DELAWARE 04-2685985
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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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.
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 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. [X]
The aggregate market value of the voting stock held by non-affiliates of the registrant as of October 31, 1998, was $184,044,525 based upon the last reported sales price of the Common Stock in the National Market System, as reported by NASDAQ.
The number of shares of the registrant's Common Stock outstanding as of October 31, 1998 was 26,292,075.
Portions of the registrant's definitive proxy statement to be filed pursuant to Regulation 14A in connection with the 1998 annual meeting of its stockholders are incorporated by reference into Part III of this Form 10-K.
The Exhibit Index begins on page 23 of this Report.
THIS REPORT ON FORM 10-K, INCLUDING WITHOUT LIMITATION THE BUSINESS SECTION AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21(e) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, STATEMENTS CONCERNING EXPECTED PRICE EROSION, THE COMPANY'S PLANS TO MAKE ACQUISITIONS OR STRATEGIC INVESTMENTS, THE COMPANY'S EXPECTATION OF INCREASED SALES TO ORIGINAL EQUIPMENT MANUFACTURERS, AND THE COMPANY'S PLANS TO IMPROVE AND ENHANCE EXISTING PRODUCTS AND DEVELOP NEW PRODUCTS.
THE FORWARD-LOOKING STATEMENTS OF PHOENIX TECHNOLOGIES LTD. ARE SUBJECT TO RISKS AND UNCERTAINTIES. SOME OF THE FACTORS THAT COULD CAUSE FUTURE RESULTS TO MATERIALLY DIFFER FROM THE COMPANY'S RECENT RESULTS OR THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, SIGNIFICANT INCREASES OR DECREASES IN DEMAND FOR THE COMPANY'S PRODUCTS, INCREASED COMPETITION, LOWER PRICES AND MARGINS, FAILURE TO SUCCESSFULLY DEVELOP AND MARKET NEW PRODUCTS AND TECHNOLOGIES, COMPETITOR INTRODUCTIONS OF SUPERIOR PRODUCTS, CONTINUED INDUSTRY CONSOLIDATION, INSTABILITY AND CURRENCY FLUCTUATIONS IN INTERNATIONAL MARKETS, PRODUCT DEFECTS, FAILURE TO SECURE INTELLECTUAL PROPERTY RIGHTS, RESULTS OF LITIGATION, AND FAILURE TO RETAIN AND RECRUIT KEY EMPLOYEES. FOR A MORE DETAILED DISCUSSION OF CERTAIN RISKS ASSOCIATED WITH THE COMPANY'S BUSINESS, SEE THE "BUSINESS RISKS" SECTION OF THIS FORM 10-K. THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES OCCURRING AFTER THE DATE OF THIS FORM 10-K.
GENERAL
Phoenix Technologies Ltd. ("Phoenix" or the "Company") designs, develops, markets and supports standards-based system and chip level software for information platforms, including personal computers, servers, embedded systems, information appliances and peripherals. The Company's software provides compatibility, connectivity and manageability of the various components and technologies used in such devices. The Company provides these products primarily to platform or peripheral manufacturers (collectively, "OEMs"). Phoenix's products are designed to increase value and lower development risk to the OEM by ensuring platform compatibility with industry standards and enabling OEMs to introduce new products quickly. The Company's product flexibility and worldwide customization services allow product differentiation and increased system value.
The Company markets and licenses its products and services worldwide to OEMs that range from large PC manufacturers to small system integrators. The majority of the Company's revenue consists of license and engineering fees. Phoenix markets its products and services primarily through a direct sales force, but also through regional distributors and sales representatives. Phoenix promotes its products through newsletters and technical bulletins, trade and business press articles, advertising, and participation in industry trade shows and conferences.
The Company was incorporated in the Commonwealth of Massachusetts on September 17, 1979, and was reincorporated in the State of Delaware on December 24, 1986.
Rapid technological change and the frequent introduction of new products incorporating new technologies characterize the personal computer and information appliance industries. The introduction of products embodying new technologies often results in the emergence of new industry standards, rendering existing products obsolete. To remain competitive, manufacturers must respond quickly to such technological changes. This rapid pace of change can benefit Phoenix as it provides a continuous flow of opportunities for the Company to provide high value technology and support to its customers. However, if the Company or its customers are unable, for technological or other reasons, to develop products in a timely manner in response to changes in the personal computer ("PC") or information appliance industries, the Company's business would be materially and adversely affected.
MERGERS AND ACQUISITIONS
Effective September 24, 1998, the Company acquired Award Software International, Inc. ("Award"), a leading provider of system enabling and management software for motherboard OEMs. In the merger, each share of Award common stock was exchanged for 1.225 shares of Phoenix common stock, and options and warrants to purchase Award common stock were exchanged for options and warrants to purchase the Company's common stock based upon the same exchange ratio. The transaction was accounted for as a pooling of interests for financial reporting purposes, and was structured to qualify as a tax-free reorganization. Also on September 24, 1998, Phoenix acquired Sand Microelectronics, Inc. ("Sand") for approximately $18.6 million in cash, 464,000 shares of Phoenix common stock, stock options to purchase approximately 264,000 shares of Phoenix common stock (in exchange for Sand stock options), and up to $3.7 million in performance incentives to be paid through fiscal 2001.
The acquisitions of Award and Sand are expected to allow the Company to efficiently serve all segments of the PC BIOS market, and become a leader in the supply of semiconductor intellectual property ("IP") and related firmware. The addition of Award's advanced interconnect enabling software and Sand's semiconductor IP to the Company's products are expected to enable the Company to provide OEMs a comprehensive solution from Phoenix, which will accelerate the rate at which they can bring new products to market, while ensuring the highest levels of interoperability, quality and adherence to industry standards.
DESCRIPTION OF BUSINESS
During fiscal 1998, the Company reorganized its product groups. The Company is now divided into three product divisions: Platform Enabling, PICO and PC Enhancing, and Interconnect. The Platform Enabling Division includes desktop, notebook and server BIOS software, including the Phoenix and Award BIOS products. The PICO and PC Enhancing Division consists of the Company's non-BIOS system enhancement software, and the Interconnect Division develops and markets synthesizable interconnect cores to the semiconductor industry. The Interconnect Division includes the Company's Virtual Chips products acquired in fiscal 1996 and the Sand Microelectronics products acquired in late fiscal 1998.
The Company generates a significant portion of its revenue from customers outside the United States. See revenue segregated by geographic region for the three fiscal years ended September 30, 1998 under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations".
PLATFORM ENABLING
The Platform Enabling Division offers an extensive line of Basic Input Output System ("BIOS") and related products for desktop, portable and server PC systems and for application-specific information appliances. These include system BIOS products for various chipsets and system busses, keyboard controllers and power management. The Company's products support the latest processors, chipsets, system busses, and interconnect technologies such as Advanced Configuration and Power Interface ("ACPI").
The introduction of new hardware architectures, microprocessors,
peripheral equipment and operating systems within the PC industry has increased
the complexity, time and cost to develop system software products. The Company
believes that the reason OEM customers license the Company's system software
products rather than develop these products internally is to (1) assure
compatibility with industry standards, (2) release products to market faster,
(3) reduce product development risks, (4) reduce product development and support
costs, and/or to (5) differentiate their system offerings with advanced
features.
Demand for the Company's BIOS software products depends principally on
(1) PC manufacturers licensing rather than developing their own BIOS, (2) the
sales success of the Company's OEM customers and (3) the functions and features
offered in the Company's products compared to those of its competitors,
including the emergence of new PC technologies requiring BIOS support. The
growth rate of sales in the personal computer industry fluctuates from time to
time based on numerous factors,
PHOENIXBIOS 4.0. Phoenix provides various versions of PhoenixBIOS 4.0 as its core systems firmware for desktop and server systems. The Company believes the success of this product is attributable to its reliability and advanced features, including its fourth generation modular architecture and advanced development tools and methodology.
NOTEBIOS 4.0 FOR PORTABLE SYSTEMS. Phoenix offers its NoteBIOS system software for use with portable or notebook computers. The product adds extensive power management capabilities, such as Save-to-Disk and smart batteries, to the modular architecture of PhoenixBIOS 4.0. The Company believes that a majority of notebook PCs shipped worldwide in fiscal 1998 with commercial BIOS were delivered with Phoenix's NoteBIOS.
PICO BIOS. The Company developed the PICO brand BIOS for configuration and control of information appliances. The PICO BIOS and other PICO products are designed using small form factors in order to meet the requirements of information appliance platforms.
AWARD BIOS. The Platform Enabling Division also includes the products of Award acquired in September 1998. The Award products are system enabling and management software that includes a suite of BIOS products for designers and manufactures of motherboards, PC systems and other microprocessor-based (or embedded) devices. The Company believes that the Award BIOS products and engineering services enable customers to rapidly develop new motherboard designs for state-of-the-art computer systems.
