. Pervasive PSQL v11 delivers improvements in performance and increased simplicity of development, deployment and ease of use, including enhanced digital license management and enhanced support for IPv6 and multi-core technologies. We also plan a release in spring 2012 of Pervasive PSQL Vx, with improved support and pricing for use in virtual environments.
Our Integration products generated approximately 38% of our revenue during fiscal year 2011 and are well-received by our existing and new customers, including end users and commercial cloud and on-premises software developers alike. Our solid results in both of our core product lines allow us to continue to fund our commitment to innovation. We intend to continue to invest in innovation by allocating dedicated funds for research focused on new ways to serve our existing customers and attract new customers. Our innovation efforts in fiscal years 2009, 2010 and 2011 have resulted in the introduction and further development of various new product and service offerings:
For more than twenty-five years, Pervasive products have delivered value to tens of thousands of customers worldwide, often embedded within partners software, with breakthrough performance, flexibility, reliability and return on investment. In addition, significant portions of our database and integration flagship product lines are embeddable into commercial applications for sale predominantly through a well-developed channel of independent software vendors (ISVs), Software-as-a-Service (SaaS) vendors, value-added resellers (VARs) and system integrators.
On July 31, 2009, we completed the purchase of assets from Greenville, SC-based ChanneLinx, Inc., a Web-based electronic data interchange (Web DI) technology company, for total consideration of approximately $2.6 million in cash. The acquired business, which operates as Pervasive Business Xchange, is complementary to the Companys other products and operations.
We develop, market, sell and support our offerings worldwide through our principal office in Austin, Texas and our Greenville, South Carolina office and through international offices in Brussels, Frankfurt, Paris and London and a joint venture in Japan.
Our Operating Results
Our comparative results for the quarter ended December 31, 2011:
We believe that the software markets as a whole are going through rapid change. The emergence of cloud-based infrastructure and applications is testament to the increasing demand for the scalability and rapid deployment provided by the SaaS delivery model. Organizations increasingly demand software that provides ease of use, re-usability, interoperability with widely adopted technologies, the flexibility to be deployed on-premises or in the cloud, and cost-effective maintenance. In this environment, delivering flexibility and performance with high return on investment becomes increasingly critical. As these market disruption trends continue, we believe infrastructure software will be a key ingredient for all businesses as they seek to integrate and streamline their back-end systems and eliminate delays in the management and execution of critical processes. Infrastructure software includes, among other things, application development tools, integration tools and solutions, analytics, databases, and security solutions.
In addition, the rapid proliferation of commodity multicore hardware, along with exploding data volumes, provides opportunities for companies to leverage affordable servers and clusters of servers that have multiple cores in a single box to extract value from large volumes of databut only if they have software that can effectively scale on multiple cores. The inevitable performance gains traditionally delivered by faster processors under Moores Law now must rely on a new generation of infrastructure software that can scale on ever-updating multicore hardware platforms.
Pervasive also continues to see consolidation in markets where its data management and data integration offerings compete. In the database arena, Oracle acquired the open source Sun MySQL database while SAP acquired Sybase. For ISVs who want to avoid vendor lock-in with monolithic industry giants, Pervasive PSQL remains an attractive alternative. In the data integration market, IBM acquired CastIron Systems and Dell acquired Boomi, resulting in Pervasive being one of an increasingly small number of independent data integration providers. With a stable operating history, consistent profitability, a commitment to channel and the ability to provide a best-of-breed alternative to large technology stacks, we believe Pervasive holds a unique position as a stable yet innovative go-to partner for both channel and enterprise customers.
We believe these trends will favor Pervasive. We believe the market for data infrastructure software, in particular, is experiencing significant market disruption due to the high cost of many competing, more labor-intensive solutions. We further believe well-established technology leaders who develop deep relationships with channel partners and customers tend to prevail in cost-sensitive markets, and Pervasive, with its strengths in scalable data management, data integration, and scalable cloud delivery, is well-positioned to benefit from the trends in these markets. The current release of Pervasive PSQL database enables applications that embed the database to deliver significant performance improvements on dual-core, 4-core and 8-core servers. In addition, Pervasive DataCloud provides an elastic platform-as-a-service that both Pervasive and partners can leverage to deliver SaaS integrations. The economic environment remains uncertain, but Pervasives financial stability, strong value proposition for customers and partners, and diverse vertical and geographic markets have enabled the company to sustain profitability even in the face of economic headwinds. We believe that if an economic recovery accelerates and strengthens, our reputation as an established vendor with highly reliable offerings positions Pervasive to prosper even further.
Pervasive has a strong portfolio that consists both of established products with strong channels and recurring revenue and of innovative, cutting-edge technology that leverages potential market disruptors such as multicore hardware, cloud-based delivery models and the avalanche of big data. With a 10-year history of profitability, Pervasive remains committed to investing in technology innovation to deliver offerings that differentiate us from competitors, stay current with market trends, and deliver compelling customer value, today and in the future.
Risks to our Success
Risks and uncertainties include, among others, our ability to attract and retain existing and/or new customers; our ability to issue new products or releases of solutions that meet customers needs or achieve acceptance by the Companys customers; changes to current accounting policies which may have a significant, adverse impact upon the Companys financial results; the introduction of new products by competitors or the entry of new competitors; our ability to preserve our key strategic relationships; our ability to hire and retain key employees; and economic and political conditions in the US and abroad. All of these factors, as well as those discussed in Item 1ARisk Factors, may result in significant fluctuations in our quarterly operating results and/or our ability to sustain or increase our profitability.
In 2012, the Company is focused on:
We remain committed to a strategic balance of investment in both our flagship and emerging products while also maintaining an intense focus on operating profitability.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions are reviewed periodically. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following represent our critical accounting policies:
Revenue Recognition We license our software through OEM license agreements with software developers, or ISVs and through shrink-wrap software licenses, sold through ISVs, VARs, systems integrators and distributors, or direct to end users. Revenues are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant Company obligations with regard to implementation remain, the fee is fixed or determinable and collectability is probable. Revenues related to OEM license agreements involving nonrefundable fixed minimum license fees are generally recognized upon delivery of the product master or first copy if no significant vendor obligations remain. Per copy royalties related to OEM license agreements in excess of a fixed minimum amount are recognized as revenue when such amounts are reported to us. Revenue from post contract support and the right to receive unspecified upgrades is recognized ratably over the contract term. We generally provide telephone support to customers and end users in the 30 days immediately following the sale at no additional charge and at a minimal cost per call. We accrue the cost of providing this support. Revenue from consulting services and training is recognized when the related services are performed. We enter into agreements with certain distributors that provide for certain stock rotation and price protection rights. These rights allow the distributor to return product in a non-cash exchange for other products or for credits against future purchases. Revenue from shipping and handling is recognized at the shipping date. Shipping and handling costs are included in costs of product license revenues in the Consolidated Statements of Income.
