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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
- -
of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
__ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
COMMISSION FILE NUMBER: 0-27696
GENSYM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-2932756
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
125 CAMBRIDGEPARK DRIVE
Cambridge, MA 02140-2329
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (617) 547-2500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.01 par value
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 ___
-
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
-----
As of March 25, 1999 there were 6,055,945 shares of the Registrant's Common
Stock outstanding. As of that date, the aggregate market value of the voting
stock held by non-affiliates of the registrant was $16,653,849 based on the last
reported sale price of the registrant's Common Stock on the Nasdaq National
Market as of the close of business on March 25, 1999.
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DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K
Document into which incorporated
-------- -----------------------
Portion of the Registrant's Proxy Statement
for the 1999 Annual Meeting of Stockholders Items 10, 11, 12 and 13 of
to be held on Friday, May 21, 1999 at Part III
10:00 A.M. at the offices of Hale & Dorr LLP,
60 State Street, Boston, MA 02109
2
GENSYM CORPORATION
FORM 10-K INDEX
Page No.
--------
PART I
Item 1. Business 4-14
Item 2. Properties 14
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 15
Item 6. Selected Financial Data 15-16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 16-28
Item 7A. Qualitative and Quantitative Disclosures about Market Risk 29
Item 8. Financial Statements and Supplementary Data 30-42
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 43
PART III
Item 10. Directors and Executive Officers of the Registrant 43
Item 11. Executive Compensation 43
Item 12. Security Ownership of Certain Beneficial Owners and Management 43
Item 13. Certain Relationships and Related Transactions 43
PART IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K 44
Signatures 45
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PART I.
ITEM 1. BUSINESS
Gensym Corporation ("Gensym" or the "Company") is a leading supplier of
software products and services for intelligent operations management. The
Company's products can be used on-line to monitor complex operations, analyze
data, detect problems and opportunities, provide advice, make decisions, and
take actions in real time. These products can also be used off-line in the
design, planning, and scheduling of operations. The Company's core product,
G2, and G2-based products are sold to customers for a broad array of
applications in a wide range of industries, including manufacturing,
telecommunications, aerospace, transportation, and financial services.
The Company's success in providing software to visionary partners and end
users has resulted in a broad installed base of application-specific
solutions that provide success references for mainstream markets. In order
to better meet the buying requirements of companies in its primary target
markets, the Company has reorganized into four business units: Manufacturing,
Communications, Advanced Systems, and EMA (Europe/Middle East/Africa). These
business units generally have their own specialized sales, business
development, consulting, and product development resources to provide the
level of application and industry specific knowledge needed to achieve
sustained growth and profitability in their respective markets.
Reorganization of the Company into business units with greater application
focus has entailed a retraining of the sales force and a major change in
account structure.
STRATEGY
Gensym's objectives are to increase the market for intelligent systems and
extend its leadership in this market. To achieve these objectives, the
Company employs the following strategies:
Extend Technological Leadership and Enhance Ease of Use. The Company
plans to build upon its technology base by adding new features and
functionality to its existing products and expanding its product line,
particularly at the level of application products that address common
operational problems in its major markets. The Company believes that its
leadership is primarily a result of its extensive set of advanced software
technologies. The Company plans to continue to enhance the power,
interoperability, and ease of use of its products by developing additional
application functionality, development tools, utility components, object
libraries, and interfaces that support important object- and data-exchange
standards.
Develop Business Units for Increased Sales and Application Effectiveness
in Target Markets. To better align its sales resources with today's
market requirements, Gensym has changed, beginning in 1999, from a unified
worldwide sales organization to focused sales teams operating within four
business units: Manufacturing, Communications, Advanced Systems, and EMA
(Europe/Middle East/Africa). The Company believes that this strengthened
business unit structure better supports the level of application knowledge
needed to sell effectively and achieve high rates of application success
in its target markets.
Focus on Key Accounts and Increase Penetration of Existing Customer
Base. Gensym intends to continue to expand the market for intelligent
systems by selling and delivering tools and solutions with and through
partners to large organizations with complex operations and the potential
for extensive application proliferation. The Company works in close
cooperation with end-users and partners around the world in order to
expand the features and capabilities of its products. After proving the
effectiveness of its solutions in initial applications, Gensym and its
partners promote proliferation of additional applications at additional
sites within that organization and publicize those successes as references
for new customers.
Increase Worldwide Delivery Channel. The Company strives to have sales
and support presence in geographic regions in which the Company believes
there is significant demand for its products and services. Gensym has 20
direct sales offices in North America, Europe, Africa, and Asia. In
addition, the Company has established local distribution channels in
Japan, South Africa and other international markets and has customer
support service centers in North America and Europe.
Expand Relationships with Marketing Partners. To encourage faster
growth of the market for intelligent systems, the Company seeks to
continue to form strategic relationships with systems integrators, value-
added resellers, and OEMs that have experience in various targeted
application markets and can build and install solutions using G2 and G2-
based products.
Increase Product Line Value in Target Markets. The Company has
concentrated its sales of G2 and G2-based applications to customers in the
manufacturing process industries, including chemical, oil and gas, food
and beverage and pharmaceuticals, and in telecommunications, including
aerospace and government. Gensym intends to penetrate these markets
through the introduction of additional products that add functionality and
knowledge applicable to manufacturers, communication service providers,
and financial service providers. The Company plans to expand its
relationships with its strategic partners to help accomplish this goal.
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PRODUCTS
Gensym sells G2 and a growing number of products used with or based on G2.
G2
G2 is a comprehensive development and deployment environment for
intelligent management and optimization of complex, dynamic operations. G2
applies knowledge that represents the experience of the best operations
personnel, combined with analytical models constructed by engineers and
business professionals and models derived from past performance, to real-time
or model data, in order to reach conclusions, provide advice, and take real
or simulated actions in a timely fashion. G2 can follow multiple lines of
reasoning based on this knowledge and consider multiple problems
concurrently. G2 maintains an understanding of the behavior of processes
over time and the currency of information, both of which are important for
real-time management of operations. G2 incorporates a broad array of
integrated technologies that allow application developers to implement
object-oriented applications without the need for conventional computer
programming.
Development Features
G2 allows an application developer to express objects, rules, models and
procedures using structured natural language so that they can be readily
understood and modified. The G2 development environment allows a
developer to test an application using simulated data and to view the
results graphically. In this way, an application can be tested under
various scenarios before deployment. Rapid incremental application
development can be done interactively, to facilitate application
improvements during prototyping, during development and even while in
deployment. Using G2's ability to support rapid application development,
a developer can show a dynamic, graphically animated prototype of an
application to an end-user at an early stage.
Using G2, an application developer can model a process in terms of
interrelated objects, which may be in graphical or schematic diagram form.
These object-based graphical connections enable G2 to reason about the
interdependent behavior of connected process objects. G2's high-level
representation of knowledge allows persons in many positions and roles in
an organization to develop applications more quickly and easily, while
aiding maintainability and reusability. Using Gensym's Telewindows
product, developers at multiple geographic locations can work in teams to
concurrently develop applications.
Deployment Features
Applications built on G2 are portable and interoperable across a number of
computer platforms, so solutions can be offered on any of a wide range of
platforms and later migrated to new and more powerful computers and
operating systems. G2 currently runs on Intel PC's running Windows NT and
on workstations from Compaq/Digital, Hewlett-Packard, IBM, Sun
Microsystems and others. G2 currently runs under Windows NT, as well as
the UNIX and VMS operating systems.
G2 allows many procedures or rules to be active concurrently. A procedure
or rule can be executing, suspended to allow other computations to occur,
or waiting for a triggering event. G2 enhances the reliability of on-line
applications by its facility to save "snap-shots" of a process state and
"warm boot" to the last saved state, so that an intelligent real-time
system can resume after power failures or other interruptions.
Applications can also be modified without interrupting the running of the
application.
Through its G2 technology, G2 can support concurrent access to multiple
sources of data and high-performance data exchange. Once an application
is deployed, Telewindows and Gensym's G2 WebLink allows multiple users to
share that application concurrently. Telewindows and G2 WebLink are
available on all G2 platforms as well as on PC's running Windows 95.
Pricing
Pricing for a G2 perpetual license starts at $36,000 for on-line
development and $20,000 for the deployment version, with volume discounts
to encourage large projects and product proliferation. G2 on-line
development is also offered in a bundled starter kit that includes first
year customer support, two weeks of application consulting services and
two weeks of training.
TELEWINDOWS AND G2 WEBLINK
Telewindows operates in conjunction with G2 and enables concurrent
shared access to G2 from multiple geographic locations. Telewindows gives
each member of a development team full concurrent access to an application
as a native developer, with immediate awareness of and access to objects
and other knowledge created by other team members. Telewindows enables
remote system maintenance by allowing full developer access to on-line
deployed applications remotely across a network. Once an application is
deployed, Telewindows allows multiple users to share that application
concurrently.
Multiple end-users on a network can access multiple applications via
Telewindows. Each user is provided with specific capabilities and
restrictions according to the authorized level of access. For example, in
typical manufacturing operations, the
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process or plant operators may have access to intelligent diagnostics and
other decision support while the maintenance group, plant management,
plant engineers and others may share the knowledge and real-time analysis
appropriate to their respective tasks.
Released in October 1998, Telewindows2 Toolkit is an entirely new
component-based version of Telewindows that fully utilizes the native
graphics capability of the client platform. This product complies with
Microsoft Windows and MOTIF standards and is designed to run concurrently
with the legacy Telewindows product. Telewindows2 Toolkit permits a G2
client to be developed and deployed within industry standard programming
environments, such as Microsoft Visual Basic, Microsoft Explorer, and
Netscape Navigator. G2 programming components such as workspaces and
editors can be presented in a standards compliant manner. Telewindows2
Toolkit also supports the integration of both JavaBean and ActiveX
components into the client part of a G2 application.
In addition to Telewindows, G2 WebLink enables users to interact with G2
applications remotely from browsers like Netscape and Microsoft Explorer.
Through support of hypertext transfer protocol (HTTP), this product "Web-
enables" G2, that is, provides standard user access over Internet or
Intranet connections.
CONNECTIVITY PRODUCTS
The Company and many of its marketing partners offer specific interface
modules to allow on-line integration of G2 with external programs,
systems, and databases. The Company offers interfaces to many standard
databases such as those offered by Informix, Oracle, and Sybase. The
Company is currently developing an interface module for integration of G2
with object-oriented databases. Interfaces to most popular factory
control systems are available either from the Company and its partners or,
in several cases, directly from the vendors of these systems.
During 1998, Gensym released three new products that support industry
object-exchange standards. These products include:
G2 JavaLink
G2 JavaLink is a connectivity product that allows G2 applications to
interoperate with other software components developed using the Java
programming language and runtime environment. Java is an industry
standard language developed by SUN Microsystems for implementing software
that is highly portable across multiple platforms and operating systems.
This portability is very complementary to G2's portability. Using this
product, G2 applications can leverage the growing number of available
libraries of Java component software.
G2 ActiveXLink
G2 ActiveXLink is a connectivity product that allows G2 applications to
interoperate with other software components developed to comply with the
Microsoft DCOM/ActiveX standards. This product allows G2 applications to
interoperate with such industry standard software as EXCEL, Visual Basic,
and PowerPoint. Using this product, G2 applications can leverage the
growing amount of available software that conforms to the Microsoft
DCOM/ActiveX standards.
G2 CORBALink
G2 CORBA Link is a connectivity product that allows G2 applications to
interoperate with other software components in a CORBA compliant network.
CORBA (Common Object Request Broker Architecture) is an industry standard
for distributed object technology endorsed by the Object Management Group
(OMG). OMG membership includes IBM, SUN Microsystems, Oracle, Hewlett
Packard, and Netscape. Using this product, G2 applications will be able
to distribute data and request services from other CORBA compliant
software in a network transparent manner.
G2-RELATED PRODUCTS
The Company also offers a number of products that are built on G2 or
commonly operate in conjunction with G2. These G2-related products include
the following.
OPERATIONS EXPERT
Operations Expert (OPEX) is a family of products designed to add
intelligence and value to traditional network management systems such as
HP OpenView and IBM NetView and to provide intelligent operations support
capable of addressing today's complex communications operations problems.
With OPEX, users have an enhanced ability to meet service-level
agreements, to manage growth cost-effectively, to minimize the risks of
implementing new services and technologies, and to gain competitive
advantage. Key functional uses include early detection of network
problems, alarm/message/event filtering, alarm correlation across
disparate platforms, root cause analysis, anticipating effects of network
failures, and recommending and/or automating appropriate corrective
actions.
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The OPEX product family includes:
. OPAC--a general-purpose graphical language designed for easy graphical
representation of operational procedures
. Causal Directed Graph (CDG)--for building fault models that
automatically pinpoint root causes of failures
. IP Reachability Analyzer (IPRA)--for isolating the sources of network
outages through model-based reasoning and proactive network probes
G2 Diagnostic Assistant
G2 Diagnostic Assistant ("GDA") can be used to create diagnostic and
control applications. GDA is based on functional blocks, which are
graphical objects that can be selected from menus and connected to create
an application. The functional blocks include logic and fuzzy logic
blocks, rule blocks, statistical tests, and alarm actions. New blocks can
be created by the user and added to the application to address specific
needs. GDA has built-in facilities for alarm handling and explanations of
diagnostic conclusions, including the capability to quantify the degree of
certainty of such conclusions.
NEURON-LINE
NeurOn-Line allows non-programmers who have little or no experience with
neural networks to take advantage of this technology, particularly for on-
line, dynamic applications. NeurOn-Line can identify and generate models
of the physical behavior of processes and of relationships among process
variables, when given a sufficient set of data. These models can then be
used on-line to compare process behavior with the model's prediction and
to control processes. The development of neural network applications in
NeurOn-Line is done graphically by selecting objects from menus,
connecting them, and entering attribute and control information.
NEURON-LINE STUDIO
Released in December 1998, NeurOn-Line Studio is a Windows desktop tool
for off-line analysis, modeling, and design optimization of processes,
based on data from a data historian or spreadsheet data arrays. To make
the tool easy for process engineers to use, many technical decisions such
as selection of relevant inputs, time delays, and network architecture are
automated. Once a model has been built for a process, NeurOn-Line Studio
allows users to discover more profitable ways to run it through simulation
and optimization. NeurOn-Line Studio models can be deployed either in a
G2 environment or as Microsoft ActiveX objects in embedded Windows
applications.
RETHINK
ReThink supports the design, simulation and operational management of
processes. Using ReThink, process teams can work together to explore
alternative business or manufacturing process designs quickly and easily
on an electronic "canvas". Graphical blocks are connected to describe the
sequences and interdependencies among processing tasks. ReThink brings
process designs to life using computer animation, making it easy to
visualize complex processes and measure their performance. ReThink "what-
if" analyses can calculate the financial and performance impact of policy
and process changes. ReThink modelers draw upon G2's strength in
integration, enabling process models to be put on-line to create process
monitoring, executive information systems, or workflow control
applications.
FERMENTATION EXPERT
Fermentation Expert, introduced in 1998, supports the intelligent control
and management of difficult-to-control fermentation processes. Its out-
of-the-box application-specific capabilities make it easier for
pharmaceutical and biochemical companies to develop fermentation control
applications than if they were to begin with Gensym's G2 and GDA products,
as they historically have.
PRODUCTS UNDER DEVELOPMENT
The Company is presently developing new G2-related products. The products
and product families discussed below are in various stages of development and
pre-release and are expected to be released within the next twelve months.
G2 AGENTS
The G2 Agents family of products extends the power of Gensym technology by
allowing its distribution across a network, thus supporting massive scale-
up in the size and complexity of intelligent operations management
applications. G2 Agents are intelligent agent programs that can be
generated to operate and co-operate on behalf of a G2 host application.
G2 Agents can greatly offload and distribute intelligent processing from a
G2 host application and the network on which it runs by bringing that
processing closer to the sources of data and events. This is valuable,
for example, in applications that maintain the availability of large
communications networks. Such networks are difficult to manage since they
have vast numbers of low-level events that must be continually monitored
and analyzed. G2 Agents can be deployed throughout a network to locally
monitor and filter events, and then, either directly or at the G2 host
level, actions can be taken to resolve problems quickly. Other
application areas that can benefit from the distributed intelligent
processing enabled by G2 Agents include: supply chain
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management, advanced process control, and real time mining of data within
an organization's on-line transaction processing systems (OLTPs).
