===============================================================================
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________ to ___________.
COMMISSION FILE NUMBER 0-27084
CITRIX SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2275152
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
6400 N. W. 6TH WAY
FORT LAUDERDALE, FLORIDA
(Address of principal executive offices) 33309
(Zip Code)
Registrant's telephone number, including area code: (954) 267-3000
Not Applicable
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Former Name, Former Address and Former Fiscal Year if Changed Since Last Report.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
As of November 6, 1998 there were 42,644,898 shares of the registrant's
Common Stock, $.001 par value per share, outstanding.
Total Number of Pages: 31
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CITRIX SYSTEMS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
CONTENTS
Page Number
-----------
PART I: FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets:
September 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Income:
Three Months and Nine Months ended September 30,
1998 and 1997 5
Condensed Consolidated Statements of Cash Flows:
Nine Months Ended September 30, 1998 and 1997 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
PART II: OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
Exhibit Index 27
Exhibit 3,4 28
Exhibit 27.1 30
Exhibit 27.2 31
2
PART I: FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CITRIX SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
1998 1997
---------------------------------
ASSETS
Current assets:
Cash and cash equivalents $133,117,973 $140,080,550
Short-term investments 84,942,267 89,111,093
Trade receivables, net of allowances of $6,801,453 and
$6,297,986 at September 30, 1998 and December 31, 1997,
respectively 33,149,929 12,631,413
Inventories 4,346,815 2,273,196
Prepaid expenses 4,869,089 3,497,890
Current portion of deferred tax assets 29,697,309 10,767,437
--------------------------------
Total current assets 290,123,382 258,361,579
Property and equipment, net 14,130,563 6,678,253
Long-term portion of deferred tax assets 25,275,540 16,763,680
Intangible assets, net 8,872,230 864,513
--------------------------------
$338,401,715 $282,668,025
================================
Continued on following page.
3
CITRIX SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
1998 1997
---------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,948,783 $ 984,463
Accrued royalties and other accounts payable to stockholder 2,563,646 3,043,836
Acquisition related liabilities 822,184 1,312,569
Other accrued expenses 20,385,192 11,712,378
Deferred revenue 7,068,172 3,147,220
Current portion of deferred revenues on contract with stockholder 29,523,809 15,000,000
Current portion of capital lease obligations payable 9,188 8,396
Income taxes payable 3,624,027 236,410
---------------------------------
Total current liabilities 66,945,001 35,445,272
Long-term liabilities:
Capital lease obligations payable 179,336 -
Deferred revenues on contract with stockholder 39,125,000 50,375,000
---------------------------------
Total long-term liabilities 39,304,336 50,375,000
Stockholders' equity:
Preferred stock at $.01 par value--5,000,000 shares authorized, none
issued and outstanding at September 30, 1998 and December 31, 1997 - -
Common stock at $.001 par value--150,000,000 and 60,000,000 shares
authorized; and 42,432,203 and 41,473,088 issued and outstanding at
September 30, 1998 and December 31, 1997, respectively 42,432 41,473
Additional paid-in capital 171,961,275 148,747,326
Retained earnings 60,148,671 48,058,954
---------------------------------
Total stockholders' equity 232,152,378 196,847,753
---------------------------------
$338,401,715 $282,668,025
=================================
See accompanying notes.
4
CITRIX SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------------------
1998 1997 1998 1997
----------------------------------------------------
Revenues
Net revenues from unrelated parties $57,612,659 $31,191,160 $151,400,612 $75,103,914
Net revenues - stockholder 10,008,504 3,750,000 21,726,191 5,875,000
--------------------------------------------------------
Net revenues 67,621,163 34,941,160 173,126,803 80,978,914
Cost of revenues
Cost of revenues from unrelated parties 3,288,008 3,441,412 10,590,486 7,925,792
Cost of revenues - stockholder 620,630 - 2,848,150 -
--------------------------------------------------------
Total cost of revenues 3,908,638 3,441,412 13,438,636 7,925,792
--------------------------------------------------------
Gross margin 63,712,525 31,499,748 159,688,167 73,053,122
Operating expenses
Research and development 8,829,664 1,656,414 16,614,241 4,791,791
Sales, marketing and support 20,115,714 9,515,451 53,613,860 23,193,930
General and administrative 5,456,826 3,035,646 13,407,009 6,943,914
In-process research and development 7,200,000 - 64,796,995 -
--------------------------------------------------------
Total operating expenses 41,602,204 14,207,511 148,432,105 34,929,635
--------------------------------------------------------
Income from operations 22,110,321 17,292,237 11,256,062 38,123,487
Interest income, net 2,414,690 3,134,839 7,634,120 6,978,021
--------------------------------------------------------
Income before income taxes 24,525,011 20,427,076 18,890,182 45,101,508
Income taxes provision 8,822,852 7,353,748 6,800,465 16,236,543
--------------------------------------------------------
Net income $15,702,159 $13,073,328 $ 12,089,717 $28,864,965
========================================================
Earnings per common share:
Basic earnings per share $ 0.37 $ 0.32 $ 0.29 $ 0.71
========================================================
Weighted average shares outstanding 42,218,841 41,003,745 41,907,043 40,689,777
========================================================
Earnings per common share assuming dilution:
Diluted earnings per share $ 0.34 $ 0.30 $ 0.27 $ 0.66
========================================================
Weighted average shares outstanding 45,908,840 44,097,527 45,362,626 43,668,287
========================================================
See accompanying notes.
5
CITRIX SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1998 1997
------------------------
Operating activities
Net income $ 12,089,717 $ 28,864,965
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 6,338,635 1,012,578
Provision for doubtful accounts and product returns 503,466 4,177,772
Tax benefit related to the exercise of non-statutory stock options and
disqualified dispositions of incentive stock options 14,698,308 3,406,613
Deferred tax assets (27,441,732) (25,305,333)
In-process research and development 64,796,995 -
Changes in operating assets and liabilities, net of acquisitions:
Trade receivables (20,579,089) (7,213,449)
Inventories (2,073,619) (661,531)
Prepaid expenses (440,484) (288,922)
Deferred revenue 3,920,952 863,093
Deferred revenue on contract with stockholder 3,273,809 69,125,000
Accounts payable 1,562,348 (175,842)
Accrued royalties and other accounts payable to stockholder (480,190) 1,309,477
Income taxes payable 3,387,617 6,520,870
Other accrued expenses 842,564 4,617,665
---------------------------
Net cash provided by operating activities 60,399,297 86,252,956
INVESTING ACTIVITIES
Purchases of short-term investments (155,127,907) (71,775,345)
Proceeds from sale of short-term investments 159,296,733 38,167,404
Cash paid for acquisitions (63,449,474) -
Cash paid for licensing agreement (5,375,000) -
Purchases of property and equipment (11,194,787) (3,464,901)
---------------------------
Net cash used in investing activities (75,850,435) (37,072,842)
FINANCING ACTIVITIES
Net proceeds from issuance of common stock 8,516,600 815,560
Repurchase of common stock previously issued - (902)
Payments on capital lease obligations (28,039) (75,290)
---------------------------
Net cash provided by financing activities 8,488,561 739,368
Increase/(Decrease) in cash and cash equivalents (6,962,577) 49,919,482
Cash and cash equivalents at beginning of period 140,080,550 99,135,049
---------------------------
Cash and cash equivalents at end of period $ 133,117,973 $149,054,531
===========================
See accompanying notes.
6
Citrix Systems, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1998
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. All
adjustments which, in the opinion of management, are considered necessary for a
fair presentation of the results of operations for the periods shown are of a
normal recurring nature and have been reflected in the unaudited condensed
consolidated financial statements. The results of operations for the periods
presented are not necessarily indicative of the results expected for the full
fiscal year or for any future period. The information included in these
unaudited condensed consolidated financial statements should be read in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations herein and the consolidated financial statements and
accompanying notes included in the Citrix Systems, Inc. (the Company) Annual
Report on Form 10-K for the fiscal year ended December 31, 1997.
2. USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the condensed consolidated financial statements
and accompanying notes. While the Company believes that such estimates are fair
when considered in conjunction with the condensed consolidated financial
position and results of operations taken as a whole, the actual amount of such
estimates, when known, may vary from these estimates.
3. REVENUE RECOGNITION
In October 1997, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 97-2, "Software Revenue Recognition," which
the Company has adopted for transactions entered during the year beginning
January 1, 1998. SOP 97-2 provides guidance for recognizing revenue on software
transactions and supersedes SOP 91-1, "Software Revenue Recognition." In March
1998, the AICPA issued SOP 98-4, "Deferral of the Effective Date of a Provision
of SOP 97-2, Software Revenue Recognition." SOP 98-4 defers, for one year, the
application of certain passages in SOP 97-2 which limit what is considered
vendor-specific objective evidence necessary to recognize revenue for software
licenses in multiple-element arrangements when undelivered elements exist.
Additional guidance is expected to be provided prior to adoption of the deferred
provision of SOP 97-2. The Company will determine the impact, if any, the
additional guidance will have on current revenue recognition practices when
issued. Adoption of the remaining provisions of SOP 97-2 did not have a material
impact on revenue recognition during the first three quarters of 1998.
7
4. ACQUISITIONS AND LICENSED TECHNOLOGY
During 1998 the Company completed the acquisition and licensing of certain in-
process software technologies as detailed in the table below. The
transactions involving Insignia Solutions, plc ("Insignia") and APM Limited
("APM/Digitivity") were subject to independent valuation appraisals, while the
transactions involving EPiCON, Inc. ("EPiCON") and VDOnet Corporation, Ltd.
("VDOnet") were based on internal valuation studies. Based on these valuations,
each transaction resulted in a portion of the purchase price being allocated to
in-process research and development, which had not reached technological
feasibility and had no alternative future use. Purchase price allocations
relating to these 1998 transactions are based on estimated amounts. Final
amounts may vary from these estimates based on the completion of related
allocation studies.
COST IN-PROCESS R&D NATURE OF
DATE NAME (IN THOUSANDS) (IN THOUSANDS) TRANSACTION
- ---- ---- -------------- --------------- -----------
January 1998 EPiCON, Inc. $ 8,000 $ 7,850 License of certain
technology
February 1998 Insignia Solutions, $17,500 $15,950 Acquisition of
plc. certain in-process
technologies and
assets
June 1998 APM Limited. $40,350 $33,797 Acquisition of all
the outstanding
securities
July 1998 VDOnet $ 7,900 $ 7,200 Acquisition of
Corporation,Ltd certain technologies
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Certain Factors Which May Affect Future Results--Uncertainty as to
IPRD Valuation."
5. EARNINGS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings Per Share." Statement 128 replaced the calculation of primary and
fully diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where appropriate, restated to
conform to the Statement No. 128 requirements. All common share and per share
data have been retroactively adjusted to reflect the three-for-two stock split
in the form of a stock dividend paid on February 20, 1998, which stock dividend
was paid to stockholders of record as of February 12, 1998.
8
The following table sets forth the computation of basic and diluted earnings
per share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------
1998 1997 1998 1997
------------------------------------------------------
Numerator:
Net income $15,702,159 $13,073,328 $12,089,717 $28,864,965
=========== =========== =========== ===========
Denominator:
Denominator for basic earnings per share
weighted average shares 42,218,841 41,003,745 41,907,043 40,689,777
Effect of dilutive securities:
Employee stock options 3,689,999 3,093,782 3,455,583 2,978,510
----------- ----------- ----------- -----------
Dilutive potential common shares 3,689,999 3,093,782 3,455,583 2,978,510
----------- ----------- ----------- -----------
Denominator for diluted earnings per share
adjusted weighted-average shares 45,908,840 44,097,527 45,362,626 43,668,287
=========== =========== =========== ===========
Basic earnings per share $ 0.37 $ 0.32 $ 0.29 $ 0.71
=========== =========== =========== ===========
Diluted earnings per share $ 0.34 $ 0.30 $ 0.27 $ 0.66
=========== =========== =========== ===========
7. RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to current
period presentation.
8. LEGAL MATTERS
The Company received a letter dated February 25, 1998 from a third party
alleging that certain technology incorporated in the Company's WinFrame product
line may infringe a patent held by the third party, and requesting that the
Company contact the third party to discuss a licensing arrangement for such
patent. The Company believes that its existing products do not infringe the
patent held by the third party. There can be no assurance that the Company would
prevail in the defense of an infringement claim, if made, or that the Company
could obtain a license to the patent on a reasonable basis, if at all. Any
patent dispute or litigation, or any royalty-bearing license, could have a
material adverse effect on the Company's business, financial condition or
results of operations.
In addition, the Company may from time to time be a party to legal claims
arising in the ordinary course of business. The Company believes the ultimate
resolution of such claims will not have a material adverse effect on its
financial position, results of operations or cash flows.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company develops, markets, sells and supports innovative client and
application server software that enables effective and efficient deployment of
enterprise applications that is designed for Microsoft Windows operating
systems. The Company was incorporated in April 1989, and shipped its initial
products in 1991.
From its introduction in the second quarter of 1993 through the second
quarter of 1995, the Company's WinView product represented the largest source of
the Company's revenues. The Company began shipping its WinFrame product in final
form in the third quarter of 1995 and MetaFrame(TM) in the second quarter of
1998, and these products, together with their related options, have been the
largest source of the Company's revenue.
On May 9, 1997, the Company and Microsoft Corporation ("Microsoft") entered
into a License, Development and Marketing Agreement, as amended (the
"Development Agreement"), which provides for the licensing to Microsoft of
certain of the Company's multi-user software enhancements to Microsoft's Windows
NT Server and for the cooperation between the parties for the development of
certain future multi-user versions of Microsoft Windows NT Server, called
Windows NT Server Terminal Server Edition. The Development Agreement also
provides for each party to develop its own enhancements or "plug-ins" to the
jointly developed products which may provide access to the Windows NT Server
Terminal Server Edition base platform from a wide variety of computing devices.
In June 1998, the Company released its MetaFrame product, a Company-developed
plug-in that implements the Independent Computing Architecture (ICA) protocol on
the new platform that provides capabilities similar to those currently offered
in the WinFrame product line. Pursuant to the terms of the Development
Agreement, in May 1997, the Company received an aggregate of $75 million as a
non-refundable royalty payment and for engineering and support services to be
rendered by the Company. Under the terms of the Development Agreement, the
Company is entitled to receive payments of an additional $100 million, in
quarterly payments, a portion of which has already been received. In addition,
Microsoft and the Company have agreed to engage in certain joint marketing
efforts to promote use of Windows NT Server-based multi-user software and the
Company's ICA protocol. Additionally, subject to the terms of the Development
Agreement, Microsoft has agreed to endorse only the Company's ICA protocol as
the preferred way to provide multi-user Windows access for devices, other than
Windows client devices until at least November 1999 and the Company shall be
entitled to license its WinFrame technology based on Windows NT v.3.51 until at
least September 30, 2001.
As a result of the Development Agreement, the Company will continue to
support the Microsoft NT platform but the MetaFrame products and later releases
will no longer incorporate Windows NT technology directly into the Company's
future offerings. The MetaFrame product line was first shipped in June 1998. The
Company plans to continue developing enhancements to its MetaFrame product line
and expects that this product, WinFrame products and associated options and
royalties derived under the terms of the Development Agreement will constitute a
majority of its revenues for the foreseeable future.
Revenue is recognized when earned. The Company's revenue recognition
policies are in compliance with the American Institute of Certified Public
Accountants Statement of Position 97-2 (as amended by SOP 98-4), "Software
Revenue Recognition." Product revenues are recognized upon shipment only if no
significant Company obligations remain and collection of the resulting
receivable is deemed probable. The initial fee of $75 million relating to the
Development Agreement is being recognized ratably over the term of the contract,
which is five years. The additional $100 million due pursuant to the Development
Agreement, as amended, is being recognized ratably over the remaining term of
the contract, effective April 1998. In the case of non-cancelable product
licensing arrangements under which certain Original Equipment Manufacturers
(OEMs) have software reproduction rights, initial recognition of revenue also
requires delivery and customer acceptance of the product master or first copy.