Where software licenses are sold with maintenance or other services, we allocate the total fee to the various elements based on the fair values of the elements. We determine the fair value of each element in the arrangement based on vendor-specific objective evidence (VSOE) of fair value. VSOE of fair value is based upon the normal pricing and discounting practices for those products and services when sold separately and, for support services, is additionally measured by the renewal rate. If we do not have VSOE for one of the delivered elements of an arrangement, but do have VSOE for all undelivered elements, we use the residual method to record revenue. Under the residual method, the arrangement fee is first allocated to the undelivered elements based upon their VSOE of fair value; the remaining arrangement fee, including any discount, is allocated to the delivered element. If the residual method is not used, discounts, if any, are applied proportionately to each element included in the arrangement based on each elements fair value without regard to the discount.
Sales Returns and Bad Debt Reserves We reserve the cost of estimated sales returns, stock rotation and price protection rights as well as uncollectible accounts based on experience. We evaluate quarterly the adequacy of the reserve for sales returns, stock rotation and price protection. Because these reserves are based on our judgments and estimates, our reserves may not be adequate to cover actual sales returns and other allowances. If our reserves are not adequate, our net sales could be adversely affected.
Goodwill and Other Intangible Assets We assess whether goodwill and indefinite-lived intangibles are impaired on an annual basis and review for triggering events on an ongoing basis. Upon determining the existence of goodwill and/or indefinite-lived intangibles impairment, we measure impairment based on the amount by which the book value of goodwill and/or indefinite-lived intangibles exceeds its fair value. The fair value of an asset is the amount at which that asset could be bought or sold in a current transaction between willing parties in an orderly transaction between market participants. Additional impairment assessments may be performed on an interim basis if we encounter events or changes in circumstance that would indicate that, more likely than not, the book value of goodwill and/or indefinite-lived intangibles has been impaired.
Stock-Based Compensation Expense We utilize the Black-Scholes option pricing model to estimate the fair value of employee stock option compensation at the date of grant, which requires the input of highly subjective assumptions, including expected volatility and expected life. Expected volatility is based on historical volatility, while the expected life is estimated to be 4.75 years based on historical trends. Further, we estimate forfeitures for options granted, which are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. The estimated fair value is charged to earnings on a straight-line basis over the vesting period of the underlying awards, which is generally four years. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options having no vesting restrictions and being fully transferable. Accordingly, our estimate of fair value may not represent the value assigned by a third-party in an arms-length transaction. While our estimate of fair value and the associated charge to earnings materially impacts our results of operations, it has no impact on our cash position.
Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
We estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes and net operating loss and tax credit carryforwards. These differences result in deferred tax assets and liabilities. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not more likely than not, we establish a valuation allowance. State tax credit carryforwards are subject to potential expiration if not utilized by certain dates in the future. The valuation allowance remaining at December 31, 2011 relates entirely to estimated expiration of state tax credit carryforwards prior to utilization.
We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and recording the related assets and liabilities. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are occasionally under audit by tax authorities in various jurisdictions. Although we believe we have appropriate support for the positions taken on our tax returns, we have recorded a liability for our best estimate of the probable loss on certain of these positions. We believe that our accruals for tax liabilities are adequate for all open years, based on our assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter, which matters result primarily from intercompany transfer pricing. Although we believe our recorded assets and liabilities are reasonable, tax regulations are subject to interpretation and tax litigation is inherently uncertain; therefore our assessments can involve both a series of complex judgments about future events and rely heavily on estimates and assumptions. Although we believe the estimates and assumptions supporting our assessments are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in historical income tax provisions and recorded assets and liabilities. Based on the results of an audit or litigation, a material effect on our income tax provision, net income, or cash flows in the period or periods for which that determination is made could result. Due to the complexity involved, we are not able to estimate the range of reasonably possible losses in excess of amounts recorded.
Results of Operations
The following table sets forth for the periods indicated the percentage of revenues represented by certain lines in our Consolidated Statements of Income:
Revenue from our embedded database product, Pervasive PSQL, decreased in fiscal year 2011 relative to fiscal years 2009 and 2010. The decrease in 2011 was primarily due to a number of relatively large transactions with database customers in fiscal years 2009 and 2010. We had one relatively large transaction with database customers in each of the last three fiscal years in the amount of $3.0 million, $2.4 million and $0.9 million in fiscal years 2009, 2010 and 2011, respectively. Our embedded database and related products represented approximately 58% of our revenue in fiscal year 2011 and 57% for the six months ended December 31, 2011. However, our integration product revenue grew 9% over fiscal year 2010 and 18%
over fiscal year 2009, and represented approximately 38% of our total revenue in fiscal year 2011 and 39% for the six months ended December 31, 2011. A reduction in our embedded database business, or our inability to grow our integration products business, could have a material adverse effect on our business, operating results and financial condition.
Our revenues were $11.9 million in the three months ended December 31, 2011, with a 2% increase over the $11.7 million reported for the comparable period in the prior fiscal year. Our revenues for the six-month period ending December 31, 2011 increased 4% to $23.6 million as compared to $22.6 million for the comparable period in the prior fiscal year. Our product license revenues were $7.2 million in the three months ended December 31, 2011, an increase of 1% over the $7.1 million for the comparable period in the prior fiscal year. Our product license revenues for the six-month period ending December 31, 2011 were $14.8 million, an increase of 7% over the $13.8 million for the comparable period in the prior fiscal year. Our service and other revenues were $4.7 million in the three months ended December 31, 2011, an increase of 4% over the $4.5 million for the comparable period in the prior fiscal year. Our service and other revenues for the six-month period ending December 31, 2011 were $8.8 million, a decrease of 1% over the $8.9 million for the comparable period in the prior fiscal year.
Licenses of our embedded database software operating on Microsoft based operating systems continue to represent more than 90% of our database product license revenues. We expect the percentages of our revenues attributable to licenses of our software operating on particular platforms will continue to change from time to time. We cannot be certain our revenues attributable to licenses of our software operating on Microsoft based, or any other operating system platform, will grow in the future.
International revenues, consisting of all revenues from customers located outside of North America, were $4.0 million and $3.8 million in the three months ended December 31, 2011 and 2010, respectively, representing 34% and 33% of total revenues, respectively. International revenues were $9.2 million and $7.9 million in the six months ended December 31, 2011 and 2010, representing 39% and 35% of total revenues, respectively. We expect that international revenues will continue to account for a significant portion of our revenues in the future.
Costs and Expenses
Cost of Product License Revenues. Cost of product license revenues consists primarily of the cost to manufacture and fulfill orders for our shrink-wrap software products, payment of license fees for third-party technologies embedded in our products and amortization of purchased technology. Cost of product license revenues was $0.3 million and $0.4 million in the three months ended December 31, 2011 and 2010, representing 3% of total revenues in both periods. Cost of product license revenues was $0.7 million and $0.7 million for the six-month period ending December 31, 2011 and 2010, representing 3% of total revenues in both periods. We anticipate that cost of product license revenues in the near term will be consistent with the costs incurred during the quarter ended December 31, 2011.