The G2 Agents family of products will provide a comprehensive environment
for creating, testing, and deploying intelligent agent applications. It
will offer a visual language for graphically building and deploying
agents; a simulator for testing agent applications before putting them on
line; a distributed rule and computation processor for handling a high
volume of data and events; a deployment engine for dynamic downloading and
updating of agents on network nodes; and a control center for monitoring
agent processes, correlating information from multiple agents, and taking
actions that are beyond the scope of individual agents. Major products in
the G2 Agents family will include G2 Agent Development Environment (ADE),
for visually building and testing agent applications, and G2 Agent
Deployment Center (ADC), for automatically distributing and managing
agents in real time. G2 ADE has already been used for several
applications in the manufacturing and financial industries. G2 ADC is
currently scheduled to go into beta testing at multiple sites in 1999.
INTELLIGENT TRANSACTION MINING TOOLKIT (ITM)
Gensym's Intelligent Transaction Mining Toolkit (ITM) supports the rapid
development of applications that use G2 Agents to "eavesdrop" on
transaction streams passed among an organization's on-line transaction
processing systems (OLTPs). Agents "sniff" transactions and identify
those that match a profile for further real-time processing. Such further
processing may be graphically specified and may entail interpretation,
correlation with other data, and real-time response (e.g., displaying a
message, sending email, generating a Web page, initiating another
transaction, etc.). ITM applications are massively scalable, flexible,
and do not interfere with underlying OLTPs. ITM will be valuable to
organizations that have been prevented from tapping the wealth of data in
their transactions because of high costs and risks to their OLTP systems.
Markets include financial services, government and military, and e-
commerce. The first ITM-based product has been developed for an OEM and
is undergoing testing at a customer site. Gensym plans to immediately
begin seeking relationships with additional OEMs and large-scale
integrators who serve the financial services, customer relationship
management, and e-commerce markets.
LAB EXPERT
Lab Expert is a G2-based product that supports reduction of the new drug
development cycle time in pharmaceutical companies by improving the
productivity of chromatography methods development and execution. Lab
Expert is currently installed at a customer site, and release is
anticipated in late 1999.
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CUSTOMERS AND APPLICATIONS
The Company's customers include end-users, value-added resellers, systems
integrators and OEMs. Many of the largest industrial corporations in the
world are customers of the Company. Listed below is a sampling of the
Company's customers, in their respective industries:
AEROSPACE FOOD AND BEVERAGE
--------- -----------------
Boeing Cargill
Hughes Aircraft Nabisco
Lockheed Martin
NASA GOVERNMENT
Storm Control Systems ----------
Defence Education and Research Agency (UK)
AUTOMOTIVE US Army AI Center
----------
Ford
Nissan MINING
Toyota (Japan) ------
Noranda
CEMENT Met-Mex Penoles (Mexico)
------ Anglo American (S. Africa)
Lafarge (France)
PHARMACEUTICAL
CHEMICAL, OIL AND GAS --------------
--------------------- Eli Lilly
ABB Simcon Pfizer
Amoco Oil Glaxo
AspenTech
British Petroleum TELECOMMUNICATIONS
Citgo Petroleum ------------------
Exxon AT&T
PDVSA (Venezuela) Ericsson Hewlett-Packard (Sweden)
Siebe EUMETSAT (Germany)
ICI Chemicals (UK) GTE
Phillips Petroleum MCI
Saudi Aramco Motorola
Shell
Union Carbide TRANSPORTATION
--------------
FINANCIAL Aeroport International de Lyon (France)
--------- Serco Systems (UK)
Andersen Consulting US Dept. of Transportation
Fidelity Investments
MBNA
SWIFT
The Company has sold more than 11,000 licenses, which include both single-
user and multiple-user site licenses, for its products to over 750
industrial, service and governmental organizations in more than 59 countries.
The Company's products are used internationally in a broad array of
applications, including the following with industries noted:
BRITISH PETROLEUM, Et Al - Oil and Gas
Gensym and Gensym Solution Partner EDS developed an oil field production
management system for the Eastern Trough Area Project (ETAP) in the North
Sea. A joint project of British Petroleum, Shell, Esso, Agip, Total,
Murphy, and Moex, ETAP initially entails the integrated development of
seven oil and gas accumulations. Gensym's G2 was chosen for the Integrated
Production Management Environment (IPME) for ETAP's Central Processing
Facility that acts as an export hub for all the oil and gas produced. G2
applications are used for an operator advisory system, a production
forecasting system, and a capacity allocations system.
Citgo PETROLEUM CORPORATION - OIL AND GAS
To improve plant safety and optimize its production process to achieve
greater economies of scale, CITGO Petroleum Corp. has signed a multi-
refinery agreement with Gensym that provides for site-wide use of Gensym
software at CITGO refineries in Corpus Christi, Texas; Lake Charles,
Louisiana; and Lemont, Illinois for intelligent decision support and
optimization
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applications. CITGO's Corpus Christi refinery was recognized by CONTROL
magazine as the 1996 Plant of the Year, based partly on its G2
applications. At its Corpus Christi plant, CITGO uses Gensym software to
provide real-time, on-line standard operating procedures that enable
better communication of knowledge between different operators and shifts.
COMPUTER SCIENCES CORPORATION - COMMUNICATIONS
Computer Sciences Corporation (CSC) uses Gensym's products as the "brains"
of a new class of Information Security Systems (ISS). Combining the output
from other security tools, network management tools, and systems
management tools with the knowledge of security experts, CSC's ISS applies
the power of Gensym's reasoning engines in real time to identify security
attacks that cannot be detected by any one tool. Once detected,
notification of a potential attack is broadcast immediately with a format
and content appropriate to the different audiences receiving it. The
system uses multiple communications media for notification, including on-
screen alarms, paging, and e-mail and, in the absence of a response, can
automatically escalate the problem.
ERICSSON HEWLETT-PACKARD TELECOMMUNICATIONS (EHPT) -- TELECOMMUNICATIONS
As an OEM partner for Gensym, EHPT has chosen Gensym's G2 software as the
foundation for its Fault Management eXpert (FMX), an add-on to their Fault
Manager product that intelligently handles network faults. Designed to
improve network efficiency and service quality, FMX gives operators a way
to distill network experts' knowledge and use it to automate operator
tasks. By enabling routine and tedious tasks to be automated, FMX frees
operators to focus on important problems, detect them sooner, solve them
quickly, and thereby improve service quality.
EUMETSAT - TELECOMMUNICATIONS
Comprising 17 member states, the European Organization for the
Exploitation of Meteorological Satellites (EUMETSAT) was created to
establish, maintain, and exploit European meteorological satellite
systems. EUMETSAT is developing a new family of spacecraft, Meteosat
Second Generation (MSG), which are designed to provide comprehensive
weather data for European meteorologists. First launch is planned for
2000, and the completed system is designed to provide frequent and
comprehensive meteorological data until at least 2012. Using Gensym's G2
software, Gensym Solution partner Science Systems is developing an
intelligent system for the MSG project that will monitor and control both
the MSG satellites and the ground control centers.
IMC-AGRICO CO. - PROCESS/MINING
IMC-Agrico, the world-leading phosphate supplier, made an initial purchase
of licenses and services for Gensym's intelligent software in 1997 as the
first step in what the two companies anticipate will be a strategic
technology relationship between them. Using Gensym software, IMC-Agrico is
developing Web-based applications for information gathering, as well as
advanced process control of its fertilizer and animal feed production.
IMC-Agrico anticipates a return on its initial investment of $1 million
per site in the first year.
LAFARGE - PROCESS/CEMENT
Lafarge, the world's second largest manufacturer of cement, has G2-based
intelligent systems at 35 of its 65 cement plants around the world.
Lafarge started using G2 in 1992 to control its cement kilns. Combining
fuzzy logic and expert system technology, its advanced kiln control
applications allow Lafarge to deploy proprietary knowledge enterprise-wide
and standardize control in its cement plants around the world. Lafarge has
now logged more than one million hours of on-line cement kiln control
using G2. These applications have helped the company optimize the cement-
producing process, saving money, improving product quality, and reducing
emissions. Lafarge's recent orders for G2 are for intelligent systems to
control pre- and post-kiln operations, including raw material grinding and
clinker grinding. The goal of the new applications is to further improve
product quality and the economics of production.
LOGISTICS INTEGRATION AGENCY - GOVERNMENT
The U.S. Army's Logistics Integration Agency (LIA) is using ReThink,
Gensym's process modeling and simulation tool, to better understand the
Army's supply chain. The supply chain is complex and prone to inefficient
use, resulting in inventory tracking problems, long lead times, and
financial management difficulties. With ReThink, LIA constructed an
animated model of the entire supply chain, from the retail level to the
troops in the field. This model supports "what-if" analysis and can
measure service times and costs, inventory levels, resource requirements,
and financial performance. ReThink has given senior officers their first
end-to-end view of the supply process, has become an important training
tool for military logisticians, and is the key element in a newly-
established laboratory for logistics policy studies.
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MANITOBA - GOVERNMENT
The Provincial Government of Manitoba has been using ReThink to support
its Better Systems Initiative. The purpose of the initiative is to use
information and Internet technologies to improve government services.
Manitoba has used Gensym's ReThink to design and re-engineer its core
business and human services processes in pursuit of the initiative's
visionary goals.
MOTOROLA SATELLITE COMMUNICATIONS - Telecommunications
Utilizing a network of 66 low earth orbit satellites linked to ground
stations around the world, the IRIDIUM(R) network is a global personal
communications system designed to handle voice, data, fax, and paging
transmissions. IRIDIUM satellites will feature moving cells that can be
shared by access providers worldwide. Motorola's Satellite Communications
Group in Chandler, Arizona relies on Gensym's G2 and Fault Expert software
to manage this complex network and keep it operational.
THE PANAMA CANAL COMMISSION - Transportation
The Panama Canal Commission selected Gensym's G2 product to build a
critical component of its Enhanced Vessel Traffic Management System
(EVTMS). This system is designed to develop and monitor transit schedules
for all ships traveling through the canal. The schedules involve the
complex coordination of resources such as tug boats and locomotives. The
location and status of all ships and resources are monitored, and
schedules are regenerated as necessary. EVTMS will provide the canal with
Y2K compliant, 24x7 automated support for canal operations when control of
the canal reverts to Panama.
SALES AND MARKETING
In order to reach the broadest possible market, the Company's business
units utilize their direct sales resources and over 100 selected marketing
partners.
The Company markets its products in North America, Europe, Africa, and
parts of Asia through its business units, which together employ 31
salespersons and 23 solutions engineers as of December 31, 1998. As of
December 31, 1998, the Company had nine sales offices in North America and
direct sales offices in Australia, France, Germany, Italy, Japan, the
Netherlands, Singapore, Sweden, Tunisia and the United Kingdom. In 1996,
1997, and 1998, the Company received 42%, 46%, and 47% of its total revenues,
respectively, from international operations. See Note 8 of Notes to
Consolidated Financial Statements for financial information by geographic
area.
The Company's four strategic business units sell to major accounts and
provide face-to-face contact with customers, both directly and through
partners. Solutions engineers perform demonstrations at customer sites and
assist customers in evaluating their technical requirements and in
implementing G2 application prototypes. Regular seminars and workshops are
hosted at the Company's larger offices to demonstrate the Company's products.
The Company offers basic and advanced training courses that teach prospective
and new customers how to build application solutions using the Company's
products.
The Company also distributes its products through 167 systems integrators
and value-added resellers, who are selected for their capability to add
substantial value by providing end users with focused application solutions
built on G2. These systems integrators and VARs currently include
organizations such as ABB, Control Software, EDS, Siebe Foxboro, Siemens,
Science Systems, and L3 Communications. Product revenues from systems
integrators and value-added resellers represented over 28%, 35%, and 25% of
the Company's product revenues for 1996, 1997, and 1998, respectively.
Gensym markets its products in Japan, Brazil, South Africa and certain
other countries through distributors. These distributors have technical
competence in the application of G2, market the Company's products, provide
local training and support assistance to customers, translate documentation,
help localize software, and provide systems integration services. Sales of
the Company's products by distributors, primarily the Company's Japanese
distributor, accounted for 14%, 8%, and 3% of the Company's product revenues
in 1996, 1997, and 1998, respectively.
Gensym also licenses technology to OEMs, who embed it within their product
offerings. Gensym has established relationships with several OEMs including
Ericsson Hewlett-Packard Telecommunications ("EHPT"), an independent software
company established by Ericsson and Hewlett Packard, and Motorola. EHPT has
chosen Gensym's G2 software as the foundation for its Fault Management eXpert
(FMX) product that intelligently handles network faults. Motorola uses
Gensym's G2 technology for the intelligence within their Network Health
Analyzer (NHA), a new product within their cellular infrastructure family.
The Company's marketing personnel engage in a variety of activities,
including lead generation, seminars, trade shows, public relations, direct
marketing, advertising, and promotion of customer applications for
publication in industry magazines and journals. More than 300 case studies
of successful G2 applications have been documented.
11
SERVICE AND SUPPORT
Gensym believes that a high level of customer service and support is
critical to customer satisfaction and project and application success. Most
Gensym customers attend one to three weeks of training and implement their
applications using the development features of Gensym software. The Company
offers a regular schedule of courses in its offices in North America, Europe,
and Asia/Pacific, and special on-site training courses are offered on a
demand basis around the world. Direct application engineering services are
available to customers around the world, to support end-users as well as
Gensym marketing partners.
The Company offers several customer service options that all include
various levels of telephone support, software updates for major releases, FTP
bulletin board access, membership to Gensym User Society and access to
HelpLink, a workflow enabled web application that greatly enhances the
service experience. The highest level of customer service support includes
24x7 callback service. Maintenance is mandatory for the first year after
purchase and may be renewed in subsequent years. Gensym typically charges a
percentage of the list price license fee of the underlying product for
customer service and offers discounts for multiple year customer support
contracts. The Company has service centers located in North America and in
Europe. Service is also provided by local marketing partners in Japan and in
other areas of the world.
Gensym offers a variety of application engineering and consulting services
on a fee-for-service basis. Gensym has expertise in applying its software in
a variety of areas including network and systems management; manufacturing
process management; process design, modeling, and simulation; pharmaceutical
process design and control; water treatment; logistics; transportation; and
finance. A key mission of the consulting staff is to assist partners, as
well as end-users, in the successful development and deployment of
intelligent systems applications based on G2. As of December 31, 1998, the
Company's business units together employed a staff of 44 full-time
consultants, which they supplement, when necessary, with external
contractors.
The Company offers a progressive series of introductory, intermediate and
advanced training courses for customers, partners and potential users of its
products. The courses are taught at the Company's corporate headquarters in
Cambridge, Massachusetts, at its worldwide sales offices, and at customer
locations. In 1998, more than 1,000 individuals worldwide completed courses
offered by the Company.
Gensym provides continuing support to the Gensym Users Society, an
organization of all G2 users covered by current maintenance contracts. The
Society sponsors an annual worldwide meeting plus additional regional and
local meetings. These meetings are organized as professional technical
conferences, with formal presentations of G2 applications by end-users and
partners, company and product updates by Gensym, product planning forums,
panel discussions, tutorials, workshops, and site visits.
RESEARCH AND DEVELOPMENT
The Company believes that its future success will depend upon its ability
to enhance existing products as well as to develop and introduce new products
that keep pace with technological developments in the marketplace and address
the increasingly sophisticated needs of its customers. The Company intends
to expand existing product offerings and to introduce new applications.
While the Company expects that certain new products will be developed
internally, the Company may, based on timing and cost considerations, acquire
or license technology and/or products from third parties or consultants.
New products and enhancements to existing products are typically developed
in response to discussions at user groups and customer feedback obtained by
the Company's customer support and consulting personnel. New product
initiatives are also taken to address targeted markets and industry
standards. Recent areas of focus include conformance to Microsoft Windows
and NT standards, CORBA compliance, component-based product architectures,
Internet and World Wide Web technologies (standard browsers and Java/RMI),
and agent-based intelligent systems.
As of December 31, 1998, Gensym had 52 employees engaged in research and
development, including software and hardware engineering, test and quality
assurance and technical documentation. In 1996, 1997, and 1998 Gensym's
research and development expenditures totaled $6.0 million, $7.0 million, and
$6.0 million, respectively, representing 16.1%, 19.6%, and 17.2% of total
revenues, respectively.
COMPETITION
The Company believes that there are no other commercially available
products that offer the full range of capabilities embodied in the Company's
products. While a number of software companies offer products that perform
certain of the functions of G2 for specific applications, the Company
believes that its products offer, as a single seamlessly integrated
environment, the most comprehensive set of software technologies available to
build successfully a broad range of intelligent system applications. Across
all of the Company's markets, competition includes "point solutions," real-
time and expert system products and traditional programming or internally
developed software. In addition, virtually all of the Company's customers
have significant investments in their existing solutions and have the
resources necessary to enhance existing products and to develop future
products.