One of the functions performed by the BIOS is to handle system date
changes and calculations. Since 1995, PhoenixBIOS has been designed to
automatically handle date changes at the year 2000. Some releases of BIOS made
by the Company before 1995 require that the system date be changed the first
time the system is used in the year 2000. This update can be done by manually
changing the date or through an automatic date change program. Although the vast
majority of systems in use at the year 2000 will contain BIOS that change the
date automatically, questions about the role of the BIOS in handling date
changes may prompt the Company to receive a disproportionate number of inquiries
and complaints regarding year 2000 compliance. See discussion under "ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - YEAR 2000" below.
In fiscal 1997, Intel Corporation began shipping products containing Phoenix system software under a seven-year agreement (the "Technology Agreement") signed in December 1995. The Technology Agreement was amended in June 1998. Under the Technology Agreement, Phoenix licensed certain of its system-level software to Intel for incorporation into Intel's motherboard products for desktop and server computers. In addition, Phoenix is required to provide Intel with a dedicated engineering team to support Intel and develop agreed-upon enhancements to the licensed software in exchange for development fees that vary based upon the Company's level of effort.
Concurrent with the signing of the Technology Agreement, Phoenix and Intel entered into a Common Stock and Warrant Purchase Agreement (the "Equity Agreement") whereby Intel purchased 894,971 shares of Phoenix common stock and a warrant to purchase an additional 1,073,965 shares, which expires in April 2001.
In fiscal 1998, the Platform Enabling Division focused on re-engineering its processes and introduced "BIOS Production," which it believes improves the reliability and deployability of PhoenixBIOS. The Company played a significant role in new PC industry initiatives with Intel, Microsoft, Compaq and others, and developed and delivered ACPI technology. The Company also worked with Microsoft, Intel and Toshiba on the development of the ACPI specification for interfacing the operating system to the motherboard and supporting hardware. ACPI replaces Advanced Power Management, Plug and Play and other BIOS runtime services and is required for Microsoft's Windows 98
The Company is currently developing system software to support an upcoming 64-bit Intel processor (IA-64). This architecture represents a significant increase in capability over current 32-bit processors, and is expected to be used initially in servers and workstations. The IA-64 processor is due to be released in 2000.
PICO AND PC ENHANCING
The PICO and PC Enhancing Division was formed during the year through the combination of the PICO product line, a portion of the prior PC Systems Division (PCSD) and the Interconnect Software Group (ISG). It provides system- enhancing software for PCs, as well as for industrial, handheld, and consumer platforms in the emerging information appliance market. Examples of the application-specific information appliance platforms are handheld PCs, personal digital assistants ("PDAs"), smart phones, point-of-sale terminals, factory automation devices, digital cameras, car navigation units, and smart home entertainment (television, stereo) systems.
The Division's focus is on the following product thrusts:
- Diagnostics, Management and Security Enabling improved management and service of PCs and other platforms
- Internet Foundations
Enhancing the diagnostics and management products by providing
Internet connectivity
Providing a ROM based HTML viewer for any information platform
- Power Management
SoftPower is a Windows CE product for Mobile CE Platforms
PowerSuite enhancements for notebooks
- Other
PC Card, PlugWorks peripheral and PicoStor FLASH products
INTERCONNECT
The Interconnect Division provides semiconductor intellectual property ("IP"), which is an increasingly important component of System-On-Chip ("SOC") and embedded system designs. Semiconductor IP includes synthesizable cores and associated development tools that are used by system and semiconductor manufacturers to provide connectivity using various interconnect standards. These products are prepackaged circuit descriptions delivered in high-level languages (Verilog and Very High Level Design Language, or VHDL). They are used as building blocks for system-level Application Specific Integrated Circuits ("ASICs") to provide external connectivity using standards such as AGP, PCI, USB and IEEE 1394.
In August 1996, Phoenix acquired Virtual Chips, Inc., a supplier of synthesizable cores for the computer industry. Virtual Chips products included a full line of PCI and USB synthesizable cores and test environments. In fiscal 1998, the Company introduced a complete product offering that supports the IEEE 1394 standard, and enhanced its products to continue to support the other evolving standards.
In September 1998, Phoenix acquired Sand Microelectronics, Inc., a leading supplier of silicon-proven semiconductor IP. Sand's products include PCI and USB synthesizable cores, Ethernet datacom cores, SOC integration products, and complementary IEEE-1394 technology. Sand also provides limited design integration services to speed system OEM time-to-market. Sand is being integrated with Virtual Chips in the Interconnect Division.
WORLDWIDE DEPLOYMENT SERVICES AND SUPPORT
LEADERSHIP IN MAJOR INDUSTRY INITIATIVES
Phoenix has entered into a number of major initiatives with industry leaders and standards-setting organizations to develop next generation system standards. These initiatives include: (1) working with Intel, HP, and Dell on the Wired for Management specification, (2) co-authoring the Reserved Area BIOS Boot specification with GSI, (3) developing IEEE-1394 Boot capabilities with Seagate and Quantum (4) working with Intel and leading OEMs on the SMBIOS specification, and (5) working on industry standards or serving on several committees including the IEEE-1394 Specification Working Group, IEEE-1394 Trade Association, PCI SIG Steering Committee, several USB Class Driver Committees, NCITS T13 Committee, the On-chip Bus Committee of the VSI Alliance, and the USB Implementers Forum.
Phoenix's relationships with Compaq, Intel, Microsoft, and other industry leaders give the Company early access to new technology requirements, which the Company believes facilitates the development of its products. By building upon its core technology base, the Company is able to tailor its system software products to conform to the specific requirements of its OEM customers, allowing them to integrate new technologies and introduce their products to market more effectively.
COMPETITION
In marketing its BIOS products, Phoenix competes primarily with in-house research and development departments of PC manufacturers that may have significantly greater financial and technical resources than those of Phoenix. These companies include Acer Incorporated, Compaq Computer Corporation, Dell Computer Corporation, IBM and Toshiba Corporation. It also competes for system software business with other independent suppliers, ranging from small, privately-held companies to Acer Softech, a division of Acer Labs, a major Taiwan chip and motherboard supplier. The bases of competition for PC system software are primarily product performance and availability, engineering experience and expertise, product support and price. Phoenix believes it competes favorably on these bases. In the Virtual Chips' synthesizable core business, Phoenix competes with major EDA suppliers, such as Mentor Graphics and Synopsys, who are attempting to broaden their design tool business to include synthesizable cores; and small design houses who provide synthesizable cores, often as part of a design consulting contract.
INVESTMENTS
In fiscal 1994, the Company sold a division to Xionics Document Technologies, Inc. ("Xionics") in return for a promissory note and shares of Xionics common stock. In September 1996, the Company participated in Xionics' initial public offering (NASDAQ: XION) and sold 500,000 shares. In fiscal 1998 and 1997, the Company sold 156,500 and 250,000 shares of Xionics stock for gains of $1.5 million and $3.2 million, respectively. At September 30, 1998, the Company owned approximately one million shares, representing approximately 9% of the total outstanding Xionics common stock. The Company anticipates continuing to sell shares in future quarters.
In fiscal 1994, the Company sold 80% of its Publishing Division to Softbank Corporation of Japan ("Softbank"). In September 1997, Phoenix sold the remaining 20% for $7.5 million.
Research and development costs from continuing operations, before the capitalization of internally developed software costs, were 37%, 37%, and 32% of total revenue in fiscal 1998, 1997, and 1996, respectively. On an actual dollar basis, these costs grew to $45,398,000 in fiscal 1998, an 18% increase from fiscal 1997, and $38,522,000 in fiscal 1997, a 42% increase from fiscal 1996. The Company
EMPLOYEES
As of September 30, 1998, the Company employed 804 persons worldwide, of whom 515 are in research and development, 165 are in sales and marketing, and 124 are in general and administration.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company relies primarily on U.S. and foreign patents, trade secrets, trademarks, copyrights and contractual agreements to establish and maintain proprietary rights in its technology. Phoenix has an active program to file applications for and obtain patents in the U.S. and in selected foreign countries where a potential market for the Company's products exists. At September 30, 1998, the Company had been issued six patents and had more than twenty-five patent applications in process. There can be no assurance that any of these patents would be upheld as valid if challenged.
The Company's general policy has been to seek patent protection for those inventions and improvements likely to be incorporated in its products or otherwise expected to be of value. The Company protects the source code of its products as trade secrets and as unpublished copyrighted works. The Company licenses the source code for its products to its customers for limited uses. Wide dissemination of the Company's software products makes protection of the Company's proprietary rights difficult, particularly outside the United States. Although it is possible for competitors or users to make illegal copies of the Company's products, the Company believes the rate of technology change and the continual addition of new product features lessen the impact of illegal copying.
Although the Company believes that its products do not infringe on any copyright or other proprietary rights of third parties, there are currently significant legal uncertainties relating to the application of copyright and patent law in the field of software. The Company has no assurance that third parties will not obtain, or do not have, patents covering features of the Company's products, in which event the Company or its customers might be required to obtain licenses to use such features. If a patent holder refuses to grant a license on reasonable terms or at all, the Company may be required to alter certain products or stop marketing them. In recent years, there has been a marked increase in the number of patents applied for and issued with respect to software products.