Cost of Service and Other Revenues. Cost of service and other revenues consists primarily of the cost to provide technical support, primarily telephone support, which is typically provided within 30 days of purchase and the costs to deliver professional services and training services to others. Cost of service and other revenues was $1.5 million and $1.2 million in the three months ended December 31, 2011 and 2010, representing 12% and 11% of total revenues, respectively. Cost of service and other revenues was $2.8 million and $2.4 million for the six-month periods ending December 31, 2011 and 2010, representing 12% and 11% of total revenues, respectively. We anticipate that cost of service and other revenues in the near term will be consistent with the costs incurred during the three months ended December 31, 2011.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, foreign sales office expense, marketing programs and promotional expense, and travel and entertainment. Sales and marketing expenses were $4.9 million and $5.3 million in the three-month periods ended December 31, 2011 and 2010, respectively, representing 41% and 46% of total revenues, respectively. Sales and marketing expenses were $9.9 million and $9.9 million for the six months ending December 31, 2011 and 2010, representing 42% and 44% of total revenues, respectively. We expect sales and marketing expenses will increase in the near term due primarily to planned marketing events in the quarters ending March 31, 2012 and June 30, 2012.
Research and Development. Research and development expenses consist primarily of personnel and related costs. Research and development expenses were $3.0 million and $2.8 million in the three months ended December 31, 2011 and 2010, representing 26% and 24% of total revenues, respectively. Research and development expenses were $6.1 million and $5.7 million for the six months ended December 31, 2011 and 2010, representing 26% and 25% of total revenues, respectively. We anticipate that research and development expenses in the near term will be consistent with the costs incurred during the three months ended December 31, 2011.
General and Administrative. General and administrative expenses consist primarily of the personnel and other costs associated with our finance, human resources and administrative departments. General and administrative expenses were $1.5 million and $1.3 million in the three-month periods ending December 31, 2011 and 2010, representing 13% and 11% of total revenues, respectively. General and administrative expenses were $3.3 million and $2.6 million for the six months ended December 31, 2011 and 2010, representing 14% and 11% of total revenues, respectively. The increase in the three and six month periods ended December 31, 2011 is due primarily to certain fees associated with our defense in ongoing patent litigation and the timing of fees associated with our annual independent audit. We anticipate that our general and administrative expenses in the near term will be consistent with costs incurred during the three months ended December 31, 2011.
Share-based compensation expense. Share-based compensation expense reflects non-cash compensation expense associated with restricted stock purchase rights and employee stock options. Share-based compensation expense is included in costs and expenses as follows:
We anticipate our share-based compensation expense in the near term will be consistent with the expense in the quarter ending December 31, 2011.
Interest and Other Income. Interest and other income was $18,000 and $14,000 for the three months ended December 31, 2011 and 2010, respectively. Interest and other income was $34,000 and $24,000 for the six months ended December 31, 2011 and 2010, respectively. We do not anticipate any changes to interest and other income.
Provision for Income Taxes. Provision for income taxes was approximately $0.1 million and $0.2 million in the three months ended December 31, 2011 and 2010, respectively. Provision for income taxes was approximately $0.1 million and $0.4 million in the six months ended December 31, 2011 and 2010, respectively. The Companys estimated annual effective tax rate and associated provision for income taxes for the six months ended December 31, 2011 is based on an estimate of consolidated earnings before income taxes for fiscal 2012. The estimated annual effective tax rate is impacted primarily by estimates of non-deductible expenses, deductions related to domestic production activities and tax exempt income, the effects of state and foreign operations, tax legislation and credits generated.
Liquidity and Capital Resources
Cash provided by operations was $3.5 million and $3.0 million for the six months ended December 31, 2011 and 2010, respectively. Cash provided by operations for the six months ended December 31, 2011 resulted primarily from net income as adjusted for non-cash items, a decrease in accounts receivable, an increase in deferred rent and lease related accruals, and an increase in deferred revenue, partially offset by a decrease in accounts payable and accrued liabilities. Cash provided by operations for the six months ended December 31, 2010 resulted primarily from net income as adjusted for non-cash items, a decrease in prepaid expenses and other assets, an increase in accounts payable and accrued liabilities and an increase in deferred revenue, partially offset by an increase in trade accounts receivable.
During the six months ending December 31, 2011, we invested $1.9 million, net of investment sales, in marketable securities. During the six months ending December 31, 2010, we received net proceeds of $4.3 million from the sale or maturity of marketable securities, consisting of taxable and tax advantaged securities. In addition, we purchased property and equipment totaling approximately $0.5 million and $0.3 million in the six months ended December 31, 2011 and 2010, respectively. This property consisted primarily of computer hardware and software. We expect that our capital expenditures will be consistent with the prior fiscal year.
In July 2010, we announced the authorization of a $10.0 million stock repurchase plan which became effective on July 27, 2010. During the six months ended December 31, 2011, we repurchased 111,694 shares of common stock at a cost of approximately $0.7 million. Depending on market conditions and other factors, such purchases may be commenced or suspended at any time without prior notice.
During the six months ended December 31, 2011 and 2010, we received approximately $488,000 and $407,000, respectively, in proceeds from the exercise of stock options resulting in the issuance of shares of our common stock of approximately 126,000 and 134,000 for the six-month periods ended December 31, 2011 and 2010, respectively.
On December 31, 2011, we had $37.7 million in working capital, including $41.3 million in cash, cash equivalents and marketable securities.
The majority of our operations are based in the United States and, accordingly, the majority of our transactions are denominated in U.S. Dollars. However, we do have foreign-based operations where transactions are denominated in foreign currencies and are subject to market risk with respect to fluctuations in the relative value of currencies. Currently, we have operations in Japan, Belgium, Germany, France and England and conduct transactions in the local currency of each location. If the U.S. dollar to Japanese yen rate had remained unchanged throughout fiscal 2011, the result would have been a decrease in revenue and operating income of approximately $0.3 million. If the U.S. dollar to euro rate had remained unchanged throughout fiscal 2011, the result would have been an increase in operating income of approximately $0.4 million. We monitor our foreign currency exposure and, from time to time will attempt to reduce our exposure through hedging. The impact of fluctuations in the relative value of all currencies was not material for the six months ended December 31, 2011. Although we do not anticipate any material losses in these risk areas, no assurance can be made that material losses will not be incurred in these areas in the future.
Our management evaluated, with the participation of our chief executive officer and chief financial officer, disclosure controls and procedures as of the end of the period covered by this Report on Form 10-Q. Based on this evaluation, our chief executive officer and chief financial officer have concluded that the Companys disclosure controls and procedures were effective to ensure that information required to be disclosed in the Companys Exchange Act reports is accumulated and communicated to management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within time periods specified in the Securities and Exchange Commission rules and forms.