Subsequent recognition of revenues is based upon reported royalties from the
OEMs as well as estimates of royalties due through
10
the Company's reporting date. Product returns and sales allowances, including
stock rotations, are estimated and provided for at the time of sale. Non-
recurring engineering fees are recognized ratably as the work is performed.
Revenues from training and consulting are recognized when the services are
performed. Service revenues from customer maintenance fees for ongoing customer
support and product updates are recognized ratably over the term of the
contract, which is typically twelve months. Service revenues, which are
immaterial when compared to net revenues, are included in net revenues on the
face of the statement of income.
The Company has acquired or licensed technology that is related to its
strategic objectives. On October 2, 1997, the Company completed its acquisition
of certain of the assets, technology and operations of DataPac Australasia Pty
Limited for approximately $5.0 million. In January 1998, the Company licensed
certain software technology from EPiCON, Inc. for approximately $8.0 million.
Additionally, on February 5, 1998, the Company completed its acquisition of
certain in-process software technologies and assets of Insignia Solutions, plc
for approximately $17.5 million. Also, on June 30, 1998 the Company acquired all
of the outstanding securities of APM Limited, the parent company of Digitivity
Inc, for approximately $40.4 million. In July 1998, the Company completed its
acquisition of certain technologies of VDOnet Corporation Ltd. for approximately
$8.0 million.
The discussion below relating to the individual financial statement
captions, the Company's overall financial performance, operations and financial
position should be read in conjunction with the factors and events described in
"Overview" and "Certain Factors Which May Affect Future Results" which, it is
anticipated, will impact the Company's future performance and financial
position.
RESULTS OF OPERATIONS
The following table sets forth statement of income data of the Company
expressed as a percentage of net revenues and as a percentage of change from
period-to-period for the periods indicated.
INCREASE/(DECREASE) FROM
------------------------
THREE MONTHS NINE MONTHS
ENDED ENDED
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30,
SEPTEMBER 30, SEPTEMBER 30, 1998 VS. 1998 VS.
------------------ -----------------
1998 1997 1998 1997 1997 1997
----- ----- ----- ----- ---- ----
Net revenues................................. 100.0% 100.0% 100.0% 100.0% 93.5% 113.8%
Cost of revenues............................. 5.8 9.8 7.8 9.8 13.6 69.6
----- ----- ---- ---- ----- -----
Gross margin................................. 94.2 90.2 92.2 90.2 102.3 118.6
Operating expenses:
Research and development.................... 13.1 4.8 9.6 5.9 433.1 246.7
Sales, marketing and support................ 29.7 27.2 31.0 28.6 111.4 131.2
General and administrative.................. 8.1 8.7 7.6 8.6 79.8 93.1
In-process research and development......... 10.6 - 37.5 - * *
----- ----- ---- ---- ----- -----
Total operating expenses................... 61.5 40.7 85.7 43.1 192.8 324.9
----- ----- ---- ---- ----- -----
Income from operations...................... 32.7 49.5 6.5 47.1 27.9 (70.5)
Interest income, net......................... 3.6 9.0 4.4 8.6 (23.0) 9.4
----- ----- ---- ---- ----- -----
Income before income taxes.................. 36.3 58.5 10.9 55.7 20.1 (58.1)
Income taxes provision....................... 13.1 21.1 3.9 20.0 20.0 (58.1)
----- ----- ---- ---- ----- -----
Net income................................... 23.2% 37.4% 7.0% 35.7% 20.1% (58.1%)
===== ===== ==== ==== ===== =====
* Not meaningful.
Net Revenues. The increase in net revenues in the third quarter of 1998
compared to the third quarter of 1997 was primarily attributable to revenues
recognized in connection with the shipment of the Company's MetaFrame product,
the inter-operable products associated with the MetaFrame and WinFrame products,
and the recognition of revenue related to the Development Agreement with
Microsoft, which were partially off-set by a decline in the volume of shipments
of its WinFrame products. The increase in net revenue in the nine month period
ended September 30, 1998 compared to the nine month period ended September 30,
11
1997 was primarily attributable to the inter-operable products associated with
the MetaFrame and WinFrame products, revenues recognized in connection with the
shipment of the Company's MetaFrame product, the recognition of revenue related
to the Development Agreement with Microsoft and an increase in the volume of
shipments of its WinFrame products.
An analysis of Company net revenue is detailed in the table below. Net
revenue is segregated into five main categories: WinFrame-based products,
MetaFrame-based products, Inter-operable products, OEM revenue, Microsoft
royalties and Other revenue. Inter-operable products include additional user
licenses as well as other options, which are applicable to both the MetaFrame
and WinFrame product lines. The OEM revenue consists of license fees and
royalties from third party manufacturers who are granted a license to
incorporate and/or market the Company's multi-user technologies in their own
product offerings. Both the Company's WinFrame/MetaFrame and OEM revenues
represent product license fees based upon the Company's multi-user NT-based
technology. Microsoft royalties represent fees recognized in connection with the
Development Agreement (see discussion above).
INCREASE/(DECREASE) FROM
------------------------
THREE MONTHS NINE MONTHS
ENDED ENDED
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30,
SEPTEMBER 30, SEPTEMBER 30, 1998 VS. 1998 VS.
-------------------- -------------------
1998 1997 1998 1997 1997 1997
--------- -------- -------- -------- ---- ----
WinFrame- based products..................... 15% 50% 34% 51% (42%) 42%
MetaFrame- based products.................... 30 0 16 0 * *
Inter-operable products...................... 25 17 21 15 176 201
OEM revenue.................................. 10 17 12 21 16 19
Microsoft royalties.......................... 15 11 12 7 167 270
Other revenue............................... 5 5 5 6 118 87
--- --- --- --- --- ---
Net revenues................................. 100% 100% 100% 100% 94% 114%
* Not meaningful.
International. International revenues (sales outside of the United States)
accounted for approximately 27% and 18% of net revenues for the three months
ended September 30, 1998 and 1997, respectively. International revenues
accounted for approximately 27% and 17% of net revenues for the nine months
ended September 30, 1998 and 1997, respectively.
Cost of Goods Sold. Cost of goods sold consists primarily of the cost of
royalties, product media and duplication, manuals, packaging materials and
shipping expense. Cost of OEM revenues included in cost of goods sold primarily
consists of cost of royalties, except where the OEM elects to purchase shrink-
wrapped products, in which case such costs are as described in the previous
sentence. All development costs incurred in connection with the Development
Agreement are expensed as incurred as a component of cost of goods sold. Costs
associated with non-recurring engineering fees are included in research and
development expenses and are not separately identifiable. All development costs
included in the research and development of software products and enhancements
to existing products have been expensed as incurred. Consequently, there is no
amortization of capitalized research and development costs included in cost of
goods sold.
Gross Margin. The increases in gross margin in the three month and the nine
month periods ended September 30, 1998, was primarily attributable to changes in
product mix, representing initial licensing since June 1998, of the MetaFrame
product, which has a higher gross margin percentage, an increase in the volume
of shipments of inter-operable products and different products within the
WinFrame product line.
Research and Development Expenses. Research and development expenses
consisted primarily of personnel-related costs. The increases in research and
development expenses in the three months and nine months ended September 30,
1998 as compared to the prior respective periods, resulted mainly from
additional staffing, associated salaries and related expenses as a result of
recent acquisitions and additional hirings required to expand and enhance the
Company's product lines. These increases
12
were partially offset by the allocation of certain research and development
expenses to cost of goods sold for the portion of these expenses associated with
Development Agreement revenues.
Sales, Marketing and Support Expenses. The increases in sales, marketing
and support expenses in the three months and nine months ended September 30,
1998 as compared to the prior respective periods, resulted primarily from
increases in promotional activities, such as advertising literature production
and distribution and trade shows, as well as distributor programs, largely in
connection with the launch of the MetaFrame product. Sales, marketing and
support staff and associated salaries, commissions and related expenses also
increased, resulting from efforts to expand the Company's product distribution.