Certain companies such as Objective Systems Integrators, Inc., Micromuse,
Systems Management Arts (SMARTS), and Pavilion sell "point solutions" that
compete with the Company's products with respect to specific applications or
uses. However, an
12
intelligent system based on point solutions requires the integration of
various software packages from different vendors, and is often difficult to
maintain. Although they may provide a faster implementation, such systems may
fail to provide the capabilities and flexibility needed to satisfy the
changing requirements of a dynamic complex environment. Point solutions may
also fail to provide the extensibility to add rules and neural networks, and
may be difficult to migrate to more powerful computers.
Several companies, including Ilog S.A., offer products with limited real-
time or expert system development capabilities at lower price points than
those provided by the Company. These products often require extensive
programming with languages such as C or C++ for complete implementation. The
Company believes that these products lack the comprehensive capabilities of
its G2 environment and G2-based products, and therefore have limitations in
the types of operational problems that they can address relative to G2.
Some potential customers opt to build their own intelligent systems using
traditional programming languages. These systems require that knowledge be
programmed, usually at a high cost, and are typically difficult to adapt,
reuse, maintain, and scale up. Building an intelligent system using
traditional programming is a major effort that is often impractical --
particularly for applications that work in real time.
The principal competitive factors in all of the Company's markets are
functionality, ease of use, price, distribution capabilities, quality,
performance, customer support, and availability of application software
implementation services. The Company believes that its products are superior
in terms of functionality, ease of use, and performance in the advanced
applications that constitute the Company's principal market, and that it
competes favorably on the basis of these factors. In order to maintain its
competitive position, the Company must continue to enhance its existing
products and introduce new products that meet evolving customer requirements.
It must also maintain a valid perceived value proposition in comparison with
its expert systems competitors. There is no assurance that the market
position or the competitive advantages of the Company will continue. See
"Certain Factors That May Affect Future Results - Competition."
PROPRIETARY RIGHTS
The Company relies primarily on a combination of patent law, copyright law
and trade secret law to protect its proprietary technology. The Company also
has internal policies and systems to limit access to and keep confidential
its trade secrets. The Company distributes its products under software
license agreements that contain various provisions to protect the Company's
ownership of and the confidentiality of the underlying technology. The
Company also requires its employees and other parties with access to its
confidential information to execute agreements prohibiting the unauthorized
use or disclosure of the Company's technology. In addition, the Company
periodically reviews its proprietary technology for patentability and has one
patent covering specific aspects of G2. The Company has also placed
technical inhibitors in its software that prevent the software from running
on unauthorized computers. Despite these precautions, it may be possible for
a third party to misappropriate the Company's technology or to independently
develop similar technology. In addition, effective patent, copyright and
trade secret protection may not be available in every foreign county in which
the Company's products are distributed.
Certain technology used in the Company's products is licensed from third
parties. The Company believes that, in general, comparable licenses are
available on commercially comparable terms from a number of licensors and
does not believe that any of the Company's products are significantly
dependent upon such licensed technologies.
Despite the Company's efforts to protect its proprietary rights, attempts
may be made to copy or reverse engineer aspects of the Company's products or
to obtain and use information that the Company regards as proprietary. There
can be no assurance that others will not develop products that infringe the
Company's proprietary rights or are similar or superior to those developed by
the Company. Policing the unauthorized use of the Company's products is
difficult. Litigation may be necessary in the future to enforce the Company's
intellectual property rights, to protect the Company's trade secrets or to
determine the validity and scope of the proprietary rights of others. Such
litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's business, results of
operations and financial condition. Also, there can be no assurance that
third parties will not assert infringement claims against the Company in the
future with respect to current or future products. Any such assertion could
require the Company to enter into royalty arrangements or result in costly
litigation, which could have a material adverse effect on the Company's
business, results of operations and financial condition.
Gensym(R), G2(R), NeurOn-Line(R), ReThink(R), and Operations Expert(R) are
registered trademarks of the Company. The Gensym logo, GDA, ReThink, G2
WebLink, and OPEX are trademarks of the Company. The Company has filed
applications to register Gensym, G2, NeurOn-Line, and OPEX in certain foreign
jurisdictions. In addition, the Company has an exclusive, worldwide,
royalty-free, perpetual license from Microsoft Corporation to use the
trademark Telewindows.
BACKLOG
The Company ships software products within a short period after receipt of
an order and typically does not have a material backlog of unfilled orders of
software products. Therefore, revenues from software licenses in any quarter
are substantially dependent on orders booked in that quarter.
13
EMPLOYEES
As of December 31, 1998, the Company had 256 full-time employees,
including 97 in sales and marketing, 52 in product development, 47 in
consulting services, 27 in customer support, production and licensing, and
educational services, and 33 in general and administrative functions. None
of the Company's employees is represented by a labor union, and the Company
believes that its employee relations are good.
ITEM 2. PROPERTIES
The Company's headquarters and principal operations are located in a
leased facility with 52,322 square feet in Cambridge, Massachusetts. The
Company's lease expires on December 31, 2000, with an option to renew for an
additional term of five years. In addition to rental expenses, the Company
must also pay an allocated portion of operating expenses and taxes each year.
The Company also leases sales office space in the metropolitan areas of
several cities throughout North America, as well as Australia, France,
Germany, Italy, the Netherlands, Singapore, Sweden, Tunisia and the United
Kingdom. The Company has its European headquarters in Leiden, The
Netherlands, where it leases over 9,000 square feet of office space. The
Company's aggregate rental expense, net of rental income from sub-leases, for
all facilities during 1998 was $1.8 million. Gensym believes that its
existing facilities are adequate for its current needs and that suitable
additional space will be available as required.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's securityholders during
the fourth quarter of 1998.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company and their respective ages as of
March 10, 1999 are as follows:
Name Age Position
Lowell B. Hawkinson 56 Chairman of the Board of Directors, Chief Executive Officer, Treasurer and Secretary
Robert L. Moore 56 President and Director
William H. Wood 60 Senior Vice President, Communications Business Unit
James T. Pepe 54 Vice President, Product Development
Mark H. Whitworth 47 Vice President, Advanced Systems Business Unit
Carl Davies 37 Vice President and Managing Director, EMA
Mr. Hawkinson, a founder of the Company, has served as Chairman of the Board,
Chief Executive Officer, Treasurer and Secretary since September 1986. Prior
to founding the Company, Mr. Hawkinson was a Manager of Expert Systems
Development at Lisp Machines Inc., a specialty computer manufacturer, from
1983 to 1986. From 1973 to 1983, Mr. Hawkinson was Research Associate in the
field of artificial intelligence at the Laboratory for Computer Science at
the Massachusetts Institute of Technology. Mr. Hawkinson is also a director
of GenRad, Inc.
Dr. Moore, a founder of the Company, has served as President and a director
since September 1986. Prior to founding the Company, Dr. Moore founded and
was Vice President of the Process Systems Division of Lisp Machines Inc. from
1983 to 1986. From 1981 to 1983, Dr. Moore was President of Sentrol Systems
Inc., a supplier of process control systems. Dr. Moore received his
undergraduate degrees in Electrical Engineering and Engineering Mathematics
from the University of Michigan, his Ph.D. degree from the Massachusetts
Institute of Technology, with a major in Automatic Control and a minor in
Industrial Management.
Mr. Wood has served as Vice President, Communications Business Unit since
March 1997. Since September 1997 he has served concurrently as Vice
President of Corporate Marketing. From July 1995 through December 1996 Mr.
Wood was Vice President and General Manager, North American Operations of
Information Systems Management at Bull Information Systems. Mr. Wood held
various senior management positions at Candle Corporation from 1984 to July
1995, where he most recently served as Vice President of Worldwide Marketing.
His prior sales and marketing experience includes positions with IBM and
Xerox. Mr. Wood has a B.S. in Mechanical Engineering from University of
Cincinnati.
Dr. Pepe joined the Company in June 1994 as Vice President of Product
Development. From 1990 to 1994, Dr. Pepe served with Digital Equipment
Corporation as Group Manager for transaction processing software development.
Dr. Pepe holds SB, SM, and Ph.D. degrees in mathematics from the
Massachusetts Institute of Technology.
Mr. Whitworth joined the Company in July 1992 as its Director of Consulting
Services and has served as Vice President, Advanced Systems Business Unit
since January 1997. From May 1995 to December 1996 Mr. Whitworth served as
the Vice President of Consulting Services. Prior to joining the Company, Mr.
Whitworth was Director of Consulting Services at MainStream Software
14
Company from 1990 to 1992. Mr. Whitworth has an A.B. in Mathematics from
Colby College and an M.S. in Computer Science from the University of Oregon.
Mr. Davies joined the Company in 1993 as an Area Sales Manager for the United
Kingdom region. He was promoted in 1996 to Director of Sales for EMA
(Europe/Middle East/Africa) and in 1998 to Vice President of Operations for
EMA. Previously, Mr. Davies worked with British Petroleum as a software and
systems engineer, two years of which were spent working with BP Ventures.
Mr. Davies holds a B.S. degree in Mechanical Engineering and a Masters degree
in Systems Engineering from the University of Wales Institute of Science and
Technology, Cardiff, Wales.
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
(A) MARKET INFORMATION
The Common Stock of the Company is traded on The Nasdaq Stock Market
("Nasdaq") under the symbol "GNSM". The Common Stock was first traded on
Nasdaq on February 16, 1996. Prior to the Company's initial public offering
of Common Stock ("the Offering") there was no established public trading
market for the Company's shares of Common Stock.
The table below sets forth the high and low sales prices of the Company's
Common Stock by quarter, for the years 1997 and 1998.
1997 High Low
------------------- ------------ ----------
First quarter 15 1/4 7 5/8
Second quarter 7 4 1/2
Third quarter 6 4 1/4
Fourth quarter 7 1/4 4 9/16
1998 High Low
------------------- ------------ ----------
First quarter 8 7/8 4 9/16
Second quarter 8 3/4 4 5/16
Third quarter 4 11/16 2 15/16
Fourth quarter 4 11/16 1 3/4
The Company has never declared or paid cash dividends on its capital
stock. The Company does not anticipate paying any cash dividends in the
foreseeable future. Payment of future dividends, if any, will be at the
discretion of the Company's Board of Directors after taking into account
various factors, including the Company's financial condition, operating
results, current and anticipated cash needs and plans for expansion.
The number of holders of record of the Company's Common Stock at March 25,
1999 was 108. This number does not include stockholders for whom shares are
held in a "nominee" or "street" name.
(B) STOCK REPURCHASE PROGRAM
In the third quarter of 1998, the Company began a program to repurchase up
to 650,000 shares of its Common Stock on the open market. As of December 31,
1998, 345,200 shares had been repurchased at a cost of $1,278,000.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated balance sheet data presented below as of
Decembers 31, 1998 and 1997 and the selected consolidated statement of
operations data for each of the three years in the period ended December 31,
1998 are derived from the Company's Consolidated Financial Statements,
included elsewhere in this Annual Report, which have been audited by Arthur
Andersen LLP, independent public accountants (the "Consolidated Financial
Statements"). The selected consolidated balance sheet data presented below
as of December 31, 1996, 1995, and 1994, and the selected consolidated
statement of operations data for the years ended December 31, 1995 and 1994,
are derived from the Company's Consolidated Financial Statements, not
included in this Annual Report on Form 10-K, all of which have been audited
by Arthur Andersen LLP, independent public accountants. These data should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial
Statements and related Notes included elsewhere in this Annual Report on
Form 10-K.
15
YEAR ENDED DECEMBER 31,
1998 1997 1996 1995 1994
----------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues:
Product $16,910,670 $18,433,520 $21,358,295 $16,438,400 $11,426,593
Service 18,067,035 17,075,603 15,877,240 11,702,577 8,164,778
----------------------------------------------------------------------------------
Total revenues 34,977,705 35,509,123 37,235,535 28,140,977 19,591,371
Cost of Revenues 8,697,594 9,352,348 7,385,215 5,314,654 2,823,037
----------------------------------------------------------------------------------
Gross profit 26,280,111 26,156,775 29,850,320 22,826,323 16,768,334
----------------------------------------------------------------------------------
Operating expenses:
Sales and marketing 18,275,852 18,802,113 17,432,861 14,568,045 9,371,574
Research and development 6,022,931 6,977,143 5,983,741 5,267,461 4,590,220
General and administrative 4,133,849 4,528,147 3,699,254 2,619,103 2,630,943
Restructuring charge - 1,557,253 - - -
----------------------------------------------------------------------------------
Total operating expenses 28,432,632 31,864,656 27,115,856 22,454,609 16,592,737
----------------------------------------------------------------------------------
Operating income (loss) (2,152,521) (5,707,881) 2,734,464 371,714 175,597
Other income, net 714,509 779,118 517,758 236,030 258,077
----------------------------------------------------------------------------------
Income (loss) before provision for
income taxes (1,438,012) (4,928,763) 3,252,222 607,744 433,674
Provision for income taxes 50,000 40,000 1,204,000 411,000 302,000
----------------------------------------------------------------------------------
Net income (loss) $(1,488,012) $(4,968,763) $ 2,048,222 $ 196,744 $ 131,674
==================================================================================
Basic income (loss) per share (1) (2) $(0.23) $(0.79) $0.35 $0.05 $0.03
==================================================================================
Diluted income (loss) per share (1) (2) $(0.23) $(0.79) $0.33 $0.04 $0.03
==================================================================================
Weighted average common shares
outstanding (1) (2) 6,371,190 6,309,815 5,909,511 3,993,600 3,990,531
==================================================================================
Weighted average common shares outstanding
assuming dilution (1)(2) 6,371,190 6,309,815 6,286,170 4,762,245 4,758,411
==================================================================================
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments $14,533,627 $15,801,349 $19,589,852 $ 5,092,201 $ 6,772,671
Working capital 14,650,126 15,148,820 20,469,778 6,176,328 6,585,277
Total assets 28,267,762 31,517,107 36,257,621 17,846,495 14,335,231
Total stockholders' equity $17,483,311 $19,828,365 $24,068,455 $ 8,610,577 $ 8,360,244
(1) Computed as described in Note 1(i) of Notes to Consolidated Financial
Statements.
(2) Income (loss) per share has been restated for the effect of adopting SFAS
No. 128, Earnings per Share
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company was incorporated in 1986 to provide software products for
intelligent operations management. The Company's core product, G2, and G2-
based products are sold to customers for a broad array of intelligent
operations management applications in a wide range of industries, including
manufacturing, telecommunications, government, aerospace, transportation, and
financial services. In addition, the Company derives significant service
revenues from maintenance contracts, consulting services, and training
courses related to its software products.
The Company markets and sells its products through its direct sales force
in the United States, Europe, Africa, and Asia, as well as through selected
distributors in other countries, including Japan. The Company also sells its
products through value-added resellers and systems integrators, who provide
consulting services and integrated solutions to their customers. The Company
further licenses technology to OEMs, who embed it within their product
offerings.
In order to better meet the buying requirements of companies in its
primary target markets, the Company has reorganized into four business units:
Manufacturing, Communications, Advanced Systems, and EMA (Europe/Middle
East/Africa). These business units generally have their own specialized
sales, business development, consulting, and product development resources to
provide the level of application and industry specific knowledge needed to
achieve sustained growth, and profitability in their respective markets.
Reorganization of the Company into business units with greater application
focus has entailed a retraining of the sales force and a major change in
account structure.
The Company continued tight control over operating costs throughout 1998,
maintaining level headcount and instituting cost controls as necessary.
16
This Annual Report on Form 10-K contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without
limiting the foregoing, the words "believes," "anticipates," "plans,"
"expects," "intends" and similar expressions are intended to identify
forward-looking statements. There are a number of important factors that
could cause the Company's actual results to differ materially from those
indicated by such forward-looking statements. These factors include, without
limitation, those set forth below under the caption "Certain Factors That May
Affect Future Results".
17
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of total revenues,
consolidated statements of operations data for the periods indicated:
YEAR ENDED DECEMBER 31,
1998 1997 1996
--------------- ---------------- ----------------
Revenues:
Product 48.3% 51.9 % 57.4 %
Service 51.7 48.1 42.6
--------------- ---------------- ----------------
Total revenues 100.0 100.0 100.0
Cost of revenues 24.9 26.3 19.9
--------------- ---------------- ----------------
Gross margin 75.1 73.7 80.1
--------------- ---------------- ----------------
Sales and marketing 52.3 53.0 46.8
Research and development 17.2 19.6 16.1
General and administrative 11.8 12.8 9.9
Restructuring charge - 4.4 -
--------------- ---------------- ----------------
Total operating expenses 81.3 89.8 72.8
--------------- ---------------- ----------------
Operating income (loss) (6.2) (16.1) 7.3
Other income, net 2.0 2.2 1.4
--------------- ---------------- ----------------
Income (loss) before provision for
income taxes (4.2) (13.9) 8.7
Provision for income taxes 0.1 0.1 3.2
--------------- ---------------- ----------------
Net income (loss) (4.3) % (14.0) % 5.5 %
=============== ================ ================
18
YEARS ENDED DECEMBER 31, 1998 AND 1997
REVENUES
The Company's operating revenues are derived from two sources: product
licenses and services. Product revenues include revenues from sales of
licenses for use of the Company's software products. Service revenues
consist of fees for maintenance contracts, consulting services, and training
courses related to the Company's products.