There have been no changes in the Companys internal controls over financial reporting during the Companys most recent fiscal quarter that have materially affected or are reasonably likely to materially affect, the Companys internal controls over financial reporting.
PART II. OTHER INFORMATION
The company is not a party to any material legal proceeding.
On January 21, 2010, JuxtaComm-Texas Software, LLC (JuxtaComm) filed a complaint (as amended April 22, 2010) in the Eastern District of Texas against 20 defendants, including Pervasive, alleging patent infringement. On May 12, 2011, the United States Patent and Trademark Office (US PTO) issued a Final Office Action rejecting all asserted claims of the patent in question, essentially resulting in the patent being invalid. The various defendants filed various motions to stay litigation on the matter pending completion of all appeal processes JuxtaComm might follow with the US PTO. On December 8, 2011, the Court ordered that this case is Stayed until February 1, 2012. The Court will reset pretrial and trial dates.
The patent in question, United States Patent number 6,195,662 titled System for Transforming and Exchanging Data Between Distributed Heterogeneous Computer Systems, was issued on February 27, 2001 with a filing date of June 26, 1998. Data Junction Corporation, acquired by Pervasive in December 2003, has been in the data integration business since the mid-1980s and sold its data transformation products, which are now being used by Pervasives products, long prior to the filing of the JuxtaComm patent. Additionally, as evidenced by the recent action by the US PTO to reject the claims of the JuxtaComm patent, substantial prior art exists relating to the JuxtaComm patent to point to in our defense. We believe we will prevail either in our contentions that the JuxtaComm patent is invalid or our products do not infringe the patent. Pervasive intends to vigorously defend itself and believes the outcome of this proceeding will not have a material adverse effect on our business, operating results or financial condition.
On September 14, 2010, UnilocUSA, Inc. and Uniloc Singapore Private Ltd. (Uniloc) filed a complaint in the Eastern District of Texas against 12 defendants, including Pervasive, alleging patent infringement. The patent in question, United States Patent number 5,490,216 titled System for Software Registration, was issued on February 6, 1996 (216 Patent). In November a separate complaint was filed against Uniloc by a third party claiming ownership of the 216 Patent and on November 21, 2011, the Court ordered that this case is Stayed until further notice. We believe our products do not infringe the patent. Pervasive intends to vigorously defend itself and believes the outcome of this proceeding will not have a material adverse effect on our business, operating results or financial condition.
You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below are not the only ones we face. Any of the following risks could harm our business, financial condition or results of operations. In such case, trading price of our common stock could decline, and you may lose all or part of your investment.
Our Financial Results May Vary Significantly from Quarter to Quarter
Our operating results have varied significantly from quarter to quarter at times in the past and may continue to vary significantly from quarter to quarter in the future, which could make our future operating results difficult to predict and increase the likelihood that future results may fall below analyst or investor expectations thereby causing our stock price to decline. Such variations are due to a number of factors, many of which are outside our control. These factors include:
We also derive a significant portion of our revenues from relatively large transactions. The sales cycles for these transactions tend to be longer than the sales cycles on smaller orders. This longer sales cycle for large transactions makes it difficult to predict the quarter in which these sales will occur. Accordingly, our operating results may fluctuate from quarter to quarter based on the existence and timing of larger transactions. A reduction in large transactions during any quarter could materially impact our revenues.
Additionally, significant portions of our expenses are not variable in the short term and cannot be quickly reduced to respond to decreases in revenues. Therefore, if our revenues are below our expectations, our operating results are likely to be adversely and disproportionately affected. In addition, we may change our prices, modify our distribution strategy and policies, accelerate our investment in research and development, sales or marketing efforts in response to competitive pressures or pursue new market opportunities. Any one of these activities may further limit our ability to adjust spending in response to revenue fluctuations.
Seasonality May Contribute to Fluctuations in Our Quarterly Operating Results
Our business has, on occasion, experienced seasonal customer buying patterns. In past years, we have generally experienced relatively weaker demand in the quarter ending September 30. Demand for our products in Europe and Japan will generally decline in the summer months because of reduced corporate buying patterns during the vacation season. We believe this pattern may occur in the future and may contribute to fluctuations in our quarterly operating results.
Uncertain Economic Conditions May Harm Our Operating Results
Our revenue and profitability depend on the overall demand for our products and services, which in turn depends on general economic and business conditions. The nature and extent of the effect of the recent adverse economic conditions and the subsequent economic recovery on our ability to sell our products and services is uncertain. A softening of demand for our products and services caused by uncertain economic conditions may result in decreased revenues. In addition, such uncertain economic conditions may impact our customers ability to pay for the products they have purchased and as a consequence, we may not be able to collect our accounts receivable balances and our reserves for doubtful accounts and write-offs of accounts receivable may increase. There can be no assurance we will be able to effectively promote revenue growth rates if the current uncertain economic conditions continue or deteriorate.
We Generally Operate Without a Backlog
We generally operate with virtually no order backlog because our software products are shipped and revenue is recognized shortly after orders are received. This lack of backlog makes product revenues in any quarter unpredictable and substantially dependent on orders booked and shipped throughout that quarter. Accordingly, a material decrease in orders in any quarter could have a materially adverse effect on our revenues and operating results.
Our Performance Depends on Market Acceptance of Pervasive PSQL and Our Integration Products
We derive a substantial portion of our revenues from the license of our Pervasive PSQL® products. Continued market acceptance of Pervasive PSQL may be influenced heavily by factors outside of our control, such as new product offerings or promotions by competitors, mergers and acquisitions of customers and competitors, the product development and deployment cycles of developers and resellers who embed or bundle our products into packaged software applications and demand for applications of the type built on our products. Market acceptance of Pervasive PSQL v11 (first released in September 2010), and future upgrades also may be influenced by factors in our control such as product quality, relative demand for feature and functionality upgrades and any future product announcements or price changes.
Revenue from our embedded database product, Pervasive PSQL, decreased in fiscal year 2011 relative to fiscal years 2009 and 2010. We believe the decrease in 2011 was primarily due to a number of relatively large transactions with database customers in 2009 and 2010. For example, we separately disclosed one relatively large transaction with database customers in each of the last three fiscal years in the amount of $3.0 million, $2.4 million and $0.9 million in fiscal years 2009, 2010 and 2011, respectively. Our embedded database and related products represented approximately 58% of our revenue in fiscal year 2011 and 57% of our revenue in the six months ended December 31, 2011. However, our integration product revenue in fiscal year 2011 grew 9% over fiscal year 2010 and 18% over fiscal year 2009, and represented approximately 38% of total revenue in fiscal year 2011 and 39% of our revenue in the six months ended December 31, 2011. A reduction in our embedded database business or our integration product business, could have a material adverse effect on our business, operating results and financial condition.