The Company's corporate headquarters are located in an 86,000 square foot building in San Jose, California, which the Company leases pursuant to a lease expiring in November 2003. In fiscal 1997, the Company entered into a five-year lease for a 63,000 square foot facility in Irvine, California. The Company subleases 37,000 square feet building located in Mountain View, California, which is renewable on a yearly basis. The Company also leases smaller office facilities in other locations including: Norwood, Massachusetts; Beaverton, Oregon; Houston, Texas; Taipei, Taiwan; Hong Kong, China; Tokyo, Japan; Seoul, Korea; Munich, Germany; and Surrey, England. These offices generally provide sales and technical support to the Company's customers.
The Company considers its leased properties to be in good condition, well maintained, and
The Company, from time to time, becomes involved in litigation claims and disputes in the ordinary course of business. There are currently no material pending legal proceedings to which either the Company or any of its subsidiaries is a party.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the NASDAQ National Market System under the symbol PTEC. The following table presents the quarterly high and low bid quotations in the over the counter market, as quoted by NASDAQ. These quotations reflect the inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
HIGH LOW
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YEAR ENDED SEPTEMBER 30, 1997:
First quarter $ 19.63 $ 14.63
Second quarter 19.75 14.75
Third quarter 15.63 11.00
Fourth quarter 16.69 12.75
YEAR ENDED SEPTEMBER 30, 1998:
First quarter $ 18.38 $11.63
Second quarter 14.75 11.13
Third quarter 13.50 8.88
Fourth quarter 12.88 5.59
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The Company had 403 shareholders of record as of September 30, 1998. The Company has never paid cash dividends on its common stock. The Company currently intends to retain all earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. In addition, the Company's line of credit agreement restricts the payment of cash dividends.
SELECTED FIVE-YEAR DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEAR ENDED SEPTEMBER 30,
1998 1997 1996 1995 1994
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Revenue:
License Fees $ 100,344 $ 89,884 $ 75,366 $ 51,521 $ 41,470
Services 22,541 15,612 10,841 7,550 5,837
Publishing - - - - 45,584
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Total revenue 122,885 105,496 86,207 59,071 92,891
Merger, acquisition and restructuring charges 14,730 - 889 - -
Income (loss) from operations (431) 16,407 14,637 10,131 4,182
Income before discontinued operations 722 20,335 11,932 9,980 20,488*
Net income 722 20,335 15,684 9,980 8,052
Diluted earnings per share:
Income before discontinued operations $ 0.03 $ 0.74 $ 0.48 $ 0.46 $ 1.05
Net income 0.03 0.74 0.63 0.46 0.41
AS OF SEPTEMBER 30,
1998 1997 1996 1995 1994
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Cash and short-term investments $ 71,297 $ 72,168 $ 80,287 $ 39,442 $ 35,263
Working capital 77,143 96,383 87,328 43,438 29,759
Total assets 159,102 161,149 141,959 71,473 66,354
Long-term debt - - - - -
Stockholders' equity 125,336 133,539 114,668 57,587 41,141
* Includes $23,538 gain on sale of publishing division and $9,095 of other operating expenses.
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SELECTED UNAUDITED QUARTERLY DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FISCAL 1998, QUARTER ENDED
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DEC 31 MAR 31 JUN 30 SEP 30
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Revenue $ 30,090 $ 31,798 $ 31,909 $29,088
Gross margin 23,702 26,021 26,484 22,626
Merger, acquisition and restructuring charges - - 750 13,980
Income from operations 4,094 3,751 3,750 (12,026)
Net income (loss) 4,477 3,375 3,543 (10,673)
Earnings (loss) per share - basic $ 0.18 $ 0.13 $ 0.14 ($ 0.41)
Earnings (loss) per share - diluted $ 0.16 $ 0.13 $ 0.13 ($ 0.41)
FISCAL 1997, QUARTER ENDED
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DEC 31 MAR 31 JUN 30 SEP 30
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Revenue $ 25,604 $ 24,202 $ 26,111 $ 29,579
Gross margin 22,175 20,429 21,268 22,985
Income from operations 4,511 3,460 3,739 4,697
Net income 4,109 3,162 3,920 9,144
Earnings per share - basic $ 0.16 $ 0.12 $ 0.15 $ 0.36
Earnings per share - diluted $ 0.15 $ 0.11 $ 0.14 $ 0.33
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OVERVIEW
The Company designs, develops, markets and supports standards-based system software and semiconductor IP for personal computers, peripherals and information appliances. The Company recently reorganized and operates under the following divisions:
PLATFORM ENABLING: Develops and markets system software and related services to PC and motherboard OEMs and system integrators. PC systems products include BIOS (Basic Input Output System) and related products.
PICO AND PC ENHANCING: Provides system software and services for PCs and industrial, hand-held and consumer information appliances based on the Intel x86 and UNIX architectures.
INTERCONNECT: Provides synthesizable cores, related tools and firmware that help design teams quickly incorporate industry standard interfaces into their chip designs.
In September 1998, Award Software International, Inc. ("Award') was
merged with a wholly-owned subsidiary of the Company. Award is a leading
provider of system enabling and management software that includes a suite of
BIOS products for designers and manufactures of motherboards, PC systems and
other microprocessor-based (or embedded) devices. In the merger, Phoenix
exchanged approximately 8.8 million shares of its common stock for all of the
outstanding shares of Award. Each share of Award common stock was exchanged for
1.225 shares of Phoenix common stock. In addition, outstanding Award employee
stock options and warrants were converted at the same exchange ratio into
options and warrants to purchase approximately 2.3 million and 0.5 million
shares of Phoenix common stock, respectively. The transaction was accounted for
as a pooling of interests for financial reporting purposes, and was structured
to qualify as a tax-free reorganization. All prior period financial statements
have been restated as if the merger took place at the beginning of such periods.
Also in September 1998, Phoenix completed the acquisition of Sand Microelectronics, Inc. ("Sand"), a supplier of synthesizable cores for the computer industry. Synthesizable cores are pre-packaged circuit descriptions used as building blocks for system-level application specific integrated circuits ("ASICs"). ASICs are used in computers and peripheral devices to connect them using PCI, USB, IEEE 1394, IrDA and other emerging industry standard protocols. The purchase price consisted of $18.6 million in cash, 464,000 shares of Phoenix common stock, stock options to purchase approximately 264,000 shares of Phoenix common stock (in exchange for Sand stock options), and up to $3.7 million in performance incentives to be paid through fiscal 2001. The acquisition was accounted for using the purchase method of accounting.
In August 1996, the Company acquired Virtual Chips, Inc. ("Virtual Chips") in exchange for 1,241,842 shares of newly issued common stock. The transaction was accounted for as a pooling of interests. Shares used in the computation of net income per share have been restated for all periods presented to give effect to the shares issued and options assumed by the Company in the transaction. Virtual Chips also supplies synthesizable cores for information platforms.
The following table includes Consolidated Statement of Operations data for the years ended September 30, 1998, 1997 and 1996, as a percentage of total revenue:
1998 1997 1996
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Revenue:
License fees 82% 85% 87%
Services 18 15 13
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Total revenue 100 100 100
Cost of revenue:
License fees 7 8 9
Services 13 10 9
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Total cost of revenue 20 18 18
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Gross margin 80 82 82
Operating expenses:
Research and development 33 31 29
Sales and marketing 22 21 21
General and administrative 13 14 14
Merger, acquisition and restructuring charges 12 - 1
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Total operating expenses 80 66 65
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Income from operations - 16 17
Interest income, net 4 3 3
Other income, net 1 9 -
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Income before income taxes 5 28 20
Provision for income taxes 4 9 6
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Income from continuing operations 1 19 14
Gain on discontinued operations (after income taxes) - - 4
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Net income 1% 19% 18%
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REVENUE
Revenue increased $17.4 million (16%) to $122.9 million in fiscal 1998, from $105.5 million in fiscal 1997. Revenue increased $19.3 million (22%) in fiscal 1997 from $86.2 million in fiscal 1996.
Revenue by geographic region for the three fiscal years ended September
30, 1998, was as follows:
% CHANGE % OF REVENUE
(DOLLARS IN THOUSANDS) 1998 1997 1996 1998 1997 1998 1997 1996
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North America $ 49,076 $ 40,878 $ 36,906 20.1% 10.8% 40.0% 38.7% 42.8%
Japan 31,825 27,391 20,930 16.2% 30.9% 25.9% 26.0% 24.3%
Asia (excl. Japan) 30,384 27,214 19,848 11.6% 37.1% 24.7% 25.8% 23.0%
Europe 11,600 10,013 8,523 15.8% 17.5% 9.4% 9.5% 9.9%
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Total revenue $122,885 $105,496 $ 86,207 16.5% 22.4% 100.0% 100.0% 100.0%
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Japan revenue increased in fiscal 1998 due mostly to increased license fees from shipments of notebook BIOS. Service revenue decreased, however, as Japanese customers deployed fewer new chip designs towards the end of fiscal 1998 due to a decline in the Japan economy.