General and Administrative Expenses. The increases in general and
administrative expenses in the three months and nine months ended September 30,
1998 as compared to the prior respective periods, is primarily due to increased
expenses associated with additional staff, associated salaries and related
expenses necessary to support overall increases in the scope of the Company's
operations. The increase in the nine months ended September 30, 1998 was
partially offset by a decline in legal fees from the levels incurred in the
previous period, which were high due to the costs associated with non-recurring
contractual negotiations and litigation defense incurred in 1997.
In-Process Research and Development Expenses. In connection with the
acquisition or licensing of certain businesses, assets or technologies,
including Datapac, EPiCON, Insignia, APM/Digitivity and VDOnet the Company made
allocations of the purchase price to in-process research and development,
totaling approximately $65 million in 1998 and $3.95 million in 1997. These
amounts were expensed as non-recurring charges on the effective dates of the
respective acquisitions and licensing, because the acquired in-process
technology had not yet reached technological feasibility and had no future
alternative uses. Since the respective dates of acquisition and licensing, the
Company has used the acquired in-process technology to develop new product
offerings, which have or will become part of the Company's suite of products
when completed. Functionalities included in products using the acquired in-
process technology have been introduced at various times following the
respective transaction dates of the acquired assets and licensing, and the
Company currently expects to complete the development of the remaining projects
at various dates between 1998 and 2000. Upon completion, the Company offers the
related products to its customers.
The nature of the efforts required to develop the acquired in-process
technology into commercially viable products principally relate to the
completion of all planning, designing and testing activities that are necessary
to establish that the products can be produced to meet design requirements,
including functions, features and technical performance requirements. The
Company currently expects that products utilizing the acquired in-process
technology will be successfully developed, but there can be no assurance that
commercial viability of any of these products will be achieved. Furthermore,
future developments in the software industry, particularly the thin client-
server environment, changes in technology, changes in other products and
offerings or other developments may cause the Company to alter or abandon
product plans.
The fair value for the in-process technology in each acquisition was based
on analysis of the markets, projected cash flows and risks associated with
achieving such projected cash flows. In developing these cash flow projections,
revenues were forecasted based on relevant factors, including aggregate revenue
growth rates for the business as a whole, individual service offering revenues,
characteristics of the potential market for the service offerings and the
anticipated life of the underlying technology. Operating expenses and resulting
profit margins were forecasted based on the characteristics and cash flow
generating potential of the acquired in-process research and development, and
included assumptions that certain expenses would decline over time as operating
efficiencies were obtained. Appropriate adjustments were made to operating
income to derive net cash flow, and the estimated net cash flows of the in-
process technologies in each acquisition were then discounted to present value
using rates of return that the Company believes reflect the specific risk/return
characteristics of these research and development projects. The selection of
discount rates for application in each acquisition were based on the
consideration of: (i) the weighted average cost of capital ("WACC"), which
measures a company's cost of debt and equity financing weighted by the
percentage of debt and percentage of equity in its target capital structure;
(ii) the corresponding weighted average return on assets
13
("WARA") which measures the after-tax return required on the assets employed in
the business weighted by each asset group's percentage of the total asset
portfolio; and (iii) venture capital required rates of return which typically
relate to equity financing for relatively high-risk business projects.
Failure to complete the development of these projects in their entirety, or
in a timely manner, could have a material, adverse impact on the Company's
operating results, financial condition and results of operations. No assurance
can be given that actual revenues and operating profit attributable to acquired
in-process research and development will not deviate from the projections used
to value such technology in connection with each of the respective acquisitions.
Ongoing operations and financial results for acquired assets or licensed
technology and the Company as a whole, are subject to a variety of factors which
may not have been known or estimable at the date of such transaction, and the
estimates discussed below should not be considered the Company's current
projections for operating results for the acquired assets or licensed technology
or the Company as a whole.
Revenues attributable to the acquired in-process technology were assumed to
increase depending on the product between the first two to five years of six to
seven year projection periods at annual rates ranging from 23% to 246% before
decreasing over the remaining years at rates ranging from 12% to 84% as other
products are released in the marketplace. Projected annual revenue attributable
to the products ranged from approximately $400,000 to $255 million over the term
of the projections. These projections were based on aggregate revenue growth
rates for the business as a whole, individual product revenues, giving
consideration to transaction volumes and prices, anticipated growth rates for
the client-server market, anticipated product development and product
introduction cycles, and the estimated life of the underlying technology.
Projected revenues from the in-process research and development were assumed to
peak during periods between 1999 and 2002, depending on the product, and decline
from 2000 to 2003 as other new products are expected to enter the market.
Gross profit was assumed to increase in the first two to five years of the
projection period, depending on the product, at annual rates ranging from 23% to
248%, decreasing over the remaining years at rates ranging from 11% to 84%
annually, resulting in incremental annual gross profits ranging from
approximately $400,000 to $237 million. The gross profit projections assumed a
growth rate approximately the same as the revenue growth rate.
Operating profit was assumed to increase, depending on the product, in the
first two to four years of the projection period at annual rates ranging between
22% and 849%, and decrease over the remaining years at rates between 3% and 75%
annually, resulting in incremental annual operating profits of approximately
$200,000 to $107 million. Operating profit is projected to increase at a faster
rate than revenues in the earlier years of the projection primarily because all
product developments costs were assumed to be incurred in the first year,
reducing operating expenses as a percentage of revenue after the first year.
The Company used discount rates ranging from 15% to 50% for valuing the in-
process research and development acquired in these transactions, which the
Company believes reflected the risk associated with the completion of the
individual research and development projects acquired and the estimated future
economic benefits to be generated subsequent to the projects' completion.
A description of the in-process research and development and the estimates
made by the Company for each of Datapac, EPiCON, Insignia, APM/Digitivity and
VDOnet is summarized below. All of the projects are targeted for the client-
server market. After the acquisition or license of each technology, the Company
has continued the development of these in-process projects.
14
DATAPAC
The in-process research and development acquired in the Datapac acquisition
consisted primarily of one significant research and development project, VGA
Connect, together with two minor projects. VGA Connect is designed as an add-on
to WinFrame software and allows MVGA cards to be used as direct connect
workstations. The Company estimated these projects were less than 25% complete
at the date of acquisition. The aggregate value assigned to the Datapac in-
process research and development was $3.95 million. At the time of the
valuation, the expected cost to complete all such projects was approximately
$220,000.
EPICON
The in-process research and development acquired in the license of EPiCON
technology consisted of one significant research and development project,
Application Cloning. This project enables an application to be installed once on
a server and then replicated to all other servers in a server farm
configuration, and is targeted for the client-server market. After licensing the
EPiCON technology, the Company continued the development of this in-process
project, which the Company estimated was less than 75% complete at the date of
licensing. The aggregate value assigned to the EPiCON in-process research and
development was $7.9 million. At the time of the valuation, the expected cost to
complete the project was approximately $300,000.
INSIGNIA
The in-process research and development acquired in the Insignia
acquisition consisted primarily of one significant research and development
project, Keoke, together with three minor projects. Keoke, is a video display
protocol designed to add performance and bandwidth management enhancements to
ICA in WinFrame and MetaFrame software. The Company estimated these projects
were between 25% and 50% complete at the date of acquisition. The aggregate
value assigned to the Insignia in-process research and development was $15.95
million. At the time of the valuation, the expected cost to complete all such
projects was approximately $1.9 million.
APM/DIGITIVITY
The in-process research and development acquired in the APM/Digitivity
acquisition consisted primarily of one significant research and development
project, Java Server. The project is a Java application server, which is similar
to WinFrame software, but actually runs Java applications rather than Windows
applications. The Company estimated this project was less than 40% complete at
the date of acquisition. The aggregate value assigned to the APM/Digitivity in-
process research and development was $33.8 million. At the time of the
valuation, the expected cost to complete the project was approximately $8.0
million.