Our Efforts to Develop and Maintain Brand Awareness of Our Products May Not be Successful
Brand awareness is important given competition in the market for data infrastructure software products. We are aware of other companies that use the word Pervasive either in their marks alone or in combination with other words. We expect that it may be difficult or impossible to prevent third-party usage of the Pervasive name and variations of this name for competing goods and services. Competitors or others who use marks similar to our brand name may cause confusion among actual and potential customers, which could prevent us from achieving significant brand recognition. If we fail to promote and maintain our brand or incur significant expenses in an unsuccessful attempt to promote or maintain our brand, our business, operating results and financial condition could be materially adversely affected.
We Must Succeed in the Data Management Software Market as Well as the Data Integration Software Market if We are to be Successful
Our long-term strategic plan depends upon the successful development and introduction of products and solutions that address the needs of the data management software market as well as the data integration software market. In order for us to succeed in these markets, we must align strategies and objectives and focus a significant portion of our resources toward serving these markets.
In addition, our success in these markets will depend on several factors, many of which are outside our control including:
If we are unable to succeed in these markets, our business may be harmed.
Defects or Disruptions in Our Ability to Deliver Our Products Across Various Platforms Could Diminish Demand for Our Service and Subject Us to Substantial Liability
As we continue to provide more of our products from third party data hosting platforms, there is the potential for there to be defects or disruptions in our ability to deliver our products to our customers. These potential disruptions could result in unanticipated downtime for our customers and harm our reputation and our business. In addition, our customers may use our service in unanticipated ways that may cause a disruption in service for other customers attempting to access their data. Since our customers use our service for important aspects of their business, any errors, defects, disruptions in service or other performance problems with our service could hurt our reputation and may damage our customers businesses. If that occurs, customers could elect not to renew, or delay or withhold payment to us, we could lose future sales or customers may make warranty or other claims against us, which could result in an increase in our provision for doubtful accounts, an increase in collection cycles for accounts receivable or the expense and risk of litigation.
Interruptions or Delays in Service From Our Third-Party Data Center Hosting Facilities Could Impair the Delivery of Our Service and Harm Our Business
We currently serve some of our customers from third-party data center hosting platforms. Any damage to, or failure of, the third parties systems generally could result in interruptions in our service. Interruptions in our service may reduce our revenue, cause us to issue credits or pay penalties, cause customers to terminate their subscriptions and adversely affect our renewal rates and our ability to attract new customers. Our business will also be harmed if our customers and potential customers believe our service is unreliable.
If Our Security Measures Are Breached and Unauthorized Access is Obtained to a Customers Data or Our Data, Our Service May be Perceived as not Being Secure and We May Incur Significant Legal and Financial Exposure and Liabilities
While we have derived the majority of our historical revenues from on premise delivery of our products, we are increasingly offering our products on third party hosted platforms. This method of delivery of our products involves the storage and transmission of customers proprietary information, and security breaches could expose us to a risk of loss of this information, litigation and possible liability. These security measures may be breached as a result of third-party action,
employee error, malfeasance or otherwise, during transfer of data to additional data centers or at any time, and result in someone obtaining unauthorized access to our data or our customers data. If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise, and someone obtains unauthorized access to our customers data, we could incur significant liability to our customers or significant fines and sanctions by processing networks or governmental bodies, any of which could result in harm to our business and damage to our reputation.
We May Face Problems in Connection With Past Acquisitions, Joint Ventures or Licensing Arrangements
On July 31, 2009, we announced the completion of our purchase of assets of Greenville, South Carolina-based ChanneLinx, Inc. for total consideration of approximately $2.6 million in cash. We cannot be certain we will ultimately realize all of the anticipated benefits of this acquisition.
On December 8, 2003 we announced the completion of our acquisition of privately held Data Junction Corporation, a pioneering data and application integration company based in Austin, Texas, for approximately $16.6 million in cash, net of $6.5 million of cash held by Data Junction at the time of closing of the transaction, and 5 million shares of our common stock. We cannot be certain we will ultimately realize all of the anticipated benefits of the acquisition. In particular we may not realize the strategic and operational benefits we had anticipated, including greater revenue and market opportunities, maintaining industry leadership and consistent profitability.
In July 2001, we formed a business venture with AG-TECH Corporation, a company developing, selling and importing packaged software, to sell and support certain of our products in Japan. AG-TECH has been engaged in the sales and support of Btrieve (predecessor to Pervasive PSQL) and Pervasive PSQL products since 1986. In conjunction with the joint venture, AG-TECH launched a new operating division staffed with specialists experienced in selling and supporting Pervasive PSQL to assume responsibility for OEM sales, packaged software sales, technical support and localization and translation of our products into Japanese. In connection with the new business venture, we obtained a less than 20% ownership interest in AG-TECH and the ability to elect one director to the AG-TECH Board of Directors. While this venture has been successful to date, we cannot be certain that this venture will continue to be successful, which could result in our inability to successfully operate in Japan. In addition, as part of our venture, we executed a three year master distributor agreement with AG-TECH, the initial term of which expired June 30, 2004. This agreement has been renewed three times, most recently for an additional three-year term which expires June 30, 2015. We cannot be certain that we will continue to be able to renew our agreement with AG-TECH on terms and conditions at least as favorable to Pervasive as those contained in our present agreement.
We May Face Problems in Connection With Future Acquisitions, Joint Ventures or Licensing Agreements
In the future, we may acquire additional businesses, products and technologies, or enter into joint venture or licensing arrangements, that could complement, modify or expand our business. Our negotiations of potential acquisitions or joint ventures and our integration of acquired businesses, products or technologies could divert management time and resources. Any future acquisitions could require us to issue dilutive equity securities, reduce our cash and marketable securities, incur debt or contingent liabilities, amortize intangibles, or write-off purchased research and development and other acquisition-related expenses. If we are unable to fully integrate acquired businesses, products or technologies with our existing operations, we may not receive the intended benefits of acquisitions. In addition, market reactions to acquisitions are difficult to predict and if we do announce any future acquisitions, such market reactions may cause our stock price to fluctuate.
If Our Goodwill or Amortizable Intangible Assets Become Impaired We May Be Required to Record a Significant Charge to Earnings
Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is tested for impairment at least annually. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively impacting our results of operations.
We May Face Problems in Connection With Product Line Expansion
In the future, we may acquire, license or develop additional products. Future product line expansion may require us to modify or expand our business and expend significant time and resources. If we are unable to fully integrate new products with our existing operations, we may not receive the intended benefits of such product line expansion and related expenditures.