The increase in Europe revenue in fiscal 1998 was due to increased volumes from two major European PC OEMs and from growth in information appliance revenues.
Service revenue increased $6.9 million (or 44%) in 1998 and $4.8 million (or 44%) in 1997. These increases were due to a number of chipset generation changes, and the introduction of new PC standards such as USB that increased the required deployment effort. The Company also focused a higher proportion of field engineering resources on revenue-generating projects. In addition, in fiscal 1998, the Company generated additional design and implementation services associated with ACPI, which is required for Microsoft's Windows 98 operating system.
No customer accounted for more than 10% of revenue in fiscal 1998, 1997 or 1996.
GROSS MARGIN
Gross margin as a percent of revenue was 80%, 82% and 82% for fiscal 1998, 1997 and 1996, respectively. The decrease in gross margin in 1998 was attributable to an increase in service revenue, on which a lower margin is earned. License fee gross margin was 92%, 91% and 89% for fiscal 1998, 1997 and 1996, respectively. The increase in license fee gross margin in fiscal 1998 was primarily due to the decrease in amortization of capitalized software. The increase in fiscal 1997 was a result of lower third-party royalties from the phase-out of a consumer application product, offset by an increase in the amortization of capitalized software. Amortization of capitalized software development costs charged to Cost of Revenue in fiscal 1998, 1997 and 1996, was $4.3 million, $5.0 million, and $3.2 million, respectively.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses were $40.5 million, $32.9 million and $24.8 million in fiscal 1998, 1997 and 1996, respectively. As a percent of revenue, these expenses represented 33%, 31%, 29%, respectively. In fiscal 1998, research and development expenses increased $7.6 million or 23%. This increase reflects additions in engineering personnel, primarily for the increased development of information appliance and interconnect products and for the feature enhancement of existing PC systems software. The increase as a percent of revenue from fiscal 1996 to fiscal 1997 was primarily due to the increased engineering resources required for the Intel alliance and expansion of the Company's products beyond the PC motherboard.
The Company capitalized approximately $5.6 million, $7.2 million and $2.9 million of software costs in fiscal 1998, 1997 and 1996, respectively. In addition, the Company capitalized approximately $12.8 million of software costs in conjunction with its September 1998 acquisition of Sand. The Company believes that continued investment in new and evolving technologies is essential to meet rapidly changing industry requirements.
SALES AND MARKETING EXPENSES
Sales and marketing expenses were $27.8 million, $22.4 million and $18.4 million in fiscal 1998, 1997 and 1996, respectively. In fiscal 1998, sales and marketing expenses increased $5.4 million, or 24%, principally from additions in sales personnel to support its PICO and PC Enhancing and Interconnect divisions. Also contributing to the increases were higher product marketing costs and the addition of international field offices in Hong Kong, Korea and Japan. The increase in fiscal 1997 was primarily due to growth in sales and marketing headcount associated with higher revenues.
General and administrative expenses were approximately $16.3 million, $15.2 million and $11.8 million in fiscal 1998, 1997 and 1996, and represented 13%, 14% and 14% of total revenues, respectively. The cost increases in both fiscal 1998 and 1997 were primarily from additions in staff and facilities that were required to support the Company's growth. Fiscal 1997 costs also included non-recurring charges related to the consolidation of facilities in northern and southern California.
MERGER, ACQUISITION AND RESTRUCTURING COSTS
Merger, acquisition and restructuring charges during the three years ended September 30, 1998, were as follows:
YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS) 1998 1997 1996
--------------------------------------------------------------------------------------------------
Out-of-pocket merger and acquisition costs $ 5,677 $ - $ 889
Restructuring 1,369 - -
Asset write-offs 3,434 - -
In-process research and development 4,250 - -
---------------------------------
$ 14,730 $ - $ 889
---------------------------------
---------------------------------
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Nearly all of the merger, acquisition and restructuring costs incurred in fiscal 1998 were related to the acquisitions of Award and Sand. The costs in fiscal 1996 were due to the acquisition of Virtual Chips. Out-of-pocket merger and acquisition costs include legal, accounting and investment banking fees. Restructuring costs include the costs of disposing of excess facilities and severance costs. Asset write-offs include the carrying value of assets that were determined to be redundant as a result of merger activities. The asset write-offs in fiscal 1998 were primarily related to capitalized software costs that were determined to be redundant as a result of the Award and Sand acquisitions.
The in-process research and development charge in fiscal 1998 was an allocation of a portion of the purchase price for Sand for projects that were not yet capitalizable under the provisions of Statement of Financial Accounting Standards No. 86, "COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED." The allocation was based upon an independent appraisal. The appraised value was determined by estimating the future net cash flows from such projects, and discounting the net cash flows back to their present value. The discount rate applied includes a factor that takes into account the uncertainty surrounding the successful development of the purchased in-process technology. If these projects are not successfully developed, future revenue and profitability of the Company may be adversely affected. Additionally, the value of other intangible assets acquired may become impaired.
In November 1998, the Company announced a restructuring related to focusing and streamlining certain field operations and other functions. The restructuring included the closing of the Company's offices in Texas and France, and the elimination of 38 positions, a global workforce reduction of about five percent. The Company will record a one-time, pre-tax charge of approximately $1.9 million in the quarter ending December 31, 1998, to cover severance benefits and facilities consolidations associated with this restructuring.
INTEREST AND OTHER INCOME, NET
Interest income is primarily derived from cash investments in marketable securities. The income generated each period is highly dependent on fluctuations in U.S. interest rates. The average interest rate earned in fiscal 1998 was approximately 5.6%. In addition, certain trade balances are denominated in foreign currencies, and therefore subject to fluctuations in foreign currency exchange rates.
Net interest income was $4.7 million, $4.0 million and $2.7 million in fiscal 1998, 1997 and 1996, respectively. These increases in net interest income were primarily due to the increase in the average cash
Other income (net) decreased $7.8 million from $9.3 million in fiscal 1997 to $1.5 million in 1998. The decrease was primarily due to the sale of fewer shares of Xionics stock (see Discontinued Operations below) at lower average selling prices, and a one-time gain. In fiscal 1997, Phoenix sold a 20% interest in a former division for $7.5 million and recorded a gain on the sale of $6.2 million. The Company sold 156,500 and 250,000 shares of common stock of Xionics and recorded gains on sale of investment of $1.5 million and $3.2 million in fiscal 1998 and 1997, respectively.
DISCONTINUED OPERATIONS
In fiscal 1994, the Company sold a division to Xionics Document Technologies, Inc. ("Xionics") in return for a promissory note and shares of Xionics common stock. In September 1996, the Company sold 500,000 shares of common stock of Xionics in its initial public offering and received payment on the promissory note. A gain on the repayment of the note and sale of stock in the amount of $3.8 million was recorded as a gain from discontinued operations, net of income taxes of $2.3 million, to the extent such amounts were previously written off in previous fiscal years by a charge to discontinued operations. The remaining amount of $294,000 in fiscal year 1996, which represents investment gains, was recorded in continuing operations as other income on the Company's income statement.
PROVISION FOR INCOME TAXES
The Company recorded income tax provisions of $5.0 million, $9.5 million and $5.5 million in fiscal 1998, 1997 and 1996, respectively. Excluding non-deductible in-process research and development and transaction costs related to the acquisitions of Award and Sand, the Company's effective tax rate was 32%, 32% and 30% in fiscal 1998, 1997 and 1996, respectively. The Company's effective tax rate (excluding non-deductible acquisition charges and transaction costs) has been lower than the statutory rate due to various federal and state tax credits and lower tax rates imposed on foreign earnings in certain jurisdictions.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income," and Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures About Segments of an Enterprise and Related Information". SFAS 130 establishes standards for the reporting of comprehensive income, and will require the Company to disclose comprehensive income to supplement the current reporting of income. SFAS 131 sets forth standards for the disclosure of certain information by segments, such as products or services, geographic regions or major customers. The Company will adopt both SFAS 130 in its first quarter of fiscal 1999. SFAS 131 will be effective for fiscal 1999 year-end reporting, and will apply to both annual and interim financial reporting subsequent to that date.
In October 1997 and March 1998, the Accounting Standards Executive Committee issued Statement of Position 97-2 ("SOP 97-2"), "Software revenue recognition," and SOP 98-4, "Deferral of the effective date of a provision of SOP 97-2, software revenue recognition," respectively. These standards provide guidance on applying generally accepted accounting principles in recognizing revenue on software transactions. The adoption of both SOP 97-2 and SOP 98-4, which is required in the first quarter of fiscal 1999, is not expected to have a significant impact on the Company's consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 establishes new standards of accounting and reporting for derivative instruments and hedging activities. The Company will adopt SFAS 133 in the first quarter of fiscal 2000. The adoption of SFAS 133 is not expected to have a material impact on the Company's consolidated financial statements.