VDONET
The in-process research and development acquired in the VDOnet acquisition
consisted primarily of one significant research and development project, ICA
Video Server. This project allows video applications and applications containing
video to be viewed on an ICA client, and is targeted for the client-server
market. After acquiring VDOnet, the Company continued the development of this
in-process project, which the Company estimates was less than 40% complete at
the date of acquisition. The aggregate value assigned to the VDOnet in-process
research and development was $7.2 million. At the time of the valuation, the
expected cost to complete the project was approximately $200,000.
See "--Certain Factors Which May Affect Future Results--Uncertainty as to
IPRD Valuation."
15
Interest Income, Net. Interest income, net, increased during the nine
months ended September 30, 1998 compared to the respective period in the prior
year primarily due to interest income earned on additional cash generated from
the receipt of an initial license fee under the terms of the Development
Agreement.
Income Taxes. The Company's effective tax rate amounted to 36% for the
three months and nine months ended September 30, 1998 and 1997.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1998, the Company's activities
resulted in negative operating cash flows of approximately $7.0 million, which
includes cash used to purchase and license in-process research and development
of $68.8 million. These amounts were also affected by an increase in trade
receivables during the period. During the same period, the Company also
recognized tax benefits from the exercise of non-statutory stock options and
disqualifying dispositions of incentive stock options of approximately $14.7
million. The Company purchased and sold short-term investments for
approximately $155.1 million and $159.3 million, respectively, during the nine
months ended September 30, 1998. Additionally, the Company expended
approximately $11.2 million in the same period for the purchase of leasehold
improvements and equipment. These capital expenditures were primarily
associated with the Company's expansion into new facilities.
As of September 30, 1998, the Company had approximately $133.1 million in
cash and cash equivalents, $84.9 million in short-term investments and $223.2
million of working capital. The Company's cash and cash equivalents and short-
term investments are invested in investment grade, interest bearing securities
to minimize interest rate risk and allow for flexibility in the event of
immediate cash needs. At September 30, 1998, the Company had approximately $33.1
million in trade receivables, net of allowances, and $75.7 million of deferred
revenues, of which the Company anticipates $36.6 million will be earned over the
next twelve months.
The Company believes existing cash and cash equivalents and short-term
investments will be sufficient to meet operating and capital expenditure
requirements for at least the next twelve months.
The Company paid cash amounting to approximately $3,000 in lieu of
fractional shares in connection with its three-for-two stock split effected
February 20, 1998. The Company does not anticipate paying any cash dividends on
its Common Stock in the foreseeable future.
YEAR 2000 READINESS DISCLOSURE STATEMENT AND RELATED INFORMATION.
Until recently, many computer programs were written using two digits rather
than four digits to define the applicable year in the twentieth century. Such
software may recognize a date using "00" as the year 1900 rather than the year
2000. The consequences of this issue may include systems failures and business
process interruption to the extent companies fail to upgrade, replace or
otherwise address year 2000 problems. The year 2000 problem may also result in
additional business and competitive differentiation. Aside from the well-known
calculation problems with the use of 2-digit date formats as the year changes
from 1999 to 2000, the year 2000 is a special case leap year. As a result,
significant uncertainty exists in the software industry concerning the potential
impact of the year 2000 problem.
The Company believes that it has four general areas of potential exposure
with respect to the year 2000 problem: (1) its own software products; (2) its
internal information systems; (3) computer hardware and other equipment related
systems; and (4) the effects of third party compliance efforts.
16
The Company's existing principal software product lines consist of WinFrame
and MetaFrame. The Company's WinFrame product line is an authorized extension to
Microsoft Windows NT, v.3.51. The Company's MetaFrame product line adds
additional functionality to Microsoft's Windows NT Server, Terminal Server
Edition. Customers can obtain current information about the year 2000 compliance
of the Company's products from the Company's web site. Information on the
Company's Web site is provided to customers for the sole purpose of assisting in
planning for the transition to the year 2000. Such information is the most
currently available concerning the behavior of the Company's products in the
next century and is provided "as is" without warranty of any kind.
While the Company believes that the current versions of its WinFrame and
MetaFrame products are currently capable of storing four-digit year data,
allowing applications to differentiate between dates from the 1900s and the year
2000 and beyond, potential incompatibility with two-digit application programs
may limit the Company's sales of product in those situations. Further,
notwithstanding the operating system's ability to store four-digit year data, it
is typically the application's function to collect and properly store date data.
There can be no assurance that the Company's products will not be integrated by
the Company or its customers with, or otherwise interact with, non-year 2000
compliant software or other products which may malfunction and expose the
Company to claims from its customers or other third parties. The foregoing
could result in the loss of or delay in market acceptance of the Company's
products and services, increased service costs to the Company or payment by the
Company of compensatory or other damages. Although the Company believes that
many Windows applications do store four-digit year dates today, it is possible
that some applications are now or have historically only collected two-digit
year data, and in such cases WinFrame cannot create four-digit year data for
applications which have collected only two digits in year fields. Further,
there can be no assurance that the Company's software products that are designed
to be year 2000 compliant contain all necessary technology to make them year
2000 compliant. If any of the Company's licensees experience year 2000
problems, such licensees could assert claims for damages against the Company.
With respect to internal information systems, the Company has commenced,
but has not yet completed, a testing and compliance program to identify any year
2000 problems. An audit will be conducted to identify all business critical
applications and responses sought from vendors as to whether the application is
compliant or not and what plans they have in place to ensure compliance before
December 31, 1999.
The third type of potential year 2000 exposure relates to the Company's
computer hardware and other equipment related systems including such equipment
as the Company's workstations, phone systems, security systems and elevator
systems. The Company is in the early stages of identifying and evaluating such
systems' year 2000 exposure. Due to the early stage of analysis with respect to
the Company's computer hardware and other equipment related systems, the Company
cannot yet estimate the costs involved, although the Company does not expect
such costs to have a material adverse effect on its financial condition.
The fourth aspect of the Company's year 2000 analysis involves evaluating
the year 2000 efforts of third parties, including critical suppliers and other
strategic relationships. The Company intends to contact critical suppliers and
other strategic relationships through written and/or telephone inquiries. The
Company is conducting such inquiries with existing personnel and does not expect
the costs of such inquiries to be material. If the Company determines, after
conducting the aforementioned survey, that the year 2000 exposure of any
critical suppliers or other strategic relationships could result in material
disruptions to their respective businesses, the Company may develop appropriate
contingency plans. Further, if certain critical third party providers, such as
those supplying outsourced manufacturing, electricity, water, or
telecommunications services, experience difficulties resulting in a material
interruption of services to the Company, such interruption would likely result
in a material adverse effect on the Company's business, results of operations
and financial condition.
To date, the Company has not incurred any material expenditure in
connection with identifying or evaluating year 2000 compliance issues. The
Company estimates it will not incur any material levels of expenditure on this
issue during 1998 and 1999 to support its compliance initiatives. Most of these
expenses have been, and in the future are expected to be, related to the
17
opportunity costs of employees evaluating the Company's financial and accounting
software, the current versions of the Company's products, and year 2000
compliance matters generally. The Company believes that it is unlikely to
experience a material adverse impact on its financial condition or results of
operations due to year 2000 compliance issues. However, since the assessment
process is ongoing, year 2000 complications are not fully known, and potential
liability issues are not clear, the full potential impact of the year 2000 on
the Company is not known at this time.
As the Company has recently replaced its fundamental financial and
accounting software, no significant problems are anticipated which would result
in either the delay or the inability to process accounting and financial data.
If the audit of the other software applications used by Company lead to the
discovery of further year 2000 compliance issues, the Company intends to
evaluate the need for one or more contingency plans relating to such issues.