Total revenues were $35.0 million for the year ended December 31, 1998 as
compared to $35.5 million for 1997, a decrease of $0.5 million or 1.5%. The
decrease in total revenues was attributable to decreased sales of product
licenses, partially offset by an increase in service revenues. International
revenues accounted for 47% and 46% of total revenue in 1998 and 1997,
respectively.
Product. Product revenues decreased to $16.9 million for the year ended
December 31, 1998 from $18.4 million in 1997, a decrease of 8.3%. The
decrease in product revenues reflects, in large part, decreased demand for
the Company's products in the Asia-Pacific region and in the petrochemical
industry where low oil prices have resulted in tighter budgets and delayed
purchase decisions. The Company has historically derived a significant
percentage of its revenue from the petrochemical industry. Also contributing
to decreased revenue is the diversion of resources by some customers and
prospects to address Y2K issues, resources that might otherwise have been
used to develop and deploy G2-based solutions. The Company expects product
revenues to increase, due to the Company's reorganization into more focused
and specialized business units that can provide the required level of
application and industry specific knowledge and products in the Company's
most promising markets and due to anticipated resolution of the Year 2000
issue.
Service. Service revenues increased to $18.1 million for the year ended
December 31, 1998 from $17.1 million in the same period in 1997, an increase
of 5.8%. The increase in service revenues was primarily due to an increase
in application consulting revenues and, to a lesser extent, increased
maintenance fees derived from an increased customer base, partially offset by
a decrease in educational services. Maintenance revenues increased to $9.2
million for the year ended December 31, 1998 from $9.0 million in the same
period in 1997, an increase of 2.2%. Consulting fees increased to $7.6
million for the year ended December 31, 1998 from $6.5 million in the same
period in 1997, an increase of 16.9%. Fees for educational services
decreased to $1.3 million for the year ended December 31, 1998 from $1.6
million in the same period in 1997, a decrease of 18.8%.
COST OF REVENUES
Cost of revenues primarily consists of consulting labor, technical support
costs, and the costs of material and labor involved in producing and
distributing the Company's software. Cost of revenues decreased to $8.7
million in 1998 from $9.4 million in 1997, a decrease of 7.0%. This decrease
was primarily due to a decrease in consulting labor costs. Gross margin on
revenues increased to 75.1% for the year ended December 31, 1998 from 73.7%
in the same period in 1997. The increase in gross profit resulted primarily
from improved utilization of consulting personnel coupled with higher
consulting revenues and lower product distribution costs.
OPERATING EXPENSES
Total operating expenses decreased to $28.4 million for the year ended
December 31, 1998 from $31.9 million in the same period in 1997, a decrease
of 10.8%, due principally to cost reduction measures that were implemented in
1997. Such reductions included a 15% reduction in staff as well as reduced
facilities and related costs.
Sales and Marketing. Sales and marketing expenses consist primarily of
costs associated with personnel involved in the sales and marketing process,
sales commissions, sales facilities, travel and lodging, trade shows and
seminars, advertising, and promotional materials. For the year ended
December 31, 1998, these expenses decreased 2.8% to $18.3 million (52.3% of
total revenues) from $18.8 million (53.0% of total revenues) for the
comparable period in 1997. The decrease in absolute dollars was primarily a
result of a decrease in sales and marketing personnel and the closing and
consolidation of several field sales offices. The Company plans to maintain
approximately the current level of direct sales personnel and marketing
expenses in the coming year. It is expected that sales and marketing expenses
as a percentage of total revenues will decrease from 1998 levels due to
anticipated higher revenues.
Research and Development. Research and development expenses consist
primarily of costs of personnel, equipment, and facilities. Research and
development expenses decreased 13.7% to $6.0 million (17.2% of total
revenues) for the year ended December 31, 1998 from $7.0 million (19.6% of
total revenues) for the comparable period in 1997. The decrease in absolute
dollars was primarily due to a reduction in personnel, the consolidation of
headquarter facilities, and other actions taken in connection with the
Company's restructuring implemented in the previous year. The Company
achieved its major product release goals in 1998. The Company expects that
research and development expenses will decrease slightly as a percentage of
total revenues due to anticipated higher revenues.
General and Administrative. General and administrative expenses consist
primarily of personnel costs for finance, administration, operations,
information systems, and general management, as well as legal and accounting
expenses. These expenses decreased 8.7% to $4.1 million (11.8% of total
revenues) for the year ended December 31, 1998 from $4.5 million (12.8% of
total revenues) for the comparable period in 1997. The decrease in absolute
dollars was primarily due to a reduction in personnel, the consolidation
19
of headquarters facilities, and other actions taken in connections with the
Company's restructuring plan as primarily implemented in 1997.
Restructuring Charge. In 1998, no provision for a restructuring charge
was made. As of June 30, 1998, the Company had taken actions in all intended
areas consistent with its restructuring plan of June 1997 and had
substantially completed that plan.
OTHER INCOME
Other income consists primarily of interest income augmented by net
foreign exchange transaction gains. For the year ended December 31, 1998,
other income decreased to $715,000 from $779,000 for the comparable period in
1997. The decrease was primarily due to the Company's recording of a one-time
benefit in 1997 relating to the recovery of its interest in a joint venture.
The reduction was partially offset by an increase in investment income from
$591,000 in 1997 to $678,000 in 1998. The Company has historically
experienced nominal net foreign exchange transaction gains or losses.
INCOME TAXES
The Company recorded a provision for income taxes of $50,000 and $40,000,
for the years ended December 31, 1998 and 1997, respectively. The provision
in both years represents income taxes on income generated in foreign
jurisdictions. The Company generated a significant tax loss carryforward
during the year ended December 31, 1998. Under SFAS No. 109, the Company
cannot recognize a deferred tax asset for the future benefit of its tax loss
carryforward unless it concludes that it is "more likely than not" that such
deferred tax asset would be realized. Accordingly, the Company has
established a valuation allowance against a portion of its deferred tax asset
to the extent that it cannot conclusively demonstrate that it is "more likely
than not" that these assets will be realized. In determining the amount of
valuation allowance required, the Company considers numerous factors,
including historical profitability, estimated future taxable income and the
volatility of its historical earnings and of the industry in which it
operates.
YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUES
Total revenues were $35.5 million for the year ended December 31, 1997 as
compared to $37.2 million for 1996, a decrease of $1.7 million or 4.6%. The
decrease in total revenues was attributable to decreased sales of product
licenses, partially offset by an increase in service revenues. International
revenues accounted for 46% and 42% of total revenues in 1997 and 1996,
respectively.
Product. Product revenues decreased to $18.4 million for the year ended
December 31, 1997 from $21.4 million in 1996, a decrease of 13.7%. The
decrease in product revenues reflected lower bookings in 1997, which the
Company attributed primarily to the reorganization of the Company's sales
force, especially in the Americas, and a longer sales cycle caused by the
Company's shift to a solutions-oriented approach in the sales and marketing
organizations. In addition, orders from the Company's distributor in Japan
slowed considerably in the year ended December 31, 1997 as compared to 1996.
Service. Service revenues increased to $17.1 million for the year ended
December 31, 1997 from $15.9 million in the same period in 1996, an increase
of 7.5%. The increase in service revenues was primarily due to increased
maintenance fees derived from an increased customer base. Maintenance fees
increased to $8.9 million for the year ended December 31, 1997 from $7.9
million in the same period in 1996, an increase of 13.6%. Consulting
revenues increased to $6.5 million for the year ended December 31, 1997 from
$6.1 million in the same period in 1996, an increase of 6.2%. Fees for
educational services increased $200,000 for the year ended December 31, 1997,
as compared to the same period in 1996.
COST OF REVENUES
Cost of revenues increased to $9.4 million for the year ended December 31,
1997 from $7.4 million in 1996, an increase of 26.6%. This increase was
primarily due to an increase in consulting labor costs. Gross margin on
revenues decreased to 73.7% for the year ended December 31, 1997 from 80.1%
in the same period in 1996. This decrease in gross margin reflected
primarily a higher percentage of lower margin service revenues in 1997 as a
percentage of total revenues, and to a lesser extent, an increase in
consulting personnel, including outside contractors, and in technical support
personnel.
OPERATING EXPENSES
Sales and Marketing. For the year ended December 31, 1997, sales and
marketing expenses increased 7.9% to $18.8 million (53.0% of total revenues)
from $17.4 million (46.8% of total revenues) for the comparable period in
1996. The increase in absolute dollars was primarily a result of the
continued investment in the Company's global sales and marketing resources,
including the opening of new sales offices in the United States and in
Asia/Pacific. The increase as a percentage of total revenues was primarily
due to the lower product revenues reported in 1997 as compared to 1996.
20
Research and Development. Research and development expenses increased
16.6% to $7.0 million (19.6% of total revenues) for the year ended December
31, 1997 from $6.0 million (16.1% of total revenues) for the comparable
period in 1996. The increase in absolute dollars was primarily due to an
increase in engineering personnel devoted to enhancements, new features, and
quality assurance for the G2 product family, as well as to the development of
new products. The Company achieved several major commercial releases of the
Company's products in 1997. The increase as a percentage of total revenues
was primarily due to the lower product revenues reported in 1997 as compared
to 1996.
General and Administrative. General and administrative expenses increased
22.4% to $4.5 million (12.8% of total revenues) for the year ended December
31, 1997 from $3.7 million (9.9% of total revenues) for the comparable period
in 1996. The increase in absolute dollars was primarily due to amortization
of the cost of a newly implemented financial information system and costs
related to being a public company, such as proxy statement preparation and
shareholders' meeting expenses. The increase as a percentage of total
revenues was due to the above factors as well as to the lower product
revenues reported in 1997 as compared to 1996.
Restructuring Charge. In June 1997, the Company implemented a plan of
restructuring intended to lower operating expenses in subsequent periods by
reducing its workforce by approximately 15%, closing and consolidating
several field sales offices, and consolidating office space in its corporate
headquarters. Accordingly, the Company recorded a restructuring charge of
approximately $2.0 million in the quarter ended June 30, 1997. This amount
included $850,000 for estimated rent and lease termination costs for
consolidating facilities and equipment, $725,000 for severance and other
employee termination costs, and $425,000 for the write-off of certain assets
that would provide no future benefit to the Company. In the third quarter of
1997, the Company recorded a restructuring credit of $485,000 for the
recovery of its investment in a joint venture, a portion of which had been
written off in the previous quarter. In 1996, no provision for a
restructuring charge was made.
OTHER INCOME
Other income for the year ended December 31, 1997 consisted primarily of
interest income, partially offset by net foreign exchange transaction losses
and by the Company's 50% share of the net loss in a joint venture investment.
For the year ended December 31, 1997, other income increased to $779,000 from
$518,000 for the comparable period in 1996. In 1997, the Company sold its
interest in the joint venture and recorded a benefit from the recovery of its
investment. The increase in other income is primarily due to the benefit
recorded in 1997, partially offset by an increase in net foreign exchange
transaction losses for the year ended December 31, 1997 as compared to the
same period in 1996. Interest income was $590,000 in 1997 as compared to
$608,000 in 1996.
INCOME TAXES
The Company generated a significant tax loss carryforward during the year
ended December 31, 1997. Under SFAS No. 109, the Company cannot recognize a
deferred tax asset for the future benefit of its tax loss carryforward unless
it concludes that it is "more likely than not" that such deferred tax asset
would be realized. Accordingly, the Company has established a valuation
allowance against a portion of its deferred tax asset to the extent that it
cannot conclusively demonstrate that it is "more likely than not" that these
assets will be realized. In determining the amount of valuation allowance
required, the Company considers numerous factors, including historical
profitability, estimated future taxable income and the volatility of its
historical earnings and of the industry in which it operates. See Note 4 of
Notes to Consolidated Financial Statements.
SELECTED QUARTERLY OPERATING RESULTS
The Company's operating results have fluctuated in the past and may
fluctuate significantly in the future. Because the Company ships software
products within a short period after receipt of an order, the Company
typically does not have a material backlog of unfilled orders for software
products. Accordingly, revenues from software licenses in any quarter are
substantially dependent on orders for software products booked in the
quarter.
The revenues for a quarter typically include a number of large orders. If
the timing of any of these orders is delayed, it could result in a
substantial reduction in revenues for that quarter. Historically, a majority
of each quarter's revenues from software licenses has come from license
contracts that have been effected in the final weeks of that quarter. Since
the Company's expense levels are based in part on its expectations as to
future revenues, the Company may be unable to adjust spending in a timely
manner to compensate for any revenue shortfall. Accordingly, any revenue
shortfalls would likely have a disproportionate adverse effect on net income.
The following tables present unaudited financial information for the
Company's eight most recent quarters. The following selected quarterly
information includes all adjustments (consisting only of normal recurring
adjustments) that the Company considers necessary for a fair presentation.
The Company believes that quarter-to-quarter comparisons of its financial
results are not necessarily meaningful and that such comparisons should not
be relied upon as an indication of future performance.
21
QUARTER ENDED
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
1998 1998 1998 1998 1997 1997 1997 1997
------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Revenues:
Product $ 3,509 $4,258 $4,520 $4,624 $5,275 $ 3,889 $ 3,337 $ 5,932
Service 4,614 4,489 4,504 4,460 4,236 4,202 4,538 4,099
------- ------ ------ ------ ------ ------- ------- -------
Total revenues 8,123 8,747 9,024 9,084 9,511 8,091 7,875 10,031
Cost of revenues 2,130 2,193 2,127 2,248 2,223 2,388 2,409 2,331
------------------------------------------------------------------------------------------------
Gross margin 5,993 6,554 6,897 6,836 7,288 5,703 5,466 7,700
------------------------------------------------------------------------------------------------
Operating expenses:
Sales and marketing 4,764 4,563 4,686 4,263 4,583 4,471 5,038 4,711
Research and development 1,517 1,516 1,532 1,459 1,554 1,654 1,902 1,866
General and administrative 1,123 934 1,002 1,074 1,084 1,150 1,293 1,001
Restructuring charge (credit) - - - - - (485) 2,042 -
------------------------------------------------------------------------------------------------
Total operating expenses 7,404 7,013 7,220 6,796 7,221 6,790 10,275 7,578
------------------------------------------------------------------------------------------------
Operating income (loss) (1,411) (459) (323) 40 67 (1,087) (4,809) 122
Other income, net 203 179 171 162 137 507 150 (16)
------------------------------------------------------------------------------------------------
Income (loss) before provision for
income taxes (1,208) (280) (152) 202 204 (580) (4,659) 106
Provision for income taxes - - - 50 - - - 40
------------------------------------------------------------------------------------------------
Net income (loss) $(1,208) $ (280) $ (152) $ 152 $ 204 $ (580) $(4,659) $ 66
================================================================================================
22
QUARTER ENDED
DEC. 31, Sept. 30, JUNE 30, MAR. 31 DEC. 31 Sept. 30, JUNE 30, MAR. 31,
1998 1998 1998 1998 1997 1997 1997 1997
--------- -------- -------- -------- -------- -------- ------- --------
(AS A PERCENTAGE OF TOTAL REVENUES)
Revenues:
Product 43.2% 48.7% 50.1% 50.9% 55.5% 48.1% 42.4% 59.1%
Service 56.8 51.3 49.9 49.1 44.5 51.9 57.6 40.9
-------- -------- ------- -------- ------- ------- -------- -------
Total revenues 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenues 26.2 25.1 23.6 24.7 23.4 29.5 30.6 23.3
Gross margin 73.8 74.9 76.4 75.3 76.6 70.5 69.4 76.7
-------- -------- ------- -------- ------- ------- -------- -------
Operating expenses:
Sales and marketing 58.7 52.1 51.9 47.0 48.2 55.3 64.0 46.9
Research and development 18.7 17.3 17.0 16.1 16.3 20.4 24.2 18.6
General and administrative 13.8 10.7 11.1 11.8 11.4 14.2 16.4 10.0
Restructuring charge (credit) - - - - - (6.0) 25.9 -
-------- -------- ------- -------- ------- ------- -------- -------
Total operating expenses 91.2 80.1 80.0 74.9 75.9 83.9 130.5 75.5
-------- -------- ------- -------- ------- ------- -------- -------
Operating income (loss) (17.4) (5.2) (3.6) 0.4 0.7 (13.4) (61.1) 1.2
Other income, net 2.5 2.0 1.9 1.8 1.4 6.2 1.9 (0.1)
-------- -------- ------- -------- ------- ------- -------- -------
Income (loss) before provision for
income taxes (14.9) (3.2) (1.7) 2.2 2.1 (7.2) (59.2) 1.1
Provision for income taxes - - - 0.6 - - - 0.4
-------- -------- ------- -------- ------- ------- -------- -------
Net income (loss) (14.9)% (3.2)% (1.6)% 1.7% 2.1% (7.2)% (59.2)% 0.7%
======== ======== ======= ======== ======= ======= ======== =======
LIQUIDITY AND CAPITAL RESOURCES
The Company currently finances its operations (including capital
expenditures) primarily through cash flows from operations and its current
cash and short term investment balances. The Company's lease commitments
consist of operating leases primarily for the Company's facilities and
computer equipment. The Company used $654,000 and $2.9 million in cash for
operations for the years ended December 31, 1998 and 1997, respectively, and
generated $3.9 million in cash from operations in 1996. Cash used for
operations in 1998 and 1997 was primarily utilized to fund the Company's net
loss, partially offset by changes in working capital.