The tables in Part II, Item 6 of this Form 10-K include selected unaudited quarterly consolidated results of operations for fiscal 1998 and 1997. This information was derived from the Company's unaudited consolidated financial statements that, in the opinion of management, reflect all recurring adjustments necessary to fairly present this information, when read in conjunction with the Company's Consolidated Financial Statements. The results of operations for any period are not necessarily indicative of the results to be expected for any future period.
Phoenix's future operating results may vary substantially from period to period. The timing and amount of its license fees are subject to a number of factors that make estimating revenues and operating results prior to the end of a quarter uncertain. While Phoenix receives recurring revenue on royalty-based license agreements and some agreements contain minimum quarterly royalty commitments, a significant amount of license fees in any quarter is dependent on signing agreements and delivering the licensed software in that quarter. Generally, Phoenix has experienced a pattern of recording 50% or more of its quarterly revenues in the third month of the quarter. Phoenix has historically monitored its revenue bookings through regular, periodic worldwide forecast reviews during the quarter. However, while these reviews keep management informed of areas where additional selling effort may be needed in order to meet the internal plans and market expectations, there can be no assurances that this process will result in revenue expectations being met. Operating expenses for any year are normally based on the attainment of planned revenue levels for that year and are incurred ratably throughout the period. As a result, if revenues are less than planned in any period while expense levels remain relatively fixed, Phoenix's operating results would be adversely affected for that period. In addition, the incurring of unplanned expenses could adversely affect operating results for the period in which such expenses were incurred.
BUSINESS RISKS
The additional following factors should be considered carefully when evaluating Phoenix and its business.
PRODUCT DEVELOPMENT
Phoenix's long-term success will depend on its ability to enhance its existing products and to introduce new products on a timely and cost-effective basis that meet the needs of its current customers in their present markets and of current and future customers in new and emerging markets. There can be no assurance that Phoenix will be successful in developing new products or in enhancing existing products or that new or enhanced products will meet market requirements. Delays in introducing new products can adversely impact acceptance and revenue generated from the sale of such products. Phoenix has, from time to time, experienced such delays. Phoenix's software products and their enhancements contain complex code that may contain undetected errors or bugs when first introduced, despite testing. There can be no assurance that new products or enhancements will not contain errors or bugs that will adversely affect commercial acceptance of such products or enhancements.
PROTECTION OF INTELLECTUAL PROPERTY
Phoenix relies on a combination of patent, trade secret, copyright, and trademark laws and contractual provisions to protect its proprietary rights in its software products. There can be no assurance that these protections will be adequate or that competitors will not independently develop technologies that are substantially equivalent or superior to Phoenix's technology. In addition, copyright and trade secret protection for Phoenix's products may be unavailable or unreliable in certain foreign countries. The Company has been issued six patents with respect to its current product offerings and has more than twenty-five patent applications pending with respect to certain of the products it markets. Phoenix maintains an active internal program designed to identify internally developed inventions worthy of being patented. There can be no assurance that any of the applications pending will be approved and
IMPORTANCE OF MICROSOFT AND INTEL
For a number of years, Phoenix has worked closely with Microsoft Corporation and Intel Corporation in developing standards for the PC Industry. In addition, Phoenix supplies its system level software technology to Intel. Phoenix remains optimistic regarding its relationships with these two industry leaders. There can, however, be no assurance that either Microsoft or Intel will not develop alternative product strategies that could conflict with Phoenix's product plans and marketing strategies and, accordingly, adversely impact Phoenix's business and results of operations. Presently, there is little overlap or conflict in Phoenix's product offerings and strategies and those of Intel. Windows NT and Windows CE, Microsoft's newer operating systems, incorporate some functionality that has traditionally resided in the BIOS. Both Intel and Microsoft, in their endeavors to add value, incorporate features or functions provided by Phoenix in silicon or the operating system, respectively. Therefore, Phoenix must continually create new features and functions to sustain as well as increase its added value to OEMs. There can be no assurances that Phoenix will be successful in these efforts.
ATTRACTION AND RETENTION OF KEY PERSONNEL
Phoenix believes it employs more BIOS engineers than any other company in the PC industry. Virtual Chips' products are based on new and emerging technologies that are different from BIOS technologies. Phoenix's ability to achieve its revenue and operating performance objectives will depend in large part on its ability to attract and retain technically qualified engineers. The available pool of engineering talent is limited for both operations. Accordingly, failure to attract, retain and grow its research and development teams could adversely affect Phoenix's business and operating results.
DEPENDENCE ON KEY CUSTOMERS; CONCENTRATION OF CREDIT RISK
The loss of any key customer and the inability of the Company to replace revenues provided by a key customer could have a material adverse effect on the Company's business and financial condition. The Company's customer base includes large OEMs in the PC market and as a result, the Company maintains individually significant receivable balances due from them. If these OEMs fail to meet their guaranteed minimum royalty payments and other payment obligations, the Company's operating results could be adversely affected. As of September 30, 1998, the largest receivable balance represented approximately 10% of total accounts receivable.
COMPETITION
The market for Phoenix's products is very competitive, resulting in downward pricing pressure on the Company's products. In marketing its BIOS products, Phoenix competes primarily with in-house research and development departments of PC manufacturers that may have significantly greater financial and technical resources than those of Phoenix. These companies include Acer Incorporated, Compaq Computer Corporation, Dell Computer Corporation, International Business Machines Corporation and Toshiba Corporation. It also competes for system software business with other independent suppliers, ranging from small, privately-held companies to Acer Softech, a division of Acer Labs, a major Taiwan chip and motherboard supplier. There can be no assurance that Phoenix will continue to compete successfully with its current competitors or that it will be able to compete successfully with new
INTERNATIONAL SALES AND ACTIVITIES
Revenue derived from Phoenix's international operations comprises a majority of total revenues. There can be no assurances that Phoenix will not experience significant fluctuations in international revenues. While the major portion of Phoenix's license fee or royalty contracts are U.S. dollar denominated, Phoenix is entering into an increasing number of contracts denominated in local currencies. Phoenix has sales and engineering offices in England, Germany, Japan, Korea and Taiwan and uses a software engineering firm in India. Phoenix's operations and financial results could be adversely affected by factors associated with international operations such as changes in foreign currency exchange rates, uncertainties relative to regional economic circumstances, political instability in emerging markets, and difficulties in staffing and managing foreign operations, as well as by other risks associated with international activities.
The recent instability in the Asian financial markets has negatively impacted the Company's revenue in those markets by, among other things, decreasing end-user purchases, increasing competition from local competitors offering sales terms in local currencies, and reducing access to sources of capital needed by customers to make purchases. In addition to reducing revenue, difficulties in Asia may increase the Company's credit risk, as customers become insolvent or otherwise have their ability to meet obligations impaired.
The Year 2000 Issue may pose significant operational problems for computer systems used internally by the Company. The Company expects to incur internal staff costs as well as consulting and other expenses related to the upgrades, replacements and modifications necessary to prepare internal systems for the Year 2000. While the Company has a project plan to complete these upgrades, replacements and modifications prior to the end of 1999, if they are not completed in a timely manner, the Year 2000 Issue may have a material impact on the Company's operations. Furthermore, there can be no assurance that the systems of other companies with which the Company deals and on which the Company's systems rely will also be timely converted or that any such failure to convert by another company would not have a material impact on the Company's operations.
The Year 2000 Issue may also pose significant operational problems for the Company as a result of products it has sold or licensed. The Company intends to make available to its customers and end users upgrades to certain of its products to achieve, or increase the degree of, Year 2000 compliance for such products. Despite these efforts, the Company cannot predict whether it will be named as a defendant in claims or complaints regarding the Year 2000 Issue, nor can the Company anticipate the number of such claims or complaints if it is so named. If the Company is so named, the cost of defending and resolving such claims could have a material impact on the Company. Depending on the nature of the claims asserted, the remedy imposed or the cost of defense, even one such suit could represent a material exposure to the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operation - Year 2000."