The Company's expectations as to the extent and timeliness of modifications
required in order to achieve year 2000 compliance is a forward-looking statement
subject to risks and uncertainties. Actual results may vary materially as a
result of a number of factors, including, among others, those described in this
paragraph. There can be no assurance however, that the Company will be able to
successfully modify on a timely basis such products, services and systems to
comply with year 2000 requirements, which failure could have a material adverse
effect on the Company's operating results. Further, while the Company believes
that its year 2000 compliance efforts will be completed on a timely basis, and
in advance of the year 2000 date transition, there can be no assurance that
unexpected delays or problems, including the failure to ensure year 2000
compliance by systems or products supplied to the Company by a third party, will
not have an adverse effect on the Company, its financial performance, or the
competitiveness or customer acceptance of its products. Further, the Company's
current understanding of expected costs is subject to change as the project
progresses and does not include potential costs related to actual customer
claims, or the cost of internal software and hardware replaced in the normal
course of business unless such installation has been accelerated to provide
solutions to year 2000 compliance issues.
EUROPEAN MONETARY UNION
On January 1, 1999 eleven of the existing members of the European Union
(the "EU") will join the European Monetary Union (the "EMU"). This will lead,
among many other things, to fundamental changes in the way participating EU
states implement their monetary policies and manage local currency exchange
rates. Ultimately, there will be a single currency within certain countries of
the EU, known as the Euro and one organization, the European Central Bank,
responsible for setting European monetary policy. While some believe that the
change will bring a higher level of competition within Europe and a greater
sense of economic stability within that region, there is no certainty that the
Company's activity in this region will necessarily realize any benefits as a
result of such changes. The Company has reviewed the impact the Euro will have
on its business and whether this will give rise to a need for significant
changes in its' commercial operations or treasury management functions. While it
is uncertain whether there will be any immediate direct benefits from the
planned conversion, the Company believes it is properly prepared to accommodate
any changes deemed necessary after January 1, 1999 without any significant
changes to its current commercial operations, treasury management and management
information systems.
CERTAIN FACTORS WHICH MAY AFFECT FUTURE RESULTS
The Company does not provide financial performance forecasts. The Company's
operating results and financial condition have varied in the past and may in the
future vary significantly depending on a number of factors. Except for the
historical information contained herein, the matters contained in this report
include forward-looking statements that involve risks and uncertainties. The
following factors, among others, could cause actual results to differ materially
from those contained in
18
forward-looking statements made in this report and presented elsewhere by
management from time to time. Such factors, among others, may have a material
adverse effect upon the Company's business, results of operations and financial
condition.
Reliance Upon Strategic Relationship with Microsoft. Microsoft is the
leading provider of desktop operating systems. The Company is dependent upon the
license of certain key technology from Microsoft, including certain source and
object code licenses, technical support and other materials. The Company is also
dependent on its strategic alliance agreement with Microsoft which provides for
cooperation in the development of technologies for advanced operating systems,
and the promotion of advanced Windows application program interfaces. On May 9,
1997, the Company and Microsoft entered into a License, Development and
Marketing Agreement, as amended (the "Development Agreement"), which provides
for the licensing to Microsoft of certain of the Company's multi-user software
enhancements to Microsoft's Windows NT Server and for the cooperation between
the parties for the development of certain future multi-user versions of
Microsoft Windows NT Server, known as the Windows NT Server, Terminal Server
Edition. The Development Agreement also provides for each party to develop its
own enhancements or "plug-ins" to the jointly developed products which may
provide access to the Windows NT Server, Terminal Server Edition base platform
from a wide variety of computing devices. In June 1998, the Company released its
MetaFrame product, a Company-developed plug-in that implements the Independent
Computing Architecture (ICA(R)) protocol on the new platform, that provides
capabilities similar to those currently offered in the WinFrame product line.
Pursuant to the terms of the Development Agreement, in May 1997 the Company
received an aggregate of $75 million as a non-refundable royalty payment and for
engineering and support services to be rendered by the Company. Under the terms
of the Development Agreement, the Company is entitled to receive payments of an
additional $100 million, in quarterly payments, a portion of which has already
been received. In addition, Microsoft and the Company have agreed to engage in
certain joint marketing efforts to promote use of Windows NT Server-based multi-
user software and the Company's ICA protocol. Additionally, subject to the terms
of the Development Agreement, Microsoft has agreed to endorse only the Company's
ICA protocol as the preferred way to provide multi-user Windows access for
devices other than Windows client devices, until at least November 1999 and the
Company shall be entitled to license its WinFrame technology based on Windows NT
v.3.51 until at least September 30, 2001.
The Company's relationship with Microsoft is subject to certain risks and
uncertainties. First, the Windows NT Server, Terminal Server Edition based
platforms will allow Microsoft to create products that may be competitive with
the Company's current WinFrame and MetaFrame products. Second, as stated above,
Microsoft has agreed to endorse only the Company's ICA protocol as the preferred
method to provide multi-user Windows access for devices other than Windows
clients until at least November 1999. Subsequent to November 1999, or before
such date upon the occurrence of certain events contemplated by the Development
Agreement, it is possible that Microsoft will market or endorse other methods to
provide non-Windows client devices multi-user Windows access. Third, the
Company's ability to successfully commercialize its MetaFrame product will be
dependent on Microsoft's ability to market and sell its Windows NT Server,
Terminal Server Edition products. Finally, there may be delays in the release
and shipment of future releases of Windows NT Server, Terminal Server Edition.
Microsoft's distributors and resellers are not within the control of the Company
and, to the Company's knowledge, are not obligated to purchase products from
Microsoft. Additionally, the Company may hire additional development, marketing
and support staff to the extent they are needed in order to fulfill the
Company's responsibilities under the terms of the Development Agreement.
Further, if Microsoft (1) develops competitive plug-in products, (2) endorses
other methods to provide non-Windows client devices multi-user Windows access,
(3) is unable to successfully market and sell the Windows NT Server, Terminal
Server Edition products, or (4) encounters delays in the release and shipment of
future releases of Windows NT Server, Terminal Server Edition, the Company's
business, results of operations and financial condition could be adversely
affected.
Dependence Upon Broad-Based Acceptance of ICA Protocol. The Company
believes that its success in the markets in which it competes will depend upon
its ability to cause broad-based acceptance of its ICA protocol as an emerging
standard for supporting distributed Windows applications, thereby creating
demand for its server products.
19
Dependence Upon Strategic Relationships. In addition to its relationship
with Microsoft, the Company has relationships with NCD, Tektronix, Wyse and
others. The Company is dependent on its strategic partners to successfully
incorporate the Company's technology into their products and to successfully
market and sell such products.
Competition. The markets in which the Company competes are intensely
competitive. Most of the competitors and potential competitors, including
Microsoft, have significantly greater financial, technical, sales and marketing
and other resources than the Company. Additionally, the announcement of the
release, and the actual release of products competitive to the Company's
existing and future product lines, such as Microsoft's Windows NT Server,
Terminal Server Edition and related plug-ins, could cause existing and potential
customers of the Company to postpone or cancel plans to license certain of the
Company's existing and future product offerings, which would adversely impact
its net revenues, operating results and financial condition. Further, the
Company's ability to market ICA, MetaFrame and other future product offerings
will be dependent on Microsoft's licensing and pricing scheme to allow client
devices implementing ICA, MetaFrame or any such future product offerings to
attach to the Windows NT Server, Terminal Server Edition.
Dependence on Proprietary Technology. The Company relies primarily on a
combination of copyright, trademark and trade secret laws, as well as
confidentiality procedures and contractual provisions to protect its proprietary
rights. Despite the Company's precautions, it may be possible for unauthorized
third parties to copy certain portions of the Company's products or to obtain
and use information regarded as proprietary. Additionally, the laws of some
foreign countries do not protect the Company's intellectual property to the same
extent as do the laws of the United States and Canada. There can be no
assurance that third parties will not assert infringement claims against the
Company in the future or that any such assertion will not result in costly
litigation or require the Company to obtain a license to intellectual property
rights of such third parties. In addition, there can be no assurance that such
licenses will be available on reasonable terms or at all, which could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Product Concentration. The Company anticipates that its MetaFrame and
WinFrame product lines will constitute a majority of its revenues for the
foreseeable future. The Company's ability to generate revenue from its
MetaFrame product will be highly dependent on market acceptance of Windows NT
Server, Terminal Server Edition products, with which its product is intended to
be combined to provide capabilities similar to those currently offered in the
WinFrame technology line. The Company expects that revenue from the
MetaFrame-based products will constitute an increasing percentage of total
revenue in the foreseeable future and that the revenue from WinFrame-based
products will decrease over time as a percentage of total revenue. The Company
may experience declines in demand for products based on WinFrame technology,
whether as a result of new competitive product releases, price competition, lack
of success of its strategic partners, technological change or other factors. In
addition, the introduction of products based upon the MetaFrame technology may
be competitive with the Company's WinFrame product line and may delay or replace
orders of either technology.