At December 31, 1998, the Company had cash, cash equivalents, and short-term
investments of $14.5 million. The Company regularly invests excess funds in
highly-rated money market funds, government securities, and commercial paper.
During 1998, the Company used $1.3 million of its cash to repurchase its
shares on the open market. In addition, the Company received $488,000 in
1998 from the exercise of stock options and the sale of shares through the
employee stock purchase plan. The Company anticipates that it will continue
to repurchase its shares on the open market.
At December 31, 1998, the Company had available a bank line of credit
allowing for borrowings up to $1.0 million and providing for interest at the
prime rate. This bank line of credit will expire on April 30, 2000 and
requires the Company to comply with certain financial ratios, including
minimum levels of net worth and profitability. The Company obtained a waiver
from the bank with respect to the Company not satisfying the profitability
and net worth covenant as of December 31, 1998. There were no borrowings
under the bank line of credit for the year ended December 31, 1998.
Investing activities provided cash of $4.2 million and $1.5 million in
1998 and 1997, respectively, and utilized cash of $7.2 million in 1996. In
1998, the sale of short-term and long-term investments provided $ 5.0 million
in cash which was partially offset by purchases of $843,000 in property and
equipment. The Company expects that its requirements for computers, office
facilities, office fixtures, and office equipment in 1999 will be at or below
its requirements for fiscal 1998 and that such equipment and facilities will
be available when needed.
The Company believes that the available funds and cash generated from
operations will be sufficient to meet the Company's business requirements at
least through December 31, 1999.
23
STOCK REPURCHASE PROGRAM
In the third quarter of 1998, the Company began a program to repurchase up
to 650,000 shares of its Common Stock on the open market. As of December 31,
1998, 345,200 shares had been repurchased at a cost of $1,278,000.
YEAR 2000 DISCLOSURE
Historically, certain computer programs have been written using two
digits, rather than four digits, to define the applicable year. This could
lead, for example, to a computer's interpreting "00" as the year 1900 rather
than the Year 2000. This phenomenon could result in major computer system
failures or miscalculations and is generally referred to as the "Year 2000"
problem or issue.
The Company has developed a phased Year 2000 readiness plan for the
current versions of its products. The plan includes development of corporate
awareness, assessment, implementation (including remediation, upgrading and
replacement of certain product versions), validation testing, and contingency
planning. The Company continues to respond to customer concerns about prior
versions of its products on a case-by-case basis.
The Company has defined "Year 2000 compliant" as the ability to (i)
correctly handle date information needed for the December 31, 1999 to January
1, 2000 date change; (ii) function according to the product documentation
provided for this date change, without changes in operation resulting from
the advent of a new century, assuming correct configuration; (iii) where
appropriate, respond to two-digit date input in a way that resolves the
ambiguity as to century in a disclosed, defined, and predetermined manner;
(iv) if the date elements in interfaces and data storage specify the century,
store and provide output of date information in ways that are unambiguous as
to century; and (v) recognize Year 2000 as a leap year. The Company has not
tested its products on all platforms or all versions of operating systems
that it currently supports and has advised its customers to verify that their
platforms and operating systems support the transition to the Year 2000.
The Company has completed an initial review and assessment of its products
and, with the exception of the products discussed below, the Company believes
that its current products are Year 2000 compliant. For example, the
Company's core G2 product has two built-in techniques for storing and
processing time and date information. These techniques are time stamps and
intervals. Time stamps are 64-bit IEEE floating point numbers. Intervals
are stored as integers. Neither of these representations imposes a practical
limit on the size of the date value stored and do not pose any problems with
the passing of the millennium. Therefore, the Company does not believe that
the Company's products, except those discussed below, will be adversely
affected by date changes to the Year 2000. However, there can be no
assurance that the Company's products contain and will contain all features
and functionality considered necessary by customers, including ISVs, end
users and distributors, to be Year 2000 compliant. In addition, there can be
no assurances that the Company's current products do not contain undetected
errors or defects associated with Year 2000 date functions that may result in
material costs to the Company.
While the Company believes that current versions of its products are Year
2000 compliant, other factors may result in an application created using the
Company's products not being Year 2000 compliant. Some of these factors
include improper programming techniques used by third parties in creating the
application or non-compliance of the underlying hardware, operating system,
or third-party software on which the software runs. Known or unknown errors
or defects in the Company's products could result in delay or loss of
revenue, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs, any of which could
materially adversely affect the Company's business, operating results or
financial condition. Some commentators have predicted significant litigation
regarding Year 2000 compliance issues, and the Company is aware of such
lawsuits against other software vendors. Because of the unprecedented nature
of such litigation, it is uncertain whether or to what extent the Company may
be affected by it.
Testing has revealed that in versions of G2 prior to Rev. 3, a specific G2
system procedure and the use of two-digit years in the built-in displays are
not Year 2000 compliant. These problems were fixed in G2 5.0 Rev. 3 released
in June 1998.
The Company's internal systems include both its information technology
("IT") and non-IT systems. The Company completed a baseline assessment of
its material internal IT systems (including both the Company's own software
products and third-party software and hardware technology) and its non-IT
systems. The Company expects to substantially complete Year 2000 readiness
preparations by the end of September 1999. To the extent the Company is not
able to test the technology provided by third-party vendors, the Company is
seeking assurances from such vendors that their systems are Year 2000
compliant. Although the Company is not currently aware of any material
operational issues or costs associated with preparing its internal IT and
non-IT systems for the Year 2000, the Company may experience material
unanticipated problems and costs caused by undetected errors or defects in
the technology used in its internal IT and non-IT systems. There can be no
assurance that the Company will not experience unanticipated negative
consequences or material costs caused by undetected errors or defects in the
technology used in its internal systems.
The Company does not in general have information concerning the Year 2000
compliance status of its customers. As is the case with other similarly
situated software companies, if the Company's current or future customers
fail to achieve Year 2000 compliance, or if they divert technology
expenditures to address Year 2000 compliance problems, the Company's
business, results of operations, or financial condition could be materially
adversely affected.
24
The Company has funded its Year 2000 plan from operating cash flows and
has not separately accounted for these costs in the past. The Company may
incur additional costs related to the Year 2000 plan for administrative
personnel to manage the project, outside contractor assistance, technical
support for its products, product engineering and customer satisfaction. The
Company may experience material problems and costs with Year 2000 compliance
that could adversely affect the Company's business, results of operations,
and financial condition.
The Company has not fully developed a comprehensive contingency plan to
address situations that may result if the Company is unable to achieve Year
2000 readiness of its initial operations. The costs of developing and
implementing such plan may itself be material. The necessity of a
contingency plan will be evaluated based on the outcome of its assessment and
testing of the Year 2000 readiness of material third-parties. Preparation of
contingency plans is targeted for May 1999 (which plans will thereafter be
revised from time to time as deemed appropriate). Finally, the Company is
also subject to external forces that might generally affect industry and
commerce, such as utility company Year 2000 compliance failures and related
services interruptions.
The Company expects to complete these assessments and testing, as well as
the testing of its internal systems, by the end of September 1999, and does
not anticipate that any of these potential issues will have a material
adverse effect on the Company's business, financial condition and operating
results.
Additionally, there can be no assurance that the Company will not be the
subject of lawsuits regarding the failure of the Company's products (former
or present) in the event they are not Year 2000 compliant. Despite the
testing and remediation efforts undertaken by the Company, the Company's
products may contain errors or defects associated with the Year 2000. Known
or unknown errors or defects in the Company's products could result in delay
or loss of revenue, diversion of development resources, damage to the
Company's reputation or increased service and warranty costs, any of which
could materially adversely affect the Company's business, operating results
and financial condition. In addition, because the computer system in which
the Company's products are used involve different hardware, software and
firmware components from different manufacturers, it may be difficult to
determine which component in a system caused a Year 2000 issue. As a result,
the Company may be subjected to Year 2000-related lawsuits independent of
whether its products are Year 2000 compliant. Any Year 2000 related suits,
if adversely determined, could have a material adverse effect on the
Company's business, operating results and financial conditions.
The foregoing review of the Company's Year 2000 readiness, including
estimates of the time frames and costs for addressing the known Year 2000
issues confronting the Company, is based on management's current estimates,
which were derived using numerous assumptions. There can be no assurance
that these estimates will be achieved and actual events and results could
differ materially from those anticipated. Specific factors that might cause
such material difference include, but are not limited to, the availability of
personnel with required remediation skills, the ability of the Company to
identify and correct all relevant computer code and the success of third
parties with whom the Company does business in addressing their Year 2000
issues.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board released Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS No. 133"). SFAS No. 133 establishes the
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, (collectively
referred to as derivatives) and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
SFAS No. 133 is effective for fiscal quarters beginning after June 15, 1999.
The Companies does not expect the adoption of SFAS No. 133 to have a material
impact to its financial position.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
A number of uncertainties exist that could affect the Company's operating
results, including, without limitation, the following:
Emerging Market for Intelligent Operations Management Systems.
Substantially all of the Company's revenues are derived from the licensing
and support of software products that enable organizations to implement
intelligent operations management systems for decision support and control.
Although many organizations have begun to deploy, or have announced plans to
deploy, intelligent operations management systems, these systems are
different from the basic monitoring and control systems that are
traditionally employed by these organizations. There can be no assurance
that these organizations will be able to introduce intelligent operations
management systems successfully, nor that such systems will gain widespread
acceptance. In addition, the timing of the implementation of intelligent
operations management systems by organizations may be affected by economic
factors, government regulations, and other factors. Delays in the
introduction of intelligent operations management systems or the failure of
these systems to gain widespread market acceptance would materially and
adversely affect the Company's business, results of operations, or financial
condition. In addition, the Company believes that end-users in its markets
are increasingly seeking application-specific products and components as well
as complete solutions, rather than general software tools with which to
develop application-specific functionality and solutions. Meeting this
demand has required the Company to modify its sales approach. The Company is
also increasingly reliant on value-added resellers and systems integrators to
satisfy market requirements. The modified sales approach may also lengthen
the Company's average sales cycle. Failure by the Company to respond
appropriately to shifts in market demand could have a material adverse effect
on the Company's business, results of operations, or financial condition.
25
Dependence Upon Development of Sales and Marketing Force. The Company's
future success will depend, in part, upon the productivity of its sales and
marketing force and the ability of the Company to continue to attract,
integrate, train, motivate and retain new sales and marketing personnel.
There can be no assurance that the Company's investment in sales and
marketing will ultimately prove to be successful. In addition, there can be
no assurance that the Company's sales and marketing organization will be able
to compete successfully against the significantly more extensive and better
funded sales and marketing operations of many of the Company's current and
potential competitors. The Company's inability to manage its sales and
marketing force effectively could have a material adverse effect on the
Company's business, operating results and financial condition.
Variability of Quarterly Operating Results. The Company has experienced,
and may experience in the future, significant quarter-to-quarter fluctuations
in its operating results. The Company has, on occasion, recorded quarterly
losses, and there can be no assurance that revenue growth or profitable
operations can be attained on a quarterly or annual basis in the future. The
Company's sales cycle typically ranges from six to 12 months, and the cost of
acquiring the Company's software, building and deploying applications, and
training users represents a significant expenditure for customers. The
Company's relatively long sales cycle and high license fees, together with
fixed short-term expenses, can cause significant variations in operating
results from quarter to quarter, based on a relatively small variation in the
timing of major orders. Factors such as the timing of new product
introductions and upgrades and the timing of significant orders could
contribute to this quarterly variability. In addition, the Company ships
software products within a short period after receipt of an order and
typically does not have a material backlog of unfilled orders of software
products. Therefore, revenues from software licenses in any quarter are
substantially dependent on orders booked in that quarter. Historically, a
majority of each quarter's revenues from software licenses has come from
license contracts that have been effected in the final weeks of that quarter.
The revenues for a quarter typically include a number of large orders. If
the timing of any of these orders is delayed, it could result in a
substantial reduction in revenues for that quarter. The Company's expense
levels are based in part on expectations of future revenue levels. A
shortfall in expected revenues could therefore result in a disproportionate
decrease in the Company's net income. The Company's financial performance
has generally been somewhat weaker in the first quarter than in the other
fiscal quarters, due to customer purchasing patterns.
Economic Factors. Because capital expenditures are often viewed as
discretionary by organizations, sales of the Company's products for capital
budget projects are subject to general economic conditions. Such capital
expenditures are also susceptible to industry-specific economic downturns.
Specifically, the Company derives a significant portion of its revenues from
the chemical and petrochemical industries. The Company derived 14.5%, 26.8%,
and 19.7%, of its product revenues in the chemical and petrochemical
industries in 1998, 1997, and 1996, respectively. Accordingly, the Company's
future success is dependent upon the continued demand for process control and
optimization software from companies in the chemical and petrochemical
industries. The Company believes that economic downturns and pricing
pressures experienced by chemical and petrochemical companies in connection
with cost-containment measures have led to delays and reductions in certain
capital and operating expenditures by many such companies worldwide. These
industries are highly cyclical and have shown weakened demand in the past,
which has adversely affected the Company's revenues, gross margin, and
operating results during such periods. Future recessionary conditions in the
industries which use the Company's products may adversely affect the
Company's business, results of operations, or financial condition.
Product Concentration. The Company's only current product offerings are
G2, an object-oriented development and deployment environment for building
intelligent operations management systems, and software application products
which operate in conjunction with G2. Accordingly, the Company's business
and financial results are substantially dependent upon the continued customer
acceptance and deployment of G2 and related products. The timing of major G2
releases may affect the timing of purchases of the Company's products. The
Company has introduced several G2-based products for building applications
and is developing others. The Company believes that market acceptance of
these products will be important to the Company's future growth. There can
be no assurance that such products will achieve market acceptance or that new
products will be successfully developed. In addition, the Company relies on
many of its marketing partners to develop G2-based products for specialized
markets. Accordingly, the Company's business and financial results are also
linked to the continued successful product development by its marketing
partners and market acceptance of such G2-based products. Any decline in the
demand for G2 and related products, whether as a result of competitive
products, price competition, the lack of success of the Company's marketing
partners, technological change, the shift in customer demand toward complete
solutions, or other factors, could have a material adverse effect on the
Company's business, results of operations, or financial condition.
New Products and Rapid Technological Change. The market for the Company's
products is relatively new and is characterized by rapid technological
change, evolving industry standards, changes in end-user requirements, and
frequent new product introductions and enhancements. The Company's future
success will depend in part upon its ability to enhance its existing
products, to introduce new products and features to meet changing customer
requirements and emerging industry standards, and to manage transitions from
one product release to the next. The Company has from time to time
experienced delays in introducing new products and product enhancements.
There can be no assurance that the Company will not experience difficulties
that could delay or prevent the successful development, introduction and
marketing of these new products and product enhancements. Also there can be
no assurance that the Company will successfully complete the development of
new or enhanced products, that the Company will successfully manage the
transition to future versions of G2, or that the Company's future products
will achieve market acceptance. In addition, the introduction of products
embodying new technologies and the emergence of new industry standards could
render the Company's existing products and products currently under
development obsolete and unmarketable. From time to time, new products,
capabilities, or technologies may be announced that have the potential to
replace or shorten the life cycle of the Company's
26
existing product offerings. There can be no assurance that announcements of
currently planned or other new product offerings will not cause customers to
defer purchasing existing Company products. See "Emerging Market for
Intelligent Operations Management Systems."