VOLATILE MARKET FOR PHOENIX STOCK
The market for Phoenix's stock is highly volatile. The trading price of Phoenix common stock has been, and will continue to be, subject to fluctuations in response to operating and financial results, announcements of technological innovations, new products or customer contracts by Phoenix and its competitors, changes in Phoenix's or its competitors' product mix or product direction, changes in
CERTAIN ANTI-TAKEOVER EFFECT
Phoenix's Certificate of Incorporation, Bylaws and Stockholder Rights Plan and the Delaware General Corporation Law include provisions that may be deemed to have anti-takeover effects and may delay, defer or prevent a takeover attempt that stockholders might consider in their best interests. These include provisions under which members of the Board of Directors are divided into three classes and are elected to serve staggered three-year terms. The Stockholder Rights Plan permits holders of Phoenix common stock to purchase shares of Series A Junior participating preferred stock in the event of the acquisition by a third party of 20% or more of Phoenix's outstanding common stock or if a third party announces its tender offer for at least 30% of Phoenix's outstanding common stock. If Phoenix is acquired in a merger or other business combination, each right will entitle its holder to purchase a number of shares of Phoenix common stock that equals the exercise price of the right divided by one-half of the then current market price of Phoenix common stock. In addition, in connection with the February 1996 sale of shares representing 6% of the outstanding Phoenix common stock and of a warrant to purchase an additional 7%, Phoenix granted Intel Corporation certain rights in the event of solicited or unsolicited offers to acquire Phoenix.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company's primary sources of liquidity included cash, cash equivalents and short-term investments of $71.3 million, and available borrowings under a bank credit facility of $10.0 million. There were no borrowings outstanding under the bank credit facility at September 30, 1998. The Company believes that its existing sources of liquidity will be sufficient to satisfy the Company's cash requirements for at least the next twelve months.
CHANGES IN FINANCIAL CONDITION
Net cash generated from operating activities during fiscal 1998 was $13.2 million, resulting primarily from cash provided by net income, adjusted for non-cash items. Net cash used in investing activities was $14.5 million, which consisted primarily of the Company's investment in Sand (net of cash acquired) of $15.6 million, purchases of property and equipment of $5.5 million, and additions to computer software costs of $5.2 million, partially offset by $7.5 million received from the sale of the Company's interest in its publishing operation in fiscal 1997. Cash used for financing activities during fiscal 1998 was $0.6 million resulting from purchases of $3.6 million of treasury stock, partially offset by $2.9 million from the exercise of common stock options and issuance of stock under the Company's employee stock purchase plan.
YEAR 2000
Many software and firmware products and internally developed applications used two digits to designate the year instead of four digits. This may result in the interpretation of the year 00 as 1900 or other dates instead of correctly interpreting it as 2000. Such failure could disrupt processing transactions or even cause certain systems to fail. This possibility affects the Company's products and its information technology and other internal systems as well as the Company's customers and vendors. The PC industry has also defined the Year 2000 ("Y2K") issue to include proper handling of leap year calculations.
The Company's Year 2000 compliance effort covers the Company's products, internal systems and services provided by others.
PHOENIX PRODUCTS
HISTORY. Since the Company's inception, the Company has sold or licensed various products, including BIOS products, semiconductor intellectual property and consumer software.
The Company's BIOS products fall into differing definitions of Y2K compliance. BIOS-related products sold or licensed after fiscal 1995 are designed to automatically handle millenium date changes and leap year calculations. The Company's BIOS products prior to that date are manually compliant, which mean that end users must change the date on their system at or after the December 31, 1999 in order for the system date to be proper. The Company has identified one product line that was not manually compliant.
The Company's semiconductor IP product lines do not handle date-related functions and accordingly do not implicate Year 2000 issues. The Company discontinued its consumer software product lines in 1996. Accordingly, the Company does not believe that a significant number of these products will remain in use at the millenium. The Company has developed a list of all products it sold and licensed and has begun assessing the level of compliance of these products. This effort is expected to be completed in the second quarter of the Company's 1999 fiscal year.
REMEDIAL STEPS. The Company sells and licenses its products directly to OEMs, and therefore does not have direct customer relationships with end users of PCs or information appliances. Nonetheless, for any products deemed to be less than fully compliant, the Company will make available to end users software upgrades, fixes or patches. These solutions will be available to users through the Company's web site and by mail, if necessary. The Company will also make these solutions available to OEM customers for placement by those customers on their respective web sites. Where appropriate, the Company will undertake other efforts to inform end users and deliver solutions to end users. However, there can be no assurance that end users of products containing software sold or licensed by the Company will take steps to download these solutions from the Internet, or that such end users will have Internet access. The Company believes that the incremental costs of providing these solutions to customers will not be significant.
EXPOSURE. The Company continues to identify and assess the state of Y2K compliance of those products it sold or licensed that remain in use. There can be no assurance that the Company will be able to identify all compliance issues for each of the products it has sold or licensed during its history. Accordingly, the Company is not able to estimate the cost of obtaining compliance of its products at this time.
INFORMATION TECHNOLOGY AND OTHER SYSTEMS
The Company's plans for dealing with the Year 2000 include surveying and testing or certifying all of the hardware and software used in the Company for compliance, performing remediation where necessary and developing a contingency plan for the beginning of the millennium.
CURRENT STATUS. The Company's internal systems are generally based on purchased software and operated on personal computers, PC servers and Unix workstations and servers. The vast majority of hardware, including networking hardware, is three years old or less. Software products in use range in age generally from the latest upgrade to approximately ten years old. The Company uses Oracle for its primary financial system, which has been upgraded recently and which Oracle represents is Y2K compliant. The Company is in the process of selecting a replacement for the code management system
The Company has developed a project plan, approved by the Board of Directors, and is in the process of testing its hardware and software. A key element of the plan is to assure that all firmware and software is identified and tested, and various elements have been assigned to specific individuals. Most of the computers, and the applications thereon, can be tested over the Company's wide area network. However there are also embedded firmware and software in other systems, such as building access and temperature control systems, which will require individual testing and possibly remediation. The project plan is targeted for completion in June 1999; to date, less than 25% of all project tasks have been completed to date.
All employees have been alerted to the Y2K issues.
TEST, CERTIFICATION AND REMEDIATION. Third party software is being used to test each of the computer systems and inventory all applications in use. The application information will be compared to vendor or other published databases with Y2K compliance information. Remedial action, where necessary, which usually involves acquiring and implementing an upgrade, will be performed in groups based on the level of priority. For those applications not found in the published Y2K information, the vendors will be contacted, and where necessary, upgrades will be acquired and implemented. There will be some applications where the vendor no longer exists, in which case a determination will be made, based on the importance of the application, to test and, if necessary, modify it internally, replace it or ignore it.
COST OF COMPLIANCE TESTING AND REMEDIATION. The Company has spent approximately $50,000 in testing and upgrades to date. The new code management system is expected to cost approximately $2 million for software, implementation assistance and training, excluding the cost of Phoenix personnel involved in the project. The Company's Information Technology personnel will spend approximately 15% of their time over the next fiscal year on Y2K issues at an approximate cost of $250,000. Software purchases and certain other vendor costs are capitalized and depreciated while other costs are charged directly to expense. Year 2000 expenses are being funded through operating cash flows. Total anticipated Y2K expenditures are not material to the Company's financial condition. However there can be no assurance that additional and material unanticipated costs will not arise during the course of testing, certification and remediation. In addition, there can be no assurance that the estimates of time and cost contained herein will be achieved and actual results could differ materially from those anticipated.
THIRD-PARTY SYSTEMS
The Company has relationships with various third parties and the failure of these third parties to achieve Year 2000 compliance could have a material impact on the Company's business, operating results and financial condition. The Company is making inquiries of its major vendors and suppliers, such as banks, payroll service and equipment vendors about their Y2K readiness. While responses to date or their published Y2K readiness have been satisfactory, the Company has information on less than 50% of the significant vendors. Further, there can be no assurance that unanticipated processing or supply problems will not occur at the turn of the century.
The Company does not currently have any information concerning the Y2K readiness of its customers. In the event that the Company's significant customers do not successfully and timely achieve Y2K compliance, the Company's business or operations could be adversely affected.
The most reasonably likely worst case scenario would include significant costs and business interruptions associated with: 1) previously undetected errors in the Company's products, 2) Year 2000 litigation, as currently being experienced by other software vendors, 3) a significant disruption of the Company's internal information systems and 4) the failure of infrastructure services provided by government agencies and other third parties (e.g., air travel, banking, utilities, etc.). Third-party litigation purporting to represent a class of PC or other product users containing Phoenix products, independent of merits of such claims, could require a significant amount of management time and Company resources to defend itself. The Company does not currently have a contingency plan for the Year 2000, but plans to develop one during fiscal 1999. The plan will cover rapid response to customer and end-user problems as well as manual or other temporary remedies in the event of failure of Company or third party systems. In addition, the plan will include comprehensive tests of internal systems. There can be no assurance that the actions being taken, as described above, will prevent any Y2K problems. In addition, there can be no assurance that the contingency plans will be sufficient to counteract such problems, which could result in a material adverse effect upon the Company's business, operating results and financial condition.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14(a) for an index to the consolidated financial statements and supplementary financial information that are attached hereto.
ITEM 9. CHANGES IN, AND DISAGREEMENTS WITH, ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to directors of the Company will be contained in the Company's definitive proxy statement to be filed pursuant to Regulation 14A in connection with the 1998 annual meeting of its stockholders (the "Proxy Statement) and is incorporated herein by this reference.