A Small Number of Distributors and Sales Related to Accounting Software Applications Account for a Significant Percentage of Our Revenues
The loss of a major distributor, changes in a distributors payment practices, changes in the financial stability of a major distributor or any reduction in orders by such distributor, including reductions due to market or competitive conditions, combined with the potential inability to replace the distributor on a timely basis, or any modifications to our pricing or distribution channel strategy could materially adversely affect our business, operating results and financial condition. Many of our ISVs, VARs and end users place their orders through distributors. A relatively small number of distributors have accounted for a significant percentage of our revenues. In the fiscal year ended June 30, 2011, one distributor (our joint venture partner in Japan, AG-TECH Corporation) accounted for an aggregate of approximately 11% of our revenues, as compared to 11% in the fiscal year ended June 30, 2010. Additionally, sales related to accounting software applications has, at various times, represented as much as 20% of our revenues. Furthermore, there has been consolidation taking place among our ISVs that could narrow the number of customers who sell our products. For example, one of our ISVs, The Sage Group plc, has acquired Timberline Software Corporation, Softline Limited, ACCPAC International Inc., Sage Sesame and TAS Software, five of our ISVs. The Sage Group family of companies has, at various times, represented approximately 10% of our revenues. As a result, we expect we will continue to depend on a limited number of distributors, certain of our ISV customers and sales related to accounting software applications for a significant portion of our revenues in future periods and the loss of a significant distributor or ISV customer could materially adversely affect our business, operating results and financial condition. Moreover, we expect that such distributors and sales related to accounting software applications will vary from period to period and may be impacted by recent events in Japan. Our distributors have not agreed to any minimum order requirements. Although we forecast demand and plan accordingly, if a distributor purchases excess product, we may be obligated to accept the return of some products.
Our Business Operations Could Be Negatively Impacted by the Aftereffects of the Tohoku Pacific Earthquake and Its Impact on Japan
The recent Japanese earthquake and resulting tsunami may affect our business operations. Our Japanese joint venture, AG-TECH, is located in Tokyo and operations have been relatively unaffected. However, there can be no assurances that future operations and revenue may not be seriously affected. The disaster in Japan may also result in a downturn in the Japanese economy as a whole. These occurring or potential events may seriously damage our ability to conduct business in Japan or, in the worst case, cause operations in Japan to completely cease with our business suffering a material downturn.
We Depend on Our Indirect Sales Channel
Our failure to grow our indirect sales channel or the loss of a significant number of members of our indirect channel partners would have a material adverse effect on our business, financial condition and operating results. We derive a substantial portion of our revenues from indirect sales through a channel consisting of ISVs, VARs, SIs, consultants and distributors. Our sales channel could be adversely affected by a number of factors, many of which are outside of our control, including:
We cannot be certain we will be able to continue to attract additional indirect channel partners or retain our current channel partners. In addition, we cannot be certain our competitors will not attempt to recruit certain of our current or future channel partners. Such competitive actions may have an adverse effect on our ability to attract and retain channel partners, which, in turn, may have a material adverse effect on our business, financial condition and operating results.
We May Not Be Able to Sustain or Develop Strategic Relationships
From time to time, we enter into strategic collaborative relationships with other companies in areas such as product development, marketing, distribution and implementation, which allow us to realize a variety of benefits. Many of our current strategic relationships are informal, or, if written, terminable with little or no notice. Additionally, many of our current and potential strategic partners are either actual or potential competitors with us. For these reasons, we may not be able to sustain our current strategic relationships or enter into successful new strategic relationships in the future, which could have a material adverse effect on our business, operating results and financial condition.
We Depend on Third-Party Technology in Our Products
We rely upon certain software we license from third parties, including software integrated with our internally developed software and used in our products to perform key functions. These third-party software licenses may not continue to be available to us on commercially reasonable terms. The loss of, or inability to maintain or obtain any of these software licenses, could result in product development or shipment delays or the loss or deferral of revenues until we develop, identify, license and integrate equivalent software. Any delay in product development or shipment could damage our business, operating results and financial condition.
We May be Unable to Protect Our Intellectual Property and Proprietary Rights
Our success depends to a significant degree upon our ability to protect our software and other proprietary technology. We rely primarily on a combination of copyright, trademark and trade secret laws, confidentiality procedures and contractual provisions to protect our proprietary rights. However, these measures afford us only limited protection. In addition, we rely in part on shrink wrap and click wrap licenses that are not signed by the end user and, therefore, may be unenforceable under the laws of certain jurisdictions. Therefore, our efforts to protect our intellectual property may not be adequate. We cannot be certain that others will not develop technologies that are similar or superior to our technology or design around the copyrights and trade secrets owned by us. Unauthorized parties may attempt to copy aspects of our products or to obtain and use information we regard as proprietary. Although we believe software piracy may be a problem, we are unable to determine the extent to which piracy of our software products occurs. In addition, portions of our source code have been developed in foreign countries, such as in India where we have used third-party service providers, with laws that do not protect our proprietary rights to the same extent as the laws of the United States.
We may be subjected to claims of intellectual property infringement by third parties as the number of products and competitors in our industry segment continues to grow and the functionality of products in different industry segments increasingly overlaps. Any infringement claims, with or without merit, could be time-consuming, result in costly litigation, divert management attention and resources, cause product shipment delays or the loss or deferral of sales or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In the event of a successful claim of intellectual property infringement against us, should we fail or be unable to either license the technology or similar technology or develop alternative technology on a timely basis, our business, operating results and financial condition could be materially adversely affected.
We Must Adapt to Rapid Technological Change
Our future success will depend upon our ability to continue to enhance our current products and to develop and introduce new products on a timely basis that keep pace with technological developments and new industry standards and satisfy increasingly sophisticated customer requirements. Rapid technological change, frequent new product introductions and enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards characterize the market for our products. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. As a result of the complexities inherent in client/server and Web computing environments and in data and application integration solutions, and the performance demanded by customers for data infrastructure software products, new products and product enhancements can require long development and testing periods. As a result, significant delays in the general availability of such new releases or significant problems in the installation or implementation of such new releases could have a material adverse effect on our business, operating results and financial condition. We have experienced delays in the past in the release of new products and new product enhancements. In the future, we may not be successful in developing and marketing, on a timely and cost-effective basis, new products or new product enhancements that respond to technological change, evolving industry standards or customer requirements, avoiding difficulties that could delay or prevent the successful development, introduction or marketing of these products, or achieving market acceptance for our new products and product enhancements, any of which could have a material adverse effect on our business, operating results and financial condition.
Our Software May Contain Errors or Defects
Software products such as ours may contain errors, sometimes called bugs, particularly when first introduced or when new versions or enhancements are released. From time to time, we discover software errors in certain of our new products after their introduction. Despite our testing, current versions, new versions or enhancements of our products may still have errors after commencement of commercial shipments. Errors or defects in our products may result in loss of revenues, delay in market acceptance, diversion of development resources or injury to our brand and reputation and could materially adversely affect our business, operating results and financial condition.