Migration to Microsoft Windows and Object Exchange Standards. The Company
believes that client user interfaces compliant with Microsoft Windows and
MOTIF are increasingly the preferred choice of its customers. In order to
gain wider customer penetration, the Company must respond to this market
choice. Accordingly, the Company is developing and has achieved initial
commercial release of a client access product that is Microsoft Windows and
MOTIF compliant. There can be no assurance that the Company will be
successful in further developing and marketing this new product. Any delay
or failure to bring this product to market could affect the Company's
competitive position or limit its growth opportunities.
Reliance Upon Indirect Distribution Channels and Risks Associated with
Strategic Partner Relationships. The Company sells its products in part
through value-added resellers, systems integrators, OEMs and distributors,
who are not under the control of the Company. Sales of the Company's
products by value-added resellers and systems integrators represented 25%,
35%, and 28% of the Company's product revenues in 1998, 1997, and 1996,
respectively. Sales of the Company's products to and by distributors,
primarily the Company's Japanese distributor, accounted for 3%, 8%, and 14%
of the Company's product revenues in 1998, 1997, and 1996, respectively. The
loss of one or more major third-party distributors, OEMs or resellers of the
Company's products, a significant decline in their sales, or difficulty on
the part of such third-party developers or resellers in developing successful
G2-based products and applications could have a material adverse effect on
the Company's business, results of operations, or financial condition. There
can be no assurance that the Company will be able to attract or retain
additional qualified third-party resellers or that third-party resellers will
be able to effectively sell and implement the Company's products. In
addition, the Company relies on third-party resellers to provide post-sales
service and support to its customers, and any deficiencies in such service
and support could adversely affect the Company's business, results of
operations, or financial condition.
Risks Associated With International Operations. The Company's
international revenues represented 47%, 46%, and 42%, of total revenues in
1998, 1997, and 1996, respectively. Revenues are categorized by the Company
according to product shipment destination and therefore do not necessarily
reflect the ultimate country of installation. The international portion of
the Company's business is subject to a number of inherent risks, including
difficulties in building and managing international operations, difficulties
in localizing products and translating documentation into local languages,
fluctuations in the value of international currencies including the new Euro,
fluctuating import/export duties and quotas, and unexpected regulatory,
economic, or political changes in international markets. In particular, the
continuing economic problems in Asia pose challenges to the Company's sales
and marketing operations in that region. There can be no assurance that these
factors will not adversely affect the Company's business, results of
operations, or financial condition.
Competition. Although the Company believes that there are no other
commercially available products that offer the full range of high-level
capabilities embodied in the Company's products, a number of companies offer
products that perform certain functions of G2 for specific applications. In
all of the Company's markets, there is competition from "point solutions",
real-time and expert system products, and internally developed software. At
the fundamental level, there are commercially available software development
tools that software application developers or potential customers could use
to build software having functionality similar to the Company's products.
Certain companies such as Objective Systems Integrators, Inc., Micromuse,
Systems Management Arts (SMARTS), and Pavilion sell "point solutions" that
compete with the Company's products with respect to specific applications or
uses. Several companies, including Ilog S.A. and System Management Arts,
offer products with limited real-time, expert system, or fault isolation
capabilities at lower price points than those provided by the Company. These
products often require extensive programming with languages such as C or C++
for complete implementation. Although the Company believes that these
products offer a less productive development environment than G2 and that
they lack the comprehensive capabilities of G2-based products, certain
competitors in this category have greater financial and other resources than
the Company and might introduce new or improved products to compete with G2,
possibly at lower prices.
The Company's software is integrated into industry-specific solutions by
value-added resellers. A number of software companies offer products that
compete in specific application areas addressed by these value-added
reseller, such as cement kiln control and refinery scheduling, and they could
be successful in supplying alternatives to products based on the Company's
software.
Many of the Company's customers have significant investments in their
existing solutions and have the resources necessary to enhance existing
products and to develop future products. These customers may develop and
incorporate competing technologies into their systems or may outsource
responsibility for such systems to others who do not use the Company's
products. There is no assurance that the Company can successfully persuade
development personnel within these customers' organizations to use G2-based
products that can cost effectively compete with their internally developed
products. This would reduce the need for the Company's products and services
and limit future opportunities for the Company.
The Company believes that continued investment in research and development
and sales and marketing will be required to maintain its competitive
position. There can be no assurance that competitors will not develop
products or provide services that are superior to the Company's products or
services or achieve greater market acceptance. Competitive pressures faced
by the Company
27
could force the Company to reduce its prices, which could result in reduced
profitability. There can be no assurance that the Company will be able to
compete successfully against current and future sources of competition or
that such competition will not have a material adverse effect on the
Company's business, results of operations, or financial condition.
Potential for Undetected Errors. Complex software products such as those
offered by the Company may contain unintended errors or failures commonly
referred to as "bugs". There can be no assurance that, despite significant
testing by the Company and by current and potential customers, errors will
not be found in new products after commencement of commercial shipments.
Although the Company has not experienced material adverse effects resulting
from any such errors or defects to date, there can be no assurance that
errors or defects will not be discovered in the future that could cause
delays in product introduction and shipments or require design modifications
that could adversely affect the Company's business, results of operations, or
financial condition.
Dependence Upon Proprietary Technology. The Company's success is heavily
dependent upon its proprietary technology. The Company relies upon a
combination of trade secret, contract, copyright, patent, and trademark law
to protect its proprietary rights in its products and technology. The Company
enters into confidentiality and/or license agreements with its employees,
third-party resellers, and end-users and limits access to and distribution of
its software, documentation, and other proprietary information. In addition,
the Company has placed technical inhibitors in its software that prevent such
software from running on unauthorized computers. However, effective patent,
copyright, and trade secret protection may not be available in every country
in which the Company's products are distributed. There can be no assurance
that the steps taken by the Company to protect its proprietary technology
will be adequate to prevent misappropriation of its technology by third
parties, or that third parties will not be able to develop similar technology
independently. In addition, there can be no assurance that third parties
will not assert infringement claims in the future or that such claims will
not be successful.
Dependence on Key Personnel. The Company's success depends in large part
upon certain key employees, including its executive officers, the loss of any
of whom could have a material adverse effect on the Company. The Company's
key employees are not bound by employment agreements that require them to
remain with the Company. The Company's success will depend in significant
part upon its ability to attract and retain highly-skilled management,
technical, and sales and marketing personnel. Competition for such personnel
in the software industry is intense, and there can be no assurance that the
Company will be successful in attracting and retaining such personnel, or
that new key personnel will integrate successfully into the senior management
team. The loss of certain key employees or the Company's inability to attract
and retain other qualified employees or to adequately replace key personnel
who depart the Company could have a material adverse effect on the Company's
business, results of operations, or financial condition.
Year 2000 Compliance. Many installed computer systems and software
products are coded to accept only two digit entries in the date code field.
Beginning in the year 2000, these date code fields will need to accept four
digit entries to distinguish 21st century dates from 20th century dates.
Systems that do not properly recognize such information could generate
erroneous data or cause a system to fail. Although the Company believes that
its current products and systems are Year 2000 compliant, the Company
utilizes third party equipment and software that may not be Year 2000
compliant. Known or unknown errors or defects, with regard to the Year 2000
and thereafter, in the Company's products and systems could result in delay
or loss of revenue, diversion of development resources, damage to the
Company's reputation, increased service and warranty costs, or significant
litigation, any of which could materially adversely affect the Company's
business, operating results or financial condition. Furthermore, the
purchasing patterns of customers or potential customers may be affected by
Year 2000 issues as companies expend significant resources to correct their
current systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase products and services such as those
offered by the Company.
28
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Investment Portfolio
--------------------
The Company does not use derivative financial instruments in its investing
portfolio. The Company places its investments in instruments that meet high
credit quality standards such as money market funds, government securities,
and commercial paper. The Company limits the amount of credit exposure to
any one issuer. The Company does not expect any material loss with respect
to its investment portfolio. The following table provides information about
the Company's investment portfolio. For investment securities, the table
presents principal cash flows and related weighted average interest rates by
expected maturity dates.
Principal Amounts by Expected Maturity in U. S. Dollars
(in 000s, except interest rates)
Investments
Fair Value at Maturing in
12/31/98 FY 1999
-------------- ----------------
Cash Equivalents $ 11,041 $11,041
Weighted Average Interest Rate 4.42% 4.42%
Investments $ 838 $ 838
Weighted Average Interest Rate 4.04% 4.04%
Total Portfolio $ 11,879 $11,879
Weighted Average Interest Rate 4.39% 4.39%
Impact of Foreign Currency Rate Changes
---------------------------------------
During 1998, most currencies in Europe and Asia/Pacific fluctuated, but ended
the year relatively stable against the U.S. dollar. However, the translation
of the parent Company's intercompany receivables and foreign entities,
assets, and liabilities did not have a material impact on the consolidated
results of the Company. The Company does not use foreign exchange forward
contracts to hedge its foreign currency denominated receivables. Looking
forward, there can be no assurance that changes in foreign currency rates,
relative to the U. S. dollar, will not materially affect the consolidated
results of the Company.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
GENSYM CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
1998 1997
------------------- ---------------------
ASSETS
Current Assets:
Cash and cash equivalents $13,695,495 $10,958,102
Short-term investments 838,132 4,843,247
Accounts receivable, less reserves of $423,000
in 1998 and $354,000 in 1997 7,578,272 8,310,838
Prepaid expenses 1,774,687 1,565,099
Deferred income taxes 1,547,991 1,160,276
------------- ----------------
Total current assets 25,434,577 26,837,562
------------- ---------------
Property and Equipment, at cost
Computer equipment and software 8,042,652 7,373,221
Furniture and fixtures 1,788,170 1,697,510
Leasehold improvements 490,035 407,247
------------- ---------------
10,320,857 9,477,978
Accumulated depreciation and amortization (8,339,137) (7,093,939)
------------- ---------------
1,981,720 2,384,039
------------- ---------------
Long-term investments - 1,040,855
Long-term deferred income taxes 612,285 1,000,000
Deposits and other assets 239,180 254,651
------------- ---------------
$28,267,762 $31,517,107
============= ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 516,629 $ 914,002
Accrued expenses 3,862,219 4,975,813
Deferred revenue 6,405,603 5,798,927
------------- ---------------
Total current liabilities 10,784,451 11,688,742
------------- ---------------
Commitments (Note 5)
Stockholders' Equity:
Preferred Stock, $.01 par value -
Authorized 2,000,000 shares
Issued and outstanding - none - -
Common Stock, $.01 par value
Authorized - 20,000,000 shares
Issued - 6,557,268 shares
in 1998 and 6,409,397 shares in 1997 65,573 64,094
Capital in excess of par value 20,426,908 19,940,717
Treasury stock -345,200 shares in 1998, at cost (1,278,439) -
Retained earnings (1,101,134) 386,878
Cumulative translation adjustment (629,597) (563,324)
------------- ---------------
Total stockholders' equity 17,483,311 19,828,365
------------- ---------------
$28,267,762 $31,517,107
============= ===============
The accompanying notes are an integral part of these consolidated financial
statements.
30
GENSYM CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
1998 1997 1996
------------------------------------------------
REVENUES:
Product $16,910,670 $18,433,520 $21,358,295
Service 18,067,035 17,075,603 15,877,240
------------------------------------------------
Total revenues 34,977,705 35,509,123 37,235,535
COST OF REVENUES 8,697,594 9,352,348 7,385,215
------------------------------------------------
Gross profit 26,280,111 26,156,775 29,850,320
------------------------------------------------
OPERATING EXPENSES:
Sales and marketing 18,275,852 18,802,113 17,432,861
Research and development 6,022,931 6,977,143 5,983,741
General and administrative 4,133,849 4,528,147 3,699,254
Restructuring charge - 1,557,253 -
------------------------------------------------
Total operating expenses 28,432,632 31,864,656 27,115,856
------------------------------------------------
Operating income (loss) (2,152,521) (5,707,881) 2,734,464
OTHER INCOME:
Interest income 677,876 590,659 607,761
Other income (expense) 36,633 188,459 (90,003)
------------------------------------------------
Total other income, net 714,509 779,118 517,758
------------------------------------------------
Income (loss) before provision for income taxes (1,438,012) (4,928,763) 3,252,222
PROVISION FOR INCOME TAXES 50,000 40,000 1,204,000
------------------------------------------------
Net income (loss) $(1,488,012) $(4,968,763) $ 2,048,222
================================================
Basic income (loss) per share $(0.23) $(0.79) $0.35
================================================
Diluted income (loss) per share $(0.23) $(0.79) $0.33
================================================
Weighted average common shares outstanding - Basic 6,371,190 6,309,815 5,909,511
================================================
Weighted average common shares outstanding - Diluted 6,371,190 6,309,815 6,286,170
================================================
The accompanying notes are an integral part of these consolidated financial
statements.
31
GENSYM CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Series A Series B
Convertible Convertible
Preferred Stock Preferred Stock Common Stock
-------------------------------------------------------------------------------------
Number $0.10 Number $0.10 Number $0.01 Par
of Shares Par Value of Shares Par Value of Shares Value
----------- ------------- ------------ ------------- ----------- --------------
BALANCE, DECEMBER 31, 1995 300,000 30,000 353,460 35,346 4,001,000 40,010
Conversion of Series A convertible
preferred stock into common stock (300,000) (30,000) -- -- 300,000 3,000
Conversion of Series B convertible
preferred stock into common stock -- -- (353,460) (35,346) 353,460 3,534
Issuance of common stock from Initial
Public Offering, net
of issuance costs of $ 758,737 -- -- -- -- 1,366,788 13,668
Exercise of stock options -- -- -- -- 134,900 1,349
Issuance of common stock under Employee
Stock Purchase Plan (ESPP) -- -- -- -- 34,169 342
Tax benefit from exercise of incentive
stock options and shares purchased under ESPP -- -- -- -- -- --
Translation adjustment -- -- -- -- -- --
Net income -- -- -- -- -- --
Comprehensive net income for the year ended
December 31, 1996
----------- ---------- --------- --------- ---------- ----------
BALANCE, DECEMBER 31, 1996 -- -- -- -- 6,190,317 61,903
Exercise of Stock Options -- -- -- -- 91,170 912
Issuance of common stock under ESPP -- -- -- -- 127,910 1,279
Translation adjustment -- -- -- -- -- --
Tax benefit from exercise of incentive stock
options and shares purchased under ESPP -- -- -- -- -- --
Net loss -- -- -- -- -- --
Comprehensive net loss for the year ended
December 31, 1997
----------- ---------- --------- --------- ---------- ----------
BALANCE, DECEMBER 31, 1997 -- -- -- -- 6,409,397 64,094
Exercise of Stock Options -- -- -- -- 18,050 181
Issuance of common stock under ESPP -- -- -- -- 129,821 1,298
Treasury stock--345,200 shares -- -- -- -- -- --
Translation adjustment -- -- -- -- -- --
Net loss -- -- -- -- -- --
Comprehensive net loss for the year ended
December 31, 1998 ----------- ---------- --------- --------- ---------- ----------
BALANCE, DECEMBER 31, 1998 -- -- -- -- 6,557,268 $65,573
=========== ========== ========= ========= ========== ==========
Capital in Cumulative Total
Treasury Excess of Retained Translation Stockholders' Comprehensive
Stock Par Value Earnings Adjustment Equity Income (Loss)
------------ ----------- ----------- ------------ ------------- -------------
BALANCE, DECEMBER 31, 1995 -- 5,233,955 3,307,419 (36,153) 8,610,577
Conversion of Series A convertible
preferred stock into common stock -- 27,000 -- -- --
Conversion of Series B convertible
preferred stock into common stock -- 31,812 -- -- --
Issuance of common stock from Initial
Public Offering, net of issuance
costs of $758,737 -- 11,938,723 -- -- 11,952,391
Exercise of stock options -- 611,541 -- -- 612,890
Issuance of common stock under Employee
Stock Purchase Plan (ESPP) -- 326,407 -- -- 326,749
Tax benefit from exercise of incentive
stock options and shares purchased under ESPP -- 558,000 -- -- 558,000
Translation adjustment -- -- -- (40,374) (40,374) (40,374)
Net income -- -- 2,048,222 -- 2,048,222 2,048,222
-------------
Comprehensive net income for the year ended
December 31, 1996 2,007,848
----------- ----------- ---------- ----------- ----------- =============
BALANCE, DECEMBER 31, 1996 -- 18,727,438 5,355,641 (76,527) 24,068,455
Exercise of Stock Options -- 500,039 -- -- 500,951
Issuance of common stock under ESPP -- 631,833 -- -- 633,112
Translation adjustment -- -- -- (486,797) (486,797) (486,797)
Tax benefit from exercise of incentive stock
options and shares purchased under ESPP -- 81,407 -- -- 81,407
Net loss -- -- (4,968,763) -- (4,968,763) (4,968,763)
-------------
Comprehensive net loss for the year ended
December 31, 1997 (5,455,560)
---------- ----------- ---------- ------------ ----------- =============
BALANCE, DECEMBER 31, 1997 -- 19,940,717 386,878 (563,324) 19,828,365
Exercise of Stock Options -- 82,469 -- -- 82,650
Issuance of common stock under ESPP -- 403,722 -- -- 405,020
Treasury stock--345,200 shares (1,278,439) -- -- -- (1,278,439)
Translation adjustment -- -- -- (66,273) (66,273) (66,273)
Net loss -- -- (1,488,012) (1,488,012) -- (1,488,012)
-------------
Comprehensive net loss for the year ended
December 31, 1998 $ (1,559,285)
------------- ----------- ----------- ----------- ----------- =============
BALANCE, DECEMBER 31, 1998 $(1,278,439) $20,426,908 $(1,101,134) $ (629,597) $17,483,311
============== =========== =========== =========== ===========
32
GENSYM CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------- ---------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(1,488,012) $(4,968,763) $ 2,048,222
Adjustments to reconcile net (loss) income to net cash
(Used in) provided by operating activities:
Depreciation and amortization 1,245,198 1,147,112 1,087,658
Deferred income taxes - (500,000) (637,325)
Restructuring charge - 842,251 -
Changes in assets and liabilities:
Accounts receivable 747,081 1,375,274 (1,481,427)
Prepaid expenses (214,119) 15,845 (691,719)
Accounts payable (399,829) (314,597) 242,060
Accrued expenses (1,155,348) (490,261) 1,902,329
Deferred revenue 610,805 (10,556) 1,398,857
---------------- ---------------- ----------------
Net cash (used in) provided by operating activities (654,224) (2,903,695) 3,868,655
---------------- ---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales (purchases) of short-term investments 4,005,115 3,067,702 (4,945,007)
Sales (purchases) of long-term investments 1,040,855 (298,680) (742,175)
Purchases of property and equipment (842,880) (1,187,042) (1,562,217)
Decrease (increase) in deposits and other assets 32,595 (80,330) 37,391
---------------- ---------------- ----------------
Net cash (used in) provided by investing activities 4,235,685 1,501,650 (7,212,008)
---------------- ---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchases of treasury stock (1,278,439) - -
Proceeds from exercise of stock options 82,650 500,951 612,890
Proceeds from issuance of Common Stock under employee
stock purchase plan 405,020 633,112 326,749
Proceeds from initial public offering, net of
issuance costs - - 11,952,391
---------------- ---------------- ----------------
Net cash (used in) provided by financing activities (790,769) 1,134,063 12,892,030
---------------- ---------------- ----------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (53,299) (452,819) 3,967
---------------- ---------------- ----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,737,393 (720,801) 9,552,644
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 10,958,102 11,678,903 2,126,259
---------------- ---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $13,695,495 $10,958,102 $11,678,903
================ ================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for -
Income taxes $ 423,879 $ 445,242 $ 608,805
================ ================ ================
The accompanying notes are an integral part of these consolidated financial
statements.