The executive officers of the Company, each of whom serve at the discretion of the Board of Directors, as of the date of this Form 10-K are as follows:
Name Age Position
---- --- --------
Jack Kay 52 President and Chief Executive Officer
Wayne C. Cantwell 33 Vice President and General Manager,
Worldwide Field Operations
David Frodsham 42 Chief Operating Officer
George C. Huang 56 President, Award Subsidiary, and
Senior Vice President, Strategic
Business Development
Stuart J. Nichols 38 Vice President, General Counsel and
Secretary
Robert J. Riopel 56 Vice President, Finance, Chief
Financial Officer and Treasurer
Craig Slayter 48 Senior Vice President and General
Manager, Platform Enabling Group
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Mr. Kay joined the Company as Vice President of Worldwide Sales in May 1990. In January 1992,
Mr. Cantwell was promoted to Vice President and General Manager, Worldwide Field Operations, in November 1998. From March 1998 to October 1998, he held the position of Vice President and General Manager, North America Operations. In September 1997, he was promoted to Vice President Asia/America Operations. From January 1996 to August 1997, he was General Manager, Asia Operations. Prior to that, Mr. Cantwell held various sales, sales management and general management roles with the Company.
Mr. Frodsham was President of Distributed Information Processing Ltd., a British company that was acquired by Phoenix in 1994. At that time, he became General Manager, Europe until his appointment as Vice President and General Manager, PC Systems in July 1997. He was promoted to the position of Vice President and General Manager, Product Development and Marketing in July 1998, and then to Chief Operating Officer in November 1998.
Mr. Huang has served as Chairman of the Board of Directors, President, Chief Executive Officer and Director of Award since July 1993. From January 1984 to the present, Dr. Huang has served as Chairman of the Board of Directors of GCH Systems, Inc. ("GCH"), a company that develops and markets embedded controllers, Application Specific Integrated Circuits and PC Systems, and from January 1984 until November 1994, he also served as Chief Executive Officer of GCH. From February 1987 to the present, Dr. Huang has served as a Director of GCH-Sun Systems Company Ltd. ("GSS"), a subsidiary of GCH. From January 1990 to May 1996, Dr. Huang served as a Director of Fidelity Venture Capital Corporation ("FVCC"), a shareholder of GCH and the Company. Dr. Huang received a B.S. from National Taiwan University, an M.S. from Washington State University and a Ph.D. in Electrical Engineering from the University of Washington.
Mr. Nichols joined the Company in May 1997 as Vice President, General Counsel and Secretary. For two years before joining the Company, Mr. Nichols was General Counsel for Samsung Semiconductor, Inc., a subsidiary of Samsung Electronics Co., Ltd. From 1989 to 1995, Mr. Nichols served as Corporate Counsel for Varian Associates, Inc.
Mr. Riopel joined the Company as Vice President, Finance, Chief Financial Officer, and Treasurer in February 1995. For two years before joining the Company, Mr. Riopel was Senior Vice President, Finance and Administration and Chief Financial Officer for OpenVision Technologies, Inc., a developer of system management software for client-server systems. From 1989 to 1993, Mr. Riopel served as Vice President, Finance for the international division of Silicon Graphics, Inc.
Mr. Slayter was President of Softstyle Inc, a company that was acquired by Phoenix in 1987. He has been employed in various management positions with the Company since that date. Mr. Slayter served as General Manager, Asia-Pacific Division, from April 1988 through September 1994. He was promoted to Vice President, Asia-Pacific Operations in October 1994. In April 1996, Mr. Slayter became the Vice President and General Manager of the Special Products Division. Mr. Slayter was promoted to the position of Vice President and General Manager, Worldwide Field Operations in September 1997, and then to Senior Vice President & General Manager, Platform Enabling Group in November 1998.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this section is incorporated by reference from the information contained in the section captioned, "Executive Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this section is incorporated by reference from the information contained in the section captioned, "Certain Transactions" in the Proxy Statement.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of Phoenix Technologies Ltd. and its subsidiaries are filed as part of this report on Form 10-K:
Page
----
Report of Ernst & Young LLP, Independent Auditors
Report of PricewaterhouseCoopers LLP, Independent Accountants
Consolidated Balance Sheets as of September 30, 1998 and 1997
Consolidated Statements of Income for the years ended September 30, 1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the years ended September 30, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended September 30, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
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2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not required, are not applicable or the information is included in the financial statements or notes thereto. The financial statements and financial statement schedules follow the signature page hereto.
(b) REPORTS ON FORM 8-K
On September 29, 1998, the Registrant filed a Current Report on Form 8-K reporting the Company's completion of the merger with Award Software International. On November 25, 1998, the Registrant filed a Current Report on Form 8-K/A amending the 8-K filing to include unaudited, pro forma financial statements of the Registrant and Award.
(c) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
-------------------------------------------------------------------------------
2.1 Agreement and Plan of Reorganization, dated as of April 15, 1998,
among Phoenix Technologies Ltd,. Portland Acquisition Corporation and
Award Software International Inc. (incorporated herein by this
reference to Exhibit 2.1 to the Registration Statement on Form S-4
filed with the SEC on May 26, 1998).
2.2 Agreement of Merger between Award Software International Inc. and
Portland Acquisition Corporation (incorporated herein by this
reference to Exhibit 2.2 to the Registration Statement on Form S-4
filed with the SEC on May 26, 1998).
3.1 Amended and Restated Certificate of Incorporation of Phoenix
Technologies dated as of June 29, 1998 (incorporated herein by this
reference to Exhibit 3.1 to the Registration Statement on Form S-4
filed with the SEC on May 26, 1998).
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EXHIBIT
NUMBER DESCRIPTION
-------------------------------------------------------------------------------
3.2 By-laws of the Registrant as amended through February 6, 1995
(incorporated herein by reference to Exhibit 4.2 to the Company's
Registration Statement on Form S-8, Registration No. 333-03065).
3.6 Certificate of Ownership (incorporated herein by reference to Exhibit
3.6 to the Company's 1988 Annual Report on Form 10-K).
4.1 Rights Agreement dated as of October 31, 1989 between the Company and
The First National Bank of Boston (incorporated herein by reference to
Exhibit 4.1 to the Company's Form 8-K filed on October 31, 1989).
10.4 Employment Agreement dated June 9, 1994 between the Registrant and
Jack Kay (incorporated herein by reference to Exhibit 10.9 to the
Company's Quarterly Report on Form 10-Q filed on August 15, 1994).
10.15 1994 Equity Incentive Plan, as amended through February 28, 1996
(incorporated herein by reference to Exhibit 10.17 to the Company's
Report on Form 10-K for the fiscal year ended September 30, 1995 (the
"1995 10-K")).
10.21 Amended and Restated Lease Agreement dated March 15, 1995 between The
Prudential Insurance Company of America and the Company with respect
to certain facilities located at 846 University Avenue, Norwood, MA
(incorporated herein by reference to Exhibit 10.23 to the 1995 10-K).
10.22+ Agreement dated December 18, 1995 between Intel Corporation and the
Company (incorporated herein by reference to Exhibit 10.24 to the
Company's Report on Form 10-Q for the quarter ended December 31, 1995,
as amended by a Form 10-Q/A-1 (the "December 1995 10-Q")).
10.23 Common Stock and Warrant Purchase Agreement dated as of December 18,
1995 by and between the Company and Intel Corporation (incorporated
herein by reference to Exhibit 10.25 to the December 1995 10-Q).
10.24 Warrant to Purchase Shares of Common Stock of the Company dated
February 15, 1996 (incorporated herein by reference to Exhibit 2 to
the Schedule 13D of Intel Corporation dated February 23, 1996 with
respect to the purchase by Intel of shares of the Company's common
stock and of a warrant to purchase shares of the Company's common
stock (the "Intel Schedule 13D")).
10.25 Investor Rights Agreement, dated December 18, 1995, between the
Company and Intel Corporation (incorporated herein by reference to
Exhibit 3.2 to the Intel Schedule 13D).
10.26 Standard Industrial Lease - Full Net between The Equitable Life
Assurance Society of the United States as Landlord and Phoenix
Technologies Ltd. as Tenant dated as of May 15, 1996 for that certain
property located at 411 E. Plumeria Drive, San Jose, California
(incorporated herein by reference to Exhibit 10.20 to the Company's
Report on Form 10-Q for the quarter ended June 30, 1996).
10.28 Industrial Lease (Single Tenant; Net) dated as of October 1, 1996 by
and between The Irvine Company and Phoenix Technologies Ltd. for that
certain property located at 135 Technology Drive, Irvine, California
(incorporated herein by reference to Exhibit 10.28 to the 1996 Form
10-K).
10.29 1996 Equity Incentive Plan, as amended through December 12, 1996
(incorporated herein by reference to Exhibit 4.2 to the Company's
Registration Statement on Form S-8 filed on January 27, 1997
(Registration No. 333-20447)).
|
EXHIBIT
NUMBER DESCRIPTION
-------------------------------------------------------------------------------
10.31 Loan Agreement dated as of March 27, 1998 by and between Silicon
Valley Bank and Phoenix Technologies Ltd. (incorporated herein by
reference to Exhibit 10.31 to the Company's Report on Form 10-Q for
the quarter ended March 31, 1998).