We May Become Subject to Product or Professional Services Liability Claims
A product or professional services liability claim, whether or not successful, could damage our reputation and our business, operating results and financial condition. Our license and service agreements with our customers typically contain provisions designed to limit our exposure to potential product or service liability claims. However, these contract provisions may not preclude all potential claims. Product or professional services liability claims could require us to spend significant time and money in litigation or to pay significant damages.
We Compete with Microsoft while Simultaneously Supporting Microsoft Technologies
We currently compete with Microsoft in the market for data management products while simultaneously maintaining a working relationship with Microsoft. Microsoft has a longer operating history, a larger installed base of customers and substantially greater financial, distribution, marketing and technical resources than us. As a result, we may not be able to compete effectively with Microsoft now or in the future, and our business, operating results and financial condition may be materially adversely affected.
We expect that Microsofts commitment to and presence in the data management products market will continue to assert competitive pressure. We believe that Microsoft will continue to incorporate SQL Server database technology into its operating system software and certain of its server software offerings, possibly at no additional cost to its users. Microsoft currently licenses a royalty-free limited version of its SQL Server database technology. We believe that Microsoft will also continue to enhance its SQL Server database technology and that Microsoft will continue to invest in various sales and marketing programs involving certain of our channel partners.
In addition, Microsoft has grown its presence in the software applications market. For example, they acquired Great Plains Software, a former channel partner of Pervasive, and Navision, both of which are accounting software vendors. Microsoft has also entered the customer relationship management software market. We believe that Microsoft will continue
to grow its presence in the software applications market and in doing so, may have a negative impact on the financial stability of other software application vendors who use our products, or may influence other software application vendors to use Microsoft infrastructure software products instead of those available from us.
We believe we must maintain a working relationship with Microsoft to achieve success. Many of our customers use Microsoft-based operating platforms. Thus, it is critical to our success that our products be closely integrated with Microsoft technologies. Notwithstanding our historical and current support of Microsoft platforms, Microsoft may in the future promote technologies and standards more directly competitive with or not compatible with our technology.
We Face Significant Competition From Other Companies
We encounter competition for our embedded database products primarily from large, public companies, including Microsoft, Oracle, Sybase/SAP, IBM and Progress. In particular, Sybases small memory footprint database software product, Adaptive Server Anywhere, and Microsofts product, SQL Server, directly compete with our products.
The market for our integration products is highly competitive and subject to rapidly changing technology. We often compete against custom code, where potential customers have sufficient internal technical resources to develop solutions in-house. In addition, we face competition from vendors of ETL (extract, transform and load), data warehousing and application integration software products. Such competitors include IBM, Oracle, Business Objects/SAP, Informatica, and Information Builders, as well as niche vendors in specific verticals and the SaaS marketplace. In addition, we compete or may compete against database vendors that currently offer, or may develop, products with functionalities that compete with our integration solutions. These products typically operate specifically with these competitors proprietary databases. Such competitors include IBM, Microsoft, Sybase/SAP and Oracle. And, because there are relatively low barriers to entry in the software market, we may encounter additional competition from other established or emerging companies providing integration products based on existing, new or open-source technologies.
Open-source software, which is an emerging trend in the software marketplace, may impact our business as interest, demand and use increases in the database and integration segments and poses a challenge to our business model. Firms adopting the open-source software model typically provide customers software produced by loosely associated groups of unpaid programmers, make licenses available to end users at nominal cost, and earn revenue on complementary services and products, without having to bear the full costs of research and development for the open-source software. To the extent competing open-source software products gain increasing market acceptance, sale of our products may decline, we may have to reduce prices we charge for our products, and our revenue and operating margins may decline. Mass adoption of open source databases in the SME market could have a material adverse impact on our database business.
Software-as-a-Service (SaaS) vendors have and may continue to enter our market and could cause a change in revenue models from licensing of client/server and Web-based applications to renting applications. Our competitors may be more successful than we are in adopting these revenue models and capturing related market share.
Most of our competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers. In addition, some competitors have demonstrated a willingness to, or may willingly in the future, incur substantial losses as a result of deeply discounted product offerings or aggressive marketing campaigns. For example, Microsoft, Oracle, IBM and Sybase all currently license royalty-free limited versions of their database technologies. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of competitive products, than we can. There is also a substantial risk that changes in licensing models or announcements of competing products by competitors such as Microsoft, Oracle, Sybase/SAP, IBM, Progress, MySQL/Oracle, Ascential/IBM, Cast Iron/IBM, Boomi/Dell, Business Objects/SAP, Informatica, Information Builders or others could result in the cancellation of customer orders in anticipation of the introduction of such new licensing models or products. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address customer needs, which may limit our
ability to sell our products through particular partners. Accordingly, new competitors or alliances among, or consolidations of, current and new competitors may emerge and rapidly gain significant market share in our current or anticipated markets. We also expect competition will increase as a result of software industry consolidation. Increased competition is likely to result in price reductions, fewer customer orders, reduced margins and loss of market share, any of which could materially adversely affect our business, operating results and financial condition. We cannot be certain we will be able to compete successfully against current and future competitors or that the competitive pressures we face will not materially adversely affect our business, operating results and financial condition.
We are Susceptible to a Shift in the Market for Client/Server Applications Toward Web-Based or Hosted Applications
We have derived substantially all of our historical embedded database product revenues from the use of our products in client/server applications. We expect to rely on continued market demand for client/server applications indefinitely. However, we believe market demand may shift from client/server applications to Web-based or hosted applications. If so, we cannot be certain our existing client/server developers will migrate to Web-based or hosted applications and continue to use our products or that other developers of Web-based or hosted applications would select our data management products. In addition, this shift could result in a change in revenue models from licensing of client/server applications to subscriptions of Web-based or hosted applications from SaaS vendors. A decrease in client/server application sales coupled with an inability to derive revenues from the Web-based or hosted application market could have a material adverse effect on our business, operating results and financial condition.
We Depend on International Sales and Operations
We anticipate for the foreseeable future we will derive a significant portion of our revenues from sources outside North America. In the fiscal year ended June 30, 2011, we derived 34% of our revenues outside North America. Our international operations are generally subject to a number of risks. These risks include:
We may expand or modify our operations internationally. Despite our efforts, we may not be able to expand or modify our operations internationally in a timely and cost-effective manner. Such an outcome would limit or eliminate any sales growth internationally, which in turn would materially adversely affect our business, operating results and financial condition. Even if we successfully expand or modify our international operations, we may be unable to maintain or increase international market demand for our product.
We expect our international operations will continue to place financial and administrative demands on us, including operational complexity associated with international facilities, administrative burdens associated with managing relationships with foreign partners, and treasury functions to manage foreign currency risks and collections.