Management of Growth and Anticipated Operating Expenses. The Company has
recently experienced rapid growth in the scope of its operations, the number of
its employees, and the geographic area of its operations. In addition, the
Company has completed certain international acquisitions since October 1997, and
assimilating the operations and personnel of such acquired companies has placed
and may continue to place a significant strain on the Company's managerial,
operational and financial resources. To manage its growth effectively, the
Company will be required to continue to implement and improve additional
management and financial systems and controls, and to expand, train and manage
its employee base. Although the Company believes that it has made adequate
allowances for the costs and risks associated with these expansions, there can
be no assurance that the Company's systems, procedures or controls will be
adequate to support the Company's current or future operations or that Company
management will be able to effectively manage this expansion and still achieve
the rapid execution necessary to fully exploit the market opportunity for the
Company's products and services in a timely and cost-effective manner. The
Company's future operating results will also depend on its ability to manage its
expanding product line, expand its sales and marketing organizations, and expand
its support organization commensurate with the increasing base of its installed
products. If the Company is unable to manage growth effectively or unable to
achieve the rapid execution necessary to fully exploit the
20
market window for the Company's products and services in a timely and cost-
effective manner, the Company's business, results of operations and financial
condition may be materially adversely affected.
Additionally, the Company expects that its requirements for office
facilities and equipment will grow as staffing requirements dictate. The Company
plans to increase its professional staff during 1998 and 1999 as sales,
marketing and support and product development efforts as well as associated
administrative systems are implemented to support planned growth. As a result of
this planned growth in staff, the Company believes that additional facilities
will be required during 1998 and 1999. Although the Company believes that the
cost of expanding in such additional facilities will not significantly impact
its financial position or results of operations, the Company anticipates that
operating expenses will increase during 1998 as a result of its planned growth
in staff and that such increase may reduce its income from operations and cash
flows from operating activities in 1998 and 1999.
Year 2000. Until recently, many computer programs were written using two
digits rather than four digits to define the applicable year in the twentieth
century. Such software may recognize a date using "00" as the year 1900 rather
than the year 2000. The consequences of this issue may include systems failures
and business process interruption to the extent companies fail to upgrade,
replace or otherwise address year 2000 problems. The year 2000 problem may also
result in additional business and competitive differentiation. Aside from the
well-known calculation problems with the use of 2-digit date formats as the year
changes from 1999 to 2000, the year 2000 is a special case leap year and in many
organizations using older technology, dates were used for special programmatic
functions. As a result, significant uncertainty exists in the software industry
concerning the potential impact of the year 2000 problem. The Company believes
that it has four general areas of potential exposure with respect to the year
2000 problem: (1) its own software products; (2) its internal information
systems; (3) computer hardware and other equipment related systems; and (4) the
effects of third party compliance efforts. The Company has not yet completed its
assessment of the Year 2000 compliance issues with respect to all of these
areas. Since the year 2000 complications are not fully known, there can be no
assurance that potential year 2000 problems will not result in the Company's
business, results of operations and financial condition being materially
adversely affected.
Information Systems Conversion. The Company and its wholly-owned
subsidiaries all utilize separate applications to process their accounting
transactions. As a result, the Company and its subsidiaries are currently in the
process of converting a significant part of its business operations to a single
accounting application purchased from a third-party vendor. Although the Company
believes it has addressed all the significant issues related to this conversion,
there can be no assurance that unanticipated software and hardware problems will
not arise, which may result in delays in customer billings and vendor payments,
as well as extended accounts receivable payment cycles.
Dependence on Key Personnel. The Company's success will depend, in large
part, upon the services of a number of key employees. The effective management
of the Company's anticipated growth will depend, in large part, upon the
Company's ability to retain its highly skilled technical, managerial and
marketing personnel as well as its ability to attract and maintain replacements
for and additions to such personnel in the future.
New Products and Technological Change. The markets for the Company's
products are relatively new and are characterized by rapid technological change,
evolving industry standards, changes in end-user requirements and frequent new
product introductions and enhancements, including enhancements to certain key
technology licensed from Microsoft. The Company believes it will incur
additional costs and royalties associated with the development, licensing, or
acquisition of new technologies or enhancements to existing products which will
increase the Company's cost of goods sold and operating expenses. To the extent
that such transactions have not yet occurred, the Company cannot currently
quantify such increase. The Company may use a substantial portion of its cash
and cash equivalents and short-term investments to fund these additional costs,
in which case, the Company's interest income will decrease if not offset by cash
flows from future operations. Additionally, the Company and others may announce
new products, new MetaFrame capabilities or technologies that could replace or
shorten the life cycle of the Company's existing product offerings. These market
characteristics will require the Company to continuously enhance its
21
current products and develop and introduce new products to keep pace with
technological developments and respond to evolving end-user requirements. The
Company may hire additional development staff to the extent they are needed in
order to fulfill the Company's responsibilities under the terms of the
Development Agreement. To the extent the Company is unable to add additional
staff and resources in its development efforts, future enhancements and
additional features to its existing or future products may be delayed, which may
have a material adverse effect on the Company's business, results of operations
and financial condition.
Potential for Undetected Errors. Despite significant testing by the Company
and by current and potential customers, errors may not be found in new products
until after commencement of commercial shipments. Additionally, third party
products, upon which the Company's products are dependent, may contain defects,
which could reduce the performance of the Company's products or render them
useless.
Reliance Upon Indirect Distribution Channels and Major Distributors. The
Company relies significantly on independent distributors and resellers for the
marketing and distribution of its products. The Company's distributors and
resellers are not within the control of the Company, are not obligated to
purchase products from the Company, and may also represent other lines of
products.
Need to Expand Channels of Distribution. The Company intends to leverage
its relationships with hardware and software vendors and systems integrators to
encourage these parties to recommend or distribute the Company's products. In
addition, an integral part of the Company's strategy is to expand its direct
sales force and add third-party distributors both domestically and
internationally. The Company is currently investing, and intends to continue to
invest, significant resources to develop these channels, which could adversely
affect the Company's operating margins and related cash flows from operating
activities.
Revenue Recognition Process. The Company continually re-evaluates its
programs, including specific license terms and conditions, to market its various
current and future products and services. The Company may implement new
programs which may include, among other things, specified and unspecified
enhancements to its current and future product lines. Revenues associated with
such enhancements may be recognized after the initial shipment or licensing of
the software product or may be recognized over the product's life cycle. The
timing of the implementation of such programs, the timing of the release of such
enhancements as well as factors such as determining vendor-specific objective
evidence of fair value of each element offered separately and whether upgrades
and enhancements are defined as upgrade rights pursuant to Statement of Position
(SOP) 97-2 will impact the timing of the Company's recognition of revenues and
related expenses associated with its products, related enhancements and
services. Because of the uncertainties related to the outcome of the re-
evaluation of its programs, the determination of vendor-specific objective
evidence of fair value and whether upgrades and enhancements will be defined as
upgrade rights pursuant to SOP 97-2, and its impact on revenue recognition, the
Company cannot currently quantify the impact of such re-evaluation on its
business, results of operations and financial condition.