33
GENSYM CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
The Company is a leading supplier of software products and services for
developing and deploying intelligent systems that manage and improve complex,
dynamic operations for a broad range of industrial, scientific, commercial,
and government applications.
The accompanying consolidated financial statements reflect the application of
certain significant accounting policies, as described in this note and
elsewhere in the accompanying consolidated financial statements and notes.
(A) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All material
intercompany transactions and balances have been eliminated in
consolidation.
(B) CASH EQUIVALENTS AND INVESTMENTS
The Company accounts for investments under Statement of Financial
Accounting Standards (SFAS) No. 115, Accounting for Certain Investments
in Debt and Equity Securities. The Company's investments are classified
as available-for-sale and are recorded at fair value, which approximates
amortized cost at December 31, 1998. Cash equivalents are short-term,
highly liquid investments with original maturity dates of less than three
months. Short-term investments held as of December 31, 1998 and 1997
consist of municipal bonds with original maturity dates greater than
three months that mature within one year. Long-term investments held as
of December 31, 1997 consist of municipal bonds with maturity dates of
greater than one year.
(C) DEPRECIATION AND AMORTIZATION
The Company provides for depreciation and amortization using the
straight-line method by charges to operations in amounts that allocate
the cost of the assets over their estimated useful lives as follows:
Estimated
Asset Classification Useful Lives
-------------------- ------------
Computer equipment
and software................. 3 Years
Furniture and fixtures......... 5 Years
Leasehold improvements......... Shorter of lease term or
useful life
(D) REVENUE RECOGNITION
Product revenues are recognized upon shipment or upon the completion of
all significant obligations by the Company, whichever is later, provided
that the fee is fixed or determinable and deemed collectible by
management. If conditions for acceptance are required subsequent to
delivery, revenues are recognized upon customer acceptance. Revenue from
the sale of multicopy licenses is recognized upon the shipment of the
product master or the first copy of the software product if the product
master is not to be delivered. Revenues derived from consulting and
training are recognized upon performance of the services provided that
the amounts due from customers are fixed or determinable and deemed
collectible by management. Software maintenance fees are recognized as
revenue ratably over the period to which they relate. Deferred revenue
represents primarily advance billings for software services, which
include maintenance, consulting, training and license prepayment fees.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2 ("SOP 97-2"), Software Revenue
Recognition. The Company has adopted this pronouncement in fiscal 1998,
as required by SOP 97-2. The Company believes that its current revenue
recognition practices are consistent with those required by SOP 97-2.
(E) RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS
In accordance with SFAS No. 86, Accounting for the Costs of Computer
Software to Be Sold, Leased, or Otherwise Marketed, the Company has
evaluated the establishment of technological feasibility of its various
products during the development phase. Due to the dynamic changes in the
market, the Company has concluded that it cannot determine technological
feasibility until the development phase of the project is nearly
complete. The time period during which costs could be capitalized from
the point of reaching technological feasibility until the time of general
product release is very short and, consequently, the amounts that could
be capitalized are not material to the Company's financial position or
results of operations. Therefore, the Company charges all research and
development expenses to operations in the period incurred.
34
(F) FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the foreign subsidiaries are translated in
accordance with SFAS No. 52, Foreign Currency Translation. In accordance
with SFAS No. 52, assets and liabilities of the Company's foreign
operations are translated into U.S. dollars at current exchange rates, and
income and expense items are translated at average rates of exchange
prevailing during the year. Gains and losses arising from translation are
accumulated as a separate component of stockholders' equity. Gains and
losses arising from transactions denominated in foreign currencies are
included in other income and were not material for the periods presented.
(G) RETIREMENT PLAN
Effective January 1997, the Company amended the Gensym Corporation 401(k)
Plan (the "Plan") to allow for employer matching contributions. The
Company has elected to contribute an amount equal to 50% of the first 4%,
and 25% of the next 4% of an employee's compensation (as defined)
contributed to the Plan as an elective deferral. The Company's
contributions to the Plan were $316,000 and $314,000 for the years ended
December 31, 1998 and 1997, respectively. There were no Company
contributions for the year ended December 31, 1996.
(H) CONCENTRATION OF CREDIT RISK
SFAS No. 105, Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentration of
Credit Risk, requires disclosure of any significant off-balance-sheet and
credit risk concentrations. Financial instruments, which potentially
subject the Company to concentrations of credit risk, are principally cash,
cash equivalents, investments and accounts receivable. The Company places
its cash, cash equivalents and investments in highly rated institutions.
No single customer accounted for greater than 10% of total revenues or
represented a significant credit risk to the Company in 1998, 1997, or
1996. No single customer accounted for greater than 10% of accounts
receivable during 1998 or 1997. The Company has no significant off-
balance-sheet concentration of credit risk such as foreign exchange
contracts, options contracts, or other foreign hedging arrangements.
(I) INCOME (LOSS) PER SHARE
In accordance with SFAS No. 128, Earnings per Share, basic income (loss)
per share was computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the periods. Diluted
income (loss) per share was computed using the weighted average number of
common and potential common shares outstanding during the periods in
accordance with the treasury stock method. For the years ended December
31, 1998 and 1997, the computation for diluted loss per share excludes the
effect of 31,066 shares and 81,872 shares, respectively, shares issuable
from assumed exercise of options, as their effect would be antidilutive.
The weighted average common shares outstanding, assuming dilution, for the
year ended December 31, 1996 includes 376,659 potential common shares from
the assumed exercise of options.
(J) USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
(K) RECLASSIFICATION
Certain balances have been reclassified to conform with current year
presentation.
(L) NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board released Statement
of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 133
establishes the accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure
those instruments at fair value. SFAS No. 133 is effective for fiscal
quarters beginning after June 15, 1999. The Company does not expect the
adoption of SFAS No. 133 to have a material impact to its financial
position.
(2) LINE OF CREDIT
The Company has a working capital line of credit with a bank under which
borrowings and/or letters of credit are limited to $1,000,000. The line of
credit is unsecured, and borrowings bear interest at the prime rate (7.75% as
of December 31, 1998). The line of credit expires on April 30, 2000 and
requires the Company to comply with certain financial ratios, including
minimum levels
35
of net worth and profitability. The Company obtained a waiver from the bank
with respect to the Company not satisfying the profitability and net worth
covenant as of December 31, 1998. As of December 31, 1998, there were no
borrowings outstanding under the line of credit.
(3) STOCKHOLDERS' EQUITY
(A) INITIAL PUBLIC OFFERING
In February 1996, the Company sold, through an underwritten public
offering, 1,200,000 shares of its Common Stock at $10 per share. Also in
February 1996, the Company sold an additional 166,788 shares, at $10 per
share, pursuant to an underwriters' over-allotment provision. The Company
received proceeds of $11,952,381 from its initial public offering, which
are net of issuance costs of $758,737.
(B) COMMON STOCK
On January 16, 1996, the stockholders increased the Company's authorized
capitalization to 20,000,000 shares of Common Stock and 2,000,000 shares of
Preferred Stock.
(C) SERIES A AND SERIES B CONVERTIBLE PREFERRED STOCK
The Series A and Series B Convertible Preferred Stock were converted into
shares of Common Stock upon the closing of the Company's initial public
offering in February 1996.
(D) STOCK OPTION PLANS
The following table shows the Company's stock option plans, the number of
shares reserved for issuance by the Company's Board of Directors, and the
number of shares available for future issuance as of December 31, 1998:
Number of Shares
Available for
Future Issuance
Number of Shares as of December
Plan Name Reserved for Issuance 31, 1998
------------------------------ --------------------- -------------------
1987 Stock Plan 600,000 0
1994 Stock Option Plan 534,850 170,350
1995 Director Stock Option Plan 500,000 216,047
1997 Stock Incentive Plan 100,000 78,000
--------- -------
1,734,850 464,397
========= =======
The 1987 Stock Plan provided for the grant of incentive stock options,
nonqualified stock options, stock awards, and direct sales of stock. The
Board of Directors has resolved not to grant any more options under the
1987 Stock Plan. The 1994 Stock Option Plan provides for the grant of
incentive stock options and nonqualified stock options. The 1997 Stock
Incentive Plan provides for the grant of incentive stock options,
nonqualified stock options, restricted stock and other stock-based awards.
Under these plans, incentive stock options may be granted at an exercise
price not less than the fair market value of the Company's Common Stock on
the date of grant or, in the case of 10% stockholders, not less than 110%
of the fair market value. Nonqualified options may be granted by the Board
of Directors at its discretion. The difference, if any, between the
exercise price and the fair value of the underlying Common Stock at the
measurement date is charged to operations over the vesting period of such
options. The terms of exercise of options granted under these plans are
determined by the Board of Directors. Incentive stock options expire no
later than 10 years after the date of grant.
The Board of Directors, on October 22, 1998, authorized the repricing of
certain incentive stock options. Under the repricing plan, option holders
were permitted to voluntarily exchange their old options for new options.
The new options allow the option holders to purchase 80% of the number of
shares of Common Stock represented by the old options at a price equal to
the closing price of the Company's Common Stock, or for officers, at a
price equal to 110% of the closing price, on November 20, 1998. All other
terms and conditions of the new options remain identical to the old options
agreement. The closing price of the Common Stock on November 20, 1998 was
$3.88. Under the repricing plan, 670,160 incentive stock options were
cancelled and 539,948 incentive stock options were reissued.
The 1995 Director Stock Option Plan (the "Director Plan") was approved by
the stockholders in January 1996 and amended in May 1997. The Director
Plan provides for the grant of options to purchase Common Stock of the
Company to non-employee directors of the Company. Upon completion of the
initial public offering of the Company's Common Stock, each non-employee
36
director was granted an option under the Director Plan to purchase 2,000
shares of Common Stock at the initial public offering price. On June 30 of
each year, beginning in 1997, each non-employee director is granted an
option to purchase 3,000 shares of Common Stock at an exercise price equal
to the last reported sale price of the Company's Common Stock on the Nasdaq
National Market on the date of grant. Such options vest in equal portions
over a five year period and expire 10 years from the date of grant.
The following schedule summarizes the stock option activity under all
option plans for the three years ended December 31, 1998:
Number Option Price Weighted Average
of Shares per Share Exercise Price
--------------------- ----------------- ---------------------
Outstanding at December 31, 1995 661,850 $1.60 - $ 7.50 $ 6.30
Granted 251,000 10.00 - 21.25 17.49
Exercised (134,900) 1.60 - 7.50 4.54
Canceled (193,890) 7.50 - 21.25 14.20
--------------------- ----------------- ---------------------
Outstanding at December 31, 1996 584,060 $ 1.60 - 20.00 $ 8.73
Granted 572,620 4.50 - 11.75 6.08
Exercised (91,170) 1.60 - 7.50 5.49
Canceled (245,730) 4.88 - 20.00 10.71
--------------------- ----------------- ---------------------
Outstanding at December 31, 1997 819,780 $1.60 - $20.00 $ 6.65
Granted 835,698 3.00 - 7.50 4.94
Exercised (18,050) 1.60 - 7.50 4.58
Canceled (907,789) 3.81 - 20.00 6.90
--------------------- ----------------- ---------------------
Outstanding at December 31, 1998 729,639 $3.00 - $10.00 $ 4.44
===================== ================= =====================
Exercisable at December 31, 1998 250,366 $3.00 - $10.00 $ 4.59
===================== ================= =====================
The range of exercise prices for options outstanding and options exercisable
at December 31, 1998 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- --------------------------------
Weighted
Weighted Average Weighted Average
Options Remaining Average Options Exercise
Range of Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Price
------------------------------ ----------- -------------------- ------------------ ----------------- --------------
$ 3.00-4.50 581,589 7.00 $3.98 195,856 $3.96
$ 4.63-6.50 82,130 8.19 5.11 19,090 5.35
$ 7.50-10.00 65,920 7.96 7.65 35,420 7.67
---------- --------- ---------- ----------- -----------
729,639 7.22 $4.44 250,366 $4.59
=========== ========= ========== =========== ===========
The Company's 1995 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in November 1995 and approved by the
stockholders in January 1996. The Purchase Plan authorizes the sale of
Common Stock to participating employees. In January 1998 the board of
directors amended the Purchase Plan to increase the number of shares of
Common Stock reserved for issuance under the Plan from 200,000 to 500,000.
All employees of the Company meeting certain eligibility requirements are
eligible to participate in the Purchase Plan. An employee may elect to
have a whole number percentage from 1% to 10% of his or her base pay
withheld during the payroll deduction period "Offering Period" for purposes
of purchasing shares under the Purchase Plan. The price at which shares
may be purchased during each offering will be 85% of the fair market value
per share of the Common Stock on either the first day or the last day of
the Offering Period, whichever is lower. The Compensation Committee of
the Board of Directors may, at its discretion, choose an Offering Period of
12 months or less for each of the offerings and choose a different Offering
Period for each offering. Under the Purchase Plan, the Company had sold
291,900 shares as of December 31, 1998.
37
(E) STOCK-BASED COMPENSATION
The Company has computed the pro forma disclosure required under SFAS No.