Fluctuations in the Relative Value of Foreign Currencies Can Affect Our Business
To date, the majority of our transactions have been denominated in U.S. dollars. The majority of our international operating expenses and substantially all of our sales in Japan have been denominated in currencies other than the U.S. dollar. Therefore, our operating results may be adversely affected by changes in the relative value of the U.S. dollar. Certain of our international sales are denominated in U.S dollars, especially in Europe. Any strengthening of the U.S. dollar against the currencies of countries where we sell products denominated in U.S. dollars will increase the relative cost of our products and could negatively impact our sales in those countries. To the extent our international operations expand or are modified, our exposure to exchange rate fluctuations may increase. We have, on occasion, entered into limited hedging transactions to mitigate our exposure to currency fluctuations. Despite these hedging transactions, exchange rate fluctuations have caused, and will continue to cause, currency transaction gains and losses. Although these transactions have not resulted in material gains and losses to date, similar transactions could have a damaging effect on our business, results of operations or financial condition in future periods.
We Must Continue to Hire and Retain Skilled Personnel
Our success depends in large part on our ability to attract, motivate and retain highly skilled employees on a timely basis, particularly executive management, sales and marketing personnel, software engineers and other senior personnel. Our efforts to attract and retain highly skilled employees could be harmed by our past or any future workforce reductions. Our failure to attract and retain the highly trained technical personnel who are essential to our product development, marketing, service and support teams may limit the rate at which we can generate revenue and develop new products or product enhancements. This could have a material adverse effect on our business, operating results and financial condition.
We issue stock options and restricted stock as key components of our overall compensation. There is pressure on public companies from shareholders generally and various organizations to reduce the rate at which companies issue stock options and restricted stock to employees, which may make it more difficult to obtain shareholder approval of equity compensation plans when required. In addition, we believe expensing stock options and restricted stock will increase shareholder pressure to limit future grants and could make it more difficult for us to grant stock options and restricted stock to employees in the future. As a result, we may lose top employees to non-public, start-up companies or may generally find it more difficult to attract, retain and motivate highly skilled employees, either of which could materially and adversely affect our business, results of operations and financial condition.
We Have Anti-Takeover Provisions
Our Restated Certificate of Incorporation and Amended and Restated Bylaws contain certain provisions that may have the effect of discouraging, delaying or preventing a change in control or unsolicited acquisition proposals that a stockholder might consider favorable. These provisions include provisions to authorize the issuance of blank check preferred stock, establish advance notice requirements for stockholder nominations for elections to the Board of Directors or for proposing matters that can be acted upon at stockholders meetings; eliminate the ability of stockholders to act by written consent; require super-majority voting to approve certain amendments to the Restated Certificate of Incorporation; limit the persons who may call special meetings of stockholders; and provide for a Board of Directors with staggered, three-year terms. In addition, certain provisions of Delaware law and our 1997 Stock Incentive Plan and our 2006 Equity Incentive Plan may also have the effect of discouraging, delaying or preventing a change in control or unsolicited acquisition proposals.
We May Elect to Raise Additional Capital Which Might Not Be Available or Which, if Available, May Be on Terms That Are Not Favorable to Us
We may elect to raise additional funds, and we cannot be certain we will be able to obtain additional financing on favorable terms, if at all. If we issue equity securities, the ownership percentage of our stockholders would be reduced, and the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. If we borrow money, we may incur significant interest charges, which could harm our profitability. Holders of debt would also have rights, preferences or privileges senior to those of existing holders of our common stock. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our product, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could seriously harm our business, operating results and financial condition.
The Price of Our Stock Has Been Volatile and Could Continue to Fluctuate Substantially
Our common stock is traded in the NASDAQ Global Market. The market price of our common stock has been volatile and could fluctuate substantially based on a variety of factors outside of our control, in addition to our financial performance. Furthermore, stock prices for many companies, including our own, fluctuate widely for reasons that may be unrelated to operating results.
During the twenty-three fiscal quarters ending December 31, 2011, the Company has acquired approximately 10.3 million shares of its common stock on the open market at a total cost of approximately $45.1 million, or approximately $4.33 price per share. The Companys Board of Directors approved a new stock repurchase plan effective July 27, 2010, whereby the Company may repurchase additional shares of its common stock with a value of up to $10 million, of which approximately $2.6 million remains available as of December 31, 2011. Depending on market conditions and other factors, such purchases may be commenced or suspended at any time without prior notice. There can be no assurance that we will continue to buy any of our common stock under our share repurchase program or that any past or future repurchases will have a positive impact on our stock price. Important factors that could cause us to discontinue our share repurchases include, among others, unfavorable market conditions, the market price of our common stock, the nature of other investment opportunities presented to us from time to time, and the availability of funds necessary to continue purchasing common stock.
We May Be Exposed to Potential Risks if We Do Not Have an Effective System of Disclosure Controls or Internal Controls or Fail on an On-going Basis to Properly Address and Implement Section 404 of Sarbanes-Oxley
We must comply, on an on-going basis, with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (SOX), including those provisions that establish the requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting. If we fail to maintain an effective system of disclosure controls or internal control over financial reporting, including satisfaction of the requirements of Section 404 of SOX, we may not be able to accurately or timely report on our financial results or adequately identify and reduce the likelihood of fraud. Additionally, if we were to identify any material weakness over our internal control over financial reporting, we also cannot ensure that we could correct any such material weakness to allow our management to conclude that our internal controls over financial reporting are effective in time to enable our independent registered public accounting firm to attest that such assessment will have been fairly stated in any report to be filed with the SEC or attest that we have maintained effective internal control over financial reporting. As a result, the financial position of our business could be harmed; current and potential future shareholders could lose confidence in us and/or our reported financial results, which may cause a negative effect on our trading price; and we could be exposed to litigation or regulatory proceedings, which may be costly or divert management attention.
Our Reported Financial Results May be Adversely Affected by New Accounting Pronouncements or Changes in Existing Accounting Standards and Practices
We prepare our financial statements in conformity with accounting principles generally accepted in the U.S. These accounting principles are subject to interpretation by the Financial Accounting Standards Board (FASB), the SEC and various organizations formed to interpret and create appropriate accounting standards and practices. New accounting pronouncements and varying interpretations of accounting standards and practices have occurred and may occur in the future. New accounting pronouncements or a change in the interpretation of existing accounting standards or practices may have a significant effect on our reported financial results and may even affect our reporting of transactions completed before the change is announced or effective.
In July 2010, we announced the authorization of a new $10.0 million stock repurchase plan which became effective on July 27, 2010. During the three months ended December 31, 2011, we repurchased 82,134 shares of common stock at a cost of approximately $0.5 million under the stock repurchase plan approved on July 27, 2010. The transactions occurred in open market purchases. The repurchase program may be suspended or discontinued at any time without prior notice.
There have been no material changes to the procedures by which stockholders may recommend nominees to the Companys Board of Directors.
(a) Exhibits under Item 601 of Regulation S-K
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.