Product Returns and Price Reductions. The Company provides most of its
distributors with product return rights for stock balancing or limited product
evaluation. The Company also provides most of its distributors with price
protection rights. The Company has established reserves for each of these
circumstances where appropriate, based on historical trends and evaluation of
current circumstances. Although the Company believes that it has adequate
reserves to cover product returns, there can be no assurance that the Company
will not experience significant returns in the future or that such reserves will
be adequate.
International Operations. The Company's continued growth and profitability
will require expansion of its international operations. To successfully expand
international sales, the Company will need to establish additional foreign
operations, hire additional personnel and recruit additional international
resellers. Such international operations are subject to certain risks, such as
difficulties in staffing and managing foreign operations, dependence on
independent relicensors, fluctuations in foreign currency exchange rates,
compliance with foreign regulatory and market requirements, variability of
foreign economic and
22
political conditions and changing restrictions imposed by regulatory
requirements, tariffs or other trade barriers or by United States export laws,
costs of localizing products and marketing such products in foreign countries,
longer accounts receivable payment cycles, potentially adverse tax consequences,
including restrictions on repatriation of earnings and the burdens of complying
with a wide variety of foreign laws.
Fluctuations in Economic and Market Conditions. The demand for the
Company's products depends in part upon the general demand for computer hardware
and software, which fluctuates based on numerous factors, including capital
spending levels and general economic conditions.
Growth Rate. The Company's revenue growth rate in the current year may not
approach the levels attained in 1997 and 1996, which were high, due primarily to
the increased market acceptance of WinFrame software during that period.
However, to the extent the Company's revenue growth continues, the Company
believes that its cost of goods sold and certain operating expenses will also
increase. Due to the fixed nature of a significant portion of such expenses,
together with the possibility of slower revenue growth, the Company's income
from operations and cash flows from operating and investing activities may
decrease in the current year.
Fluctuations in Quarterly Operating Results. The Company's quarterly
operating results have in the past varied and may in the future vary
significantly depending on factors such as the success of the Company's WinFrame
or MetaFrame products, the size, timing and recognition of revenue from
significant orders, increased competition, the proportion of revenues derived
from distributors, OEMs and other channels, changes in the Company's pricing
policies or those of its competitors, the financial stability of major
customers, problems caused by year 2000 complications, new product introductions
or enhancements by competitors and partners, delays in the introduction of
products or product enhancements by the Company or by competitors and partners,
customer order deferrals in anticipation of upgrades and new products, market
acceptance of new products, or new versions of existing products, the timing and
nature of sales and marketing expenses (such as trade shows and other
promotions), other changes in operating expenses, changes in the allocation of
amounts paid for purchases of businesses and licensing of technology to in-
process research and development, personnel changes (including the addition of
personnel), foreign currency exchange rates and general economic conditions.
The Company operates with little order backlog because its software products
typically are shipped shortly after orders are received. In addition, like many
systems level software companies, the Company has often recognized a substantial
portion of its revenues in the last month of a quarter with these revenues
frequently concentrated in the last weeks or days of the quarter. As a result,
the product revenues in any quarter are substantially dependent on orders booked
and shipped in that quarter, and revenues for any future quarter are not
predictable with any degree of certainty. Any significant deferral of purchases
of the Company's products could have a material adverse effect on the Company's
business, results of operations and financial condition in any particular
quarter, and to the extent significant sales occur earlier than expected,
operating results for subsequent quarters may be adversely affected. Royalty
and license revenues are impacted by fluctuations in OEM licensing activity and
certain end user licensing and deployment activity from quarter to quarter
because initial license fees generally are recognized upon customer acceptance
and continuing royalty and subsequent ongoing license revenues are recognized
when the amount of such licensing activity can be reasonably determined. The
Company's expense levels are based, in part, on its expectations as to future
orders and sales, and the Company may be unable to adjust spending in a timely
manner to compensate for any sales shortfall. If sales are below expectations,
operating results are likely to be adversely affected. Net income may be
disproportionately affected by a reduction in sales because a significant
portion of the Company's expenses do not vary with revenues. The Company may
also choose to reduce prices or increase spending in response to competition or
to pursue new market opportunities. In particular, if new competitors,
technological advances by existing competitors or other competitive factors
require the Company to invest significantly greater resources in research and
development efforts, the Company's operating margins in the future may be
adversely affected.
23
Uncertainty as to IPRD Valuation. The Company has recently been made aware
of a letter ("SEC Letter"), dated September 1998, from the Chief Accountant of
the Securities and Exchange Commission ("SEC") to the chairman of the AICPA's
SEC Regulations Committee, suggesting that this committee provide additional
guidance concerning accounting for in-process research and development ("IPRD")
and further offering certain staff views in this area. The Company is also aware
of a response letter from the chairman of the SEC Regulations Committee
indicating that a broader-based working group ("AICPA Working Group"), under the
auspices of the AICPA, will be formed to address the accounting, auditing and
valuation issues raised in the SEC letter.
The Company completed the purchase of business combinations and technology
acquisitions involving Datapac, EPiCON, Insignia, APM/Digitivity and VDOnet,
in which a portion of the purchase price was allocated to IPRD, prior to the
date of the SEC letter. The Company believes the preliminary purchase price
allocations recorded in connection with these acquisitions, and related
amortization charges, are in accordance with widely recognized appraisal
practices and generally accepted accounting principles. To date neither the
AICPA Working Group nor the SEC has issued any final or transitional guidance.
However, the Company is currently reviewing the potential effects of applying
the SEC staff's views on the allocation of purchase price to in-process research
and development. Although the impact resulting from the ultimate resolution of
this matter is currently not determinable, there is a risk that there may be a
material reduction in the amount of related non-cash charges reflected in the
Company's financial results for the nine months ended September 30, 1998 and the
year ended December 31, 1997, which in turn may materially affect future results
of operations through increased amortization expense.
Because of these factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Due to all of
the foregoing factors, it is likely that in some future quarter the Company's
operating results will be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially adversely affected.
24
PART II: OTHER INFORMATION
Item 2. Change in Securities and Use of Proceeds
On December 8, 1995, the Company's registration statement on Form S-1
(File No. 33-98542) became effective. The net proceeds from the
offering were $38,892,728. The Company utilized the remaining proceeds
in July 1998 as part of the consideration to acquire APM Limited on the
terms disclosed in more detail above. None of the parties receiving
such payments were officers, directors, 10% or greater stockholders of
the Company, or persons affiliated with the Company or with the
officers, directors, or 10% or greater stockholders of the Company.
Item 5. Other Information
Proposals of stockholders intended for inclusion in the proxy statement
to be furnished to all stockholders entitled to vote at the next annual
meeting of stockholders of the Company must be received at the
Company's principal executive offices not later than December 4, 1998.
The deadline for providing timely notice to the Company of matters that
stockholders otherwise desire to introduce at the next annual meeting
of stockholders of the Company is February 17, 1999.
Item 6. Exhibits and Reports on Form 8-K
(a) The exhibits, which are filed with the report as, set forth on the
Exhibit Index appearing on page 27 of this report and are
incorporated herein by this reference.
(b) A report on Form 8-K was filed with the Securities and Exchange
Commission on July 15, 1998 with respect to:
Item 2 -- Acquisition or Disposition of Assets. To disclose the
consummation of the acquisition of all of the outstanding
securities of APM Limited on June 30, 1998.
25
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 on this 16th day of November 1998.
CITRIX SYSTEMS, INC.
By: /s/ ROGER W. ROBERTS
--------------------
Roger W. Roberts
Chief Executive Officer
(Principal Executive Officer)
By: /s/ JAMES J. FELCYN, JR.
-------------------------
James J. Felcyn, Jr.
Vice-President of Finance and
Administration and Chief
Financial Officer
(Principal Financial Officer)
By: /s/ MARC-ANDRE BOISSEAU
--------------------------
Marc-Andre Boisseau
Controller
(Principal Accounting Officer)
26
EXHIBIT INDEX
Page Number
-----------
3 Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Citrix Systems, Inc. 28
4 Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Citrix Systems, Inc. (filed as part of
Exhibit 3) 28
27.1 Financial Data Schedule 30
27.2 Financial Data Schedule 31