123 for all stock compensation plans during the three years ended December
31, 1998, using the Black-Scholes option pricing model under the fair value
method prescribed by SFAS No. 123. The assumptions used are as follows:
1998 1997 1996
---------------- ----------------- ------------------
Risk-free interest rate 4.65 - 5.71% 5.46 - 6.71% 5.47 - 6.88%
Expected dividend yield 0 0 0
Expected lives of option grants 7.0 Years 6.5 Years 6.5 Years
Expected volatility 70% 63% 65%
For the purposes of pro forma disclosure, the estimated fair value of
options is amortized to expense over the vesting period. Had compensation
costs for options and Purchase Plan shares been determined based on the
fair value at the grant dates as prescribed by SFAS No. 123, the effect
would have been as follows:
1998 1997 1996
---------------- ------------------ ------------------
Net income (loss) as reported $(1,488,012) $(4,968,763) $2,048,222
Pro forma net income (loss) as adjusted (2,384,191) (5,615,312) 1,736,170
Diluted income (loss) per share as reported ($0.23) ($0.79) $ 0.33
Pro forma diluted income (loss) per share as adjusted ($0.43) ($0.95) $ 0.28
The estimated weighted average fair value of options granted during 1998,
1997, and 1996 was $3.25, $3.95, and $8.48 per share, respectively. The
estimated weighted average fair values of grants made under the Purchase
Plan during 1998, 1997, and 1996 was $1.97, $1.99, and $3.97, respectively,
computed using the assumptions described above with an expected life of six
months for the option feature present in the Purchase Plan awards. At
December 31, 1998, the weighted average remaining life of outstanding stock
options was 7.22 years.
(F) STOCK REPURCHASE PROGRAM
In the third quarter of 1998, the Company began a program to repurchase
up to 650,000 shares of its Common Stock on the open market. As of December
31, 1998, 345,200 shares had been repurchased at a cost of $1,278,000.
(4) INCOME TAXES
The components of the provision for income taxes for the three years
ended December 31, 1998 are as follows:
1998 1997 1996
----------------- ------------------ -----------------
Federal
Current $ (70,898) $ (90,638) $ 758,694
Deferred (675,074) (2,221,471) (122,463)
----------------- ------------------ -----------------
(745,972) (2,312,109) 636,231
----------------- ------------------ -----------------
State
Current 7,313 6,428 252,898
Deferred (31,244) (27,620) (40,821)
----------------- ------------------ -----------------
(23,931) (21,192) 212,077
----------------- ------------------ -----------------
Foreign
Withholding 47,584 181,617 443,000
Income 66,000 524,000 386,733
----------------- ------------------ -----------------
113,584 705,617 829,733
----------------- ------------------ -----------------
Change in Valuation Allowance 706,319 1,667,684 (474,041)
----------------- ------------------ -----------------
$ 50,000 $ 40,000 $1,204,000
================= ================== =================
Foreign withholding taxes represent amounts withheld by foreign customers and
remitted to the applicable foreign tax authorities in connection with foreign
revenues. Foreign income taxes represent corporate income taxes relating to
the operations of the Company's foreign subsidiaries.
38
The components of the net deferred tax asset recognized in the accompanying
consolidated balance sheets with the approximate income tax effect of each
type of temporary difference are as follows:
1998 1997
---------------- ----------------
Net operating loss carryforward $ 2,299,149 $ 2,138,450
Research and development tax credit carryforward 1,017,783 715,871
Depreciation 122,058 136,500
Deferred revenue 316,679 451,984
Other temporary differences 778,610 385,155
---------------- ----------------
4,534,279 3,827,960
Valuation allowance (2,374,003) (1,667,684)
---------------- ----------------
Net deferred tax asset $ 2,160,276 $ 2,160,276
================ ================
The net operating loss carryforwards expire on various dates through 2012 and
are subject to review and possible adjustment by the Internal Revenue
Service.
The Internal Revenue Code contains provisions that may limit the net
operating loss and credit carryforwards that the Company may utilize in any
one year in the event of certain cumulative changes in ownership over a three
year period. In the event that the Company has had a change in ownership, as
defined, utilization of the carryforwards may be restricted.
The Company has established a valuation allowance against its deferred tax
asset to the extent that it cannot conclusively demonstrate that these assets
"more likely than not" will be realized.
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate as follows:
1998 1997 1996
--------------- ---------------- -------------
Provision at federal statutory rate (34.0) % (34.0) % 34.0 %
State income tax, net of federal benefits (1.1) (0.4) 4.3
Foreign income and withholding taxes 27.9 6.6 19.6
Change in valuation allowance 49.1 33.8 (14.6)
Utilization of tax credits (21.0) (0.4) (9.5)
Other, net (17.4) (4.8) 3.2
--------------- ---------------- -------------
3.5% 0.8 % 37.0 %
=============== ================ =============
(5) COMMITMENTS
The Company leases its facilities and certain equipment under operating
leases. The future minimum annual payments under these leases at December 31,
1998 are as follows:
Year Amount
----------- ----------------
1999 $ 2,905,000
2000 2,548,000
2001 963,000
2002 476,000
2003 230,000
Thereafter 191,000
----------------
$ 7,313,000
================
Rent expense recorded by the Company under the above leases, net of rental
income from sub-leases, for the years ended December 31, 1998, 1997 and 1996
were approximately $2,931,000, $3,834,000, and $3,102,000, respectively.
39
(6) ACCRUED EXPENSES
Accrued expenses consist of the following:
1998 1997
---------------- ----------------
Accrued payroll and related expenses $1,099,554 $1,033,397
Accrued commissions 460,518 800,000
Other accrued expenses 2,302,147 3,142,416
---------------- ----------------
$3,862,219 $4,975,813
================ ================
(7) RESTRUCTURING CHARGE
During the second quarter of 1997, the Company recorded a charge of
approximately $2.0 million for restructuring costs associated with the
reduction of its workforce, closing and consolidation of several field sales
offices and consolidation of office space in its corporate headquarters. The
charge included accruals for rent and lease termination costs, severance and
other employee termination costs and the write off of certain assets that
would provide no future benefit to the Company as a result of the
restructuring plan. In the third quarter of 1997, the Company recorded a
restructuring credit of $485,000 for the recovery of its investment in a
joint venture, a portion of which had been written off in the previous
quarter.
As of December 31, 1998, approximately $60,000 of accrued restructuring
charges pertaining to future rent payment obligations are expected to be paid
during 1999.
40
(8) FINANCIAL INFORMATION BY GEOGRAPHIC AREA
Domestic and international sales as a percentage of total revenues are as
follows:
1998 1997 1996
---------- ---------- ------------
United States 53% 54% 58%
Europe 27 30 24
Other 20 16 18
---------- ---------- ------------
100% 100% 100%
========== ========== ============
(9) SEGMENT REPORTING
On December 31, 1998, Gensym adopted SFAS No. 131, Disclosure about Segments
of an Enterprise and Related Information. This pronouncement established
standards for public companies relating to the reporting of financial and
descriptive information about their operating segments in financial
statements. Operating segments are defined as components of an enterprise
about which separate financial information is available that is evaluated
regularly by management in deciding how to allocate resources and in
assessing performance of the business.
The Company has historically evaluated its operations in three geographical
segments: Americas, Europe/Middle East/Africa, and Asia-Pacific.
The Company markets and sells its products through its direct sales force in
the United States, Europe, Africa and Asia, as well as through selected
distributors in other countries, including Japan. The Company also sells its
products through value-added resellers and systems integrators, who provide
consulting services and integrated solutions to their customers. The Company
further licenses technology to OEMs, who embed the technology within their
product offerings.
The accounting policies of the segments are the same as those described in
Note 1. The Company evaluates performance of its segments based on revenues
and segment profitability. Segment profitability is defined by the Company
as gross contribution, which is computed based on gross profit less
identifiable operating costs--principally sales and marketing costs.
Information as to the operations of the different segments is set forth
below:
(in thousands)
Europe,
Middle East,
Americas & Africa Asia-Pacific Total
---------------- ---------------- ------------------ -----------------
Year ended December 31, 1998:
Revenues $ 22,431 $ 10,196 $ 2,351 $ 34,978
================ ================= ================== =================
Gross contribution $ 9,952 $ 2,186 $ (206) $ 11,932
================ ================= ================== =================
Identifiable assets $ 23,864 $ 3,941 $ 462 $ 28,267
================ ================= ================== =================
Year ended December 31, 1997:
Revenues $ 21,212 $ 11,293 $ 3,004 $ 35,509
================ ================= ================== =================
Gross contribution $ 8,674 $ 4,155 $ 335 $ 13,163
================ ================= ================== =================
Identifiable assets $ 28,170 $ 2,851 $ 496 $ 31,517
================ ================= ================== =================
Year ended December 31, 1996:
Revenues $ 23,451 $ 9,369 $ 4,416 $ 37,236
================ ================= ================== =================
Gross contribution/1/
================ ================= ================== =================
Identifiable assets $ 33,065 $ 2,700 $ 493 $ 36,258
================ ================= ================== =================
/1/ This information has not been provided as it would be impracticable to do
so.
41
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Gensym Corporation:
We have audited the accompanying consolidated balance sheets of Gensym
Corporation (a Delaware corporation) and subsidiaries as of December 31, 1998
and 1997, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Gensym Corporation and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ ARTHUR ANDERSEN LLP
-----------------------
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 1, 1999
42
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is contained in part under
"Executive Officers of the Company" in Part I hereof, and the remainder is
contained under the caption "PROPOSAL 1 - ELECTION OF DIRECTORS" in the
Company's Proxy Statement (the "Proxy Statement"), to be mailed in April
1999, for the Annual Meeting of Stockholders to be held on Friday, May 21,
1999 at 10:00 A.M. at the offices of Hale and Dorr LLP, 60 State Street,
Boston, MA 02109. Such information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is contained under the captions
"Director Compensation" and "Compensation to Executive Officers" in the
Company's Proxy Statement. Such information is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is contained under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's Proxy Statement. Such information is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is contained under the caption
"Certain Transactions" in the Company's Proxy Statement. Such information is
incorporated herein by reference.
43
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
The following documents are included in Item 8 of this Annual Report on Form
10-K:
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Operations for the three years ended December 31,
1998
Consolidated Statements of Stockholders' Equity for the three years ended
December 31, 1998
Consolidated Statements of Cash Flows for the three years ended December 31,
1998
Notes to Consolidated Financial Statements
Report of Independent Public Accountants
(2) FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedules are included in
Item 14(d):
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted since the required information is not
present or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements or the notes thereto.
(3) EXHIBITS
The Exhibits listed in the Exhibit Index immediately preceding such Exhibits
are filed as part of this Annual Report on Form 10-K, and are incorporated
herein by reference.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended December 31, 1998
44
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GENSYM CORPORATION
(Registrant)
By: /s/ Lowell B. Hawkinson
-----------------------
Dated: March 25, 1999 Lowell B. Hawkinson
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 22, 1999:
/s/ Lowell B. Hawkinson
-----------------------
Lowell B. Hawkinson Chairman, Chief Executive Officer,
Director, and Treasurer
(Principal Executive Officer,
Principal Financial Officer, and
Principal Accounting Officer)
/s/ Robert L. Moore
-------------------
Robert L. Moore President and Director
/s/ John A. Shane
-----------------
John A. Shane Director
/s/ Theodore Johnson
--------------------
Theodore Johnson Director
/s/ Thomas E. Swithenbank
-------------------------
Thomas E. Swithenbank Director
/s/ Barry R. Gorsun
--------------------
Barry R. Gorsun Director
45
ITEM 14(D) FINANCIAL STATEMENT SCHEDULE
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTARY SCHEDULE
To Gensym Corporation:
We have audited, in accordance with generally accepted auditing standards,
the consolidated financial statements of Gensym Corporation and subsidiaries
and have issued our report thereon dated February 1, 1999. Our audit was
made for the purpose of forming an opinion on those consolidated financial
statements taken as a whole. The schedule listed in the financial statement
schedule index is the responsibility of the Company's management and is
presented for the purpose of complying with the Securities and Exchange
Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to auditing procedures applied
in the audit of the basic consolidated financial statements and, in our
opinion, fairly states, in all material respects, the financial data required
to be set forth therein in relation to the basic consolidated financial
statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
-----------------------
Arthur Andersen LLP
Boston, Massachusetts
February 1, 1999
46
GENSYM CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Balance at Addition Balance at
Beginning of Charged to End of
Description Period Expense Deductions Period
- ----------- ---------------- -------------- -------------- -------------
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
Year ended December 31, 1998 $ 354,205 $ 110,000 $ 41,645 $ 422,560
================ ============== ============== =============
Year ended December 31, 1997 $ 453,319 $ 225,000 $ 324,114 $ 354,205
================ ============== ============== =============
Year ended December 31, 1996 $ 414,612 $ 124,600 $ 85,893 $ 453,319
================ ============== ============== =============
47
EXHIBIT INDEX
Exhibit # Description
3.1 Amended and Restated Certificate of Incorporation of the
Registrant (Incorporated by reference to the Registrant's Annual
Report on Form 10-K filed on March 31, 1997)
3.2 Amended and Restated By-Laws of the Registrant (Incorporated by
reference to the Registrant's Annual Report on Form 10-K filed on
March 31, 1997)
4.1 Specimen certificate for shares of the Registrant's Common Stock
(Incorporated by reference to the Registration Statement on Form
S-1 of the Registrant filed on December 21, 1995)
10.1 1987 Stock Plan, as amended to date (Incorporated by reference to
the Registration Statement on Form S-1 of the Registrant filed on
December 21, 1995)
10.2 1994 Stock Option Plan (Incorporated by reference to the
Registration Statement on Form S-1 of the Registrant filed on
December 21, 1995)
10.3 1995 Employee Stock Purchase Plan, as amended (Incorporated by
reference to the Registrant's Proxy Statement filed on
April 6, 1998)
10.4 1995 Director Stock Option Plan, as amended (Incorporated by
reference to the Registrant's Quarterly Report on Form 10-Q filed
on August 13, 1997)
10.5 Amended and Restated Registration Rights Agreement dated as of
August 12, 1991 by and among the Registrant and the parties named
therein (Incorporated by reference to the Registration Statement
on Form S-1 of the Registrant filed on December 21, 1995)
10.6 Lease dated as of January 1, 1995 by and between the Registrant
and CambridgePark One Limited Partnership (Incorporated by
reference to the Registration Statement on Form S-1 of the
Registrant filed on December 21, 1995)
10.7 First Amendment to Lease dated as of December 2, 1996 between the
Registrant and CambridgePark One Limited Partnership
(Incorporated by reference to the Registrant's Annual Report on
Form 10-K filed on March 31, 1997)
10.8 Second Amendment to Lease dated as of January 24, 1997 between
the Registrant and CambridgePark One Limited Partnership
(Incorporated by reference to the Registrant's Annual Report on
Form 10-K filed on March 31, 1997)
10.9 Third Amendment to Lease dated as of January 24, 1997 between the
Registrant and CambridgePark One Limited Partnership
(Incorporated by reference to the Registrant's Annual Report on
Form 10-K filed on March 31, 1997)
10.10 Amendment to the Business Loan Agreement dated June 20, 1991
between Gensym Corporation and State Street Bank and Trust
Company, as amended to date (Incorporated by reference to the
Registrant's Quarterly Report on Form 10-Q filed on August 13,
1997)
10.11 Distribution Agreement, dated as of January 1, 1995, by and among
the Registrant, Itochu Corporation and Itochu Techno-Science
Corporation (Incorporated by reference to the Registration
Statement on Form S-1 of the Registrant filed on December 21,
1995)
10.12 Severance arrangement with Raymond Wood dated December 6, 1996,
as modified on December 31, 1996 and January 22, 1997
(Incorporated by reference to the Registrant's Annual Report on
Form 10-K filed on March 31, 1997)
10.13 1997 Stock Incentive Plan (Incorporated by reference to the
Registrant's Quarterly Report on Form 10-Q filed on August 13,
1997)
10.14 Sublease Agreement dated August 26, 1997 between Gensym
Corporation and Spaulding & Slye Services Limited Partnership
(Incorporated by reference to the Registrant's Quarterly Report
on Form 10-Q filed on November 12, 1997)
10.15 Secured Promissory Note dated October 1, 1997 from Stephen R.
Quehl to Gensym Corporation (Incorporated by reference to the
Registrant's Quarterly Report on Form 10-Q filed on November 12,
1997)
10.16 Pledge Agreement dated October 1, 1997 between Gensym Corporation
and Stephen R. Quehl (Incorporated by reference to the
Registrant's Quarterly Report on Form 10-Q filed on November 12,
1997)
10.17 Rights Agreement, dated as of April 8, 1997, between Gensym
Corporation and State Street Bank & Trust Company, as Rights
Agent (Incorporated by reference to the Registrant's Current
Report on Form 8-K filed on April 17, 1997)
21 Subsidiaries of the Registrant
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
Notes
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Exhibit 10.11 - Confidential treatment has been granted with respect to certain
portions of this agreement.
Exhibit 10.12 - Management contract or compensatory plan or arrangement required
to be filed as an exhibit to this Annual Report on Form 10-K