10.32 1998 Stock Plan, as amended June 4, 1996 (incorporated herein by
reference to Exhibit 99.1 to the 1998 Stock Plan and Amended 1991
Employee Stock Purchase Plan).
10.33 Amended and Restated Employee Stock Purchase Plan, as amended June 4,
1998 (incorporated herein by reference to Exhibit 99.2 to the 1998
Stock Plan and Amended 1991 Employee Stock Purchase Plan S-8).
10.34 Form of Indemnity Agreement to be entered into between the Registrant
and its directors and officers, with related schedule (incorporated
herein by reference to Exhibit 10.1 to the Registration Statement on
Form S-1, File No. 333-05107, filed by Award Software International,
Inc. on June 3, 1996, as amended).
10.35 Lease, dated January 1, 1996, between GCH Systems, Inc. and the
Registrant (incorporated herein by reference to Exhibit 10.7 to the
Registration Statement on Form S-1, File No. 333-05107, filed by Award
Software International, Inc. on June 3, 1996, as amended).
10.36 Summary of Leases, dated March 1, 1996, between Sun Corporation, GSS
Corporation and the Registrant (incorporated herein by reference to
Exhibit 10.8 to the Registration Statement on Form S-1, File No.
333-05107, filed by Award Software International, Inc. on June 3,
1996, as amended).
10.37 Voting Agreement, dated January 12, 1996, between the Registrant and
certain persons named therein (incorporated herein by reference to
Exhibit 10.9 to the Registration Statement on Form S-1, File No.
333-05107, filed by Award Software International, Inc. on June 3,
1996, as amended).
10.38 Investors' Rights Agreement among the Registrant and certain other
persons named therein, dated as of January 12, 1996 (incorporated
herein by reference to Exhibit 10.10 to the Registration Statement on
Form S-1, File No. 333-05107, filed by Award Software International,
Inc. on June 3, 1996, as amended).
10.39 Warrant issued to Synnex Information Technologies, Inc. (incorporated
herein by reference to Exhibit 10.11 to the Registration Statement on
Form S-1, File No. 333-05107, filed by Award Software International,
Inc. on June 3, 1996, as amended).
10.40 Warrant issued to Vobis Microcomputer AG (incorporated herein by
reference to Exhibit 10.12 to the Registration Statement on Form S-1,
File No. 333-05107, filed by Award Software International, Inc. on
June 3, 1996, as amended).
10.41 Warrant issued to Venrock Associates (incorporated herein by reference
to Exhibit 10.13 to the Registration Statement on Form S-1, File No.
333-05107, filed by Award Software International, Inc. on June 3,
1996, as amended).
10.42 Warrant issued to Venrock Associates II, L.P. (incorporated herein by
reference to Exhibit 10.14 to the Registration Statement on Form S-1,
File No. 333-05107, filed by Award Software International, Inc. on
June 3, 1996, as amended).
10.43 Warrant issued to Walden Capital Partners II, L.P. (incorporated
herein by reference to Exhibit 10.15 to the Registration Statement on
Form S-1, File No. 333-05107, filed by Award Software International,
Inc. on June 3, 1996, as amended).
10.44 Warrant issued to Walden Technology Ventures II, L.P. (incorporated
herein by reference to Exhibit 10.16 to the Registration Statement on
Form S-1, File No. 333-05107, filed by Award Software International,
Inc. on June 3, 1996, as amended).
10.45+ Technology Development and Support Agreement, dated June 28, 1996,
between Registrant and Advanced Micro Devices, Inc. (incorporated
herein by reference to Exhibit 10.17 to the Registration Statement on
Form S-1, File No. 333-05107, filed by Award Software International,
Inc. on June 3, 1996, as amended).
10.46 Common Stock Purchase Agreement by and among Award Software
International, Inc., Sun Corporation and Axis Corporation dated April
13, 1998 (incorporated herein by reference to Exhibit 10.1 of the 10-Q
of Award Software International, Inc. for the quarter ended June 30,
1998).
10.47 Support Agreement by and between Award Software International, Inc.
and Vobis Microcomputer AG dated April 15, 1998 (incorporated herein
by reference to Exhibit 10.2 of the 10-Q of Award Software
International, Inc. for the quarter ended June 30, 1998).
10.48+ Memorandum of Understanding by and among Sun Corporation, Axis
Corporation and the Company (incorporated herein by reference to
Exhibit 10.25 of the 10-Q of Award Software International, Inc. for
the quarter ended June 30, 1997).
10.49 Commercial Lease, dated as of January 5, 1996 by and between Unicore
Software, Inc. and 114 Realty Trust, as amended on May 30, 1997 and
September 1, 1997 (incorporated herein by reference to Exhibit 10.26
of the 10-K of Award Software International, Inc. for the year ended
December 31, 1997).
10.50 Executive Severance Benefits Agreement, dated September 24, 1998
between the Company and George C. Huang (incorporated herein by
reference to Exhibit 10.27 of the 10-K of Award Software
International, Inc. for the year ended December 31, 1997).
10.51 Executive Severance Benefits Agreement, dated April 14, 1998 between
the Company and Laurent K. Gharda (incorporated herein by reference to
Exhibit 10.34 of the 10-K of Award Software International, Inc. for
the year ended December 31, 1997).
10.52 Promissory Note, dated March 1, 1998, issued by Pierre A. Narath to
the Company (incorporated herein by reference to Exhibit 10.35 of the
10-K of Award Software International, Inc. for the year ended December
31, 1997).
10.53 Letter Agreement, dated March 1, 1998, between Pierre A. Narath and
the Company (incorporated herein by reference to Exhibit 10.36 of the
10-K of Award Software International, Inc. for the year ended December
31, 1997).
10.54+ Master Original Equipment Manufacturer (OEM) Software License
Agreement, dated September 10, 1997, between the Company and Intel
Corporation (incorporated herein by reference to Exhibit 10.37 of the
10-K of Award Software International, Inc. for the year ended December
31, 1997).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of PricewaterhouseCoopers LLP, Independent Accountants.
24 Power of Attorney. See signature page.
27 Financial Data Schedule.
|
+ THE SECURITIES AND EXCHANGE COMMISSION HAS GRANTED CONFIDENTIAL
TREATMENT FOR PORTIONS OF THIS DOCUMENT.
|
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
|
By:/s/ Jack Kay ------------ Jack Kay President and Chief Executive Officer Date: December 14, 1998 |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Jack Kay /s/ Robert J. Riopel ------------ -------------------- Jack Kay Robert J. Riopel Director and Principal Executive Principal Finance and Officer Accounting Officer Date: December 14, 1998 Date: December 14, 1998 /s/ Charles Federman /s/ George C. Huang -------------------- ------------------- Charles Federman George C. Huang Director Director Date: December 14, 1998 Date: December 14, 1998 /s/ Ronald D. Fisher /s/ Anthony Sun -------------------- --------------- Ronald D. Fisher Anthony Sun Director Director Date: December 14, 1998 Date: December 14, 1998 /s/ Anthony P. Morris --------------------- Anthony P. Morris Director Date: December 14, 1998 |
The Board of Directors and Stockholders
Phoenix Technologies Ltd.
We have audited the accompanying consolidated balance sheets of Phoenix Technologies Ltd. as of September 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1998. Our audits also included the financial statement schedule listed in Part IV, Item 14(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. In September 1998, the Company merged with Award Software International, Inc. in a transaction which was accounted for as a pooling of interests. We did not audit the financial statements of Award Software International, Inc. for the years prior to the year ended September 30, 1998, which statements reflect total assets constituting 21% and 20% of the related 1997 and 1996 consolidated financial statement totals, and revenues constituting 22% and 16% of the related 1997 and 1996 consolidated financial statement totals, respectively. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Award Software International, Inc., is based solely on the report of the other auditors.
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 and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Phoenix Technologies Ltd. at September 30, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
San Jose, California
October 21, 1998
|
To the Board of Directors and Shareholders of Award Software International, Inc.
In our opinion, the consolidated balance sheet and the related consolidated statements of income, shareholders' equity and cash flows present fairly, in all material respects, the financial position of Award Software International, Inc., and its subsidiaries (not presented separately herein) at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audits 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
January 29, 1998
|
SEPTEMBER 30,
1998 1997
----------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 44,234 $ 46,800
Short-term investments 27,063 25,368
Accounts receivable, net of allowances of $1,113 and $697 at
September 30, 1998 and 1997 28,446 28,175
Deferred income taxes 2,759 3,237
Other current assets 4,361 14,767
------------ -------------
Total current assets 106,863 118,347
Other marketable securities 7,782 26,524
Property and equipment, net 13,244 10,974
Computer software costs, net 16,575 5,949
Goodwill and other intangible assets, net 12,693 297
Other assets 1,945 1,101
------------ -------------
Total assets $ 159,102 $ 163,192
------------ -------------
------------ -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 6,976 $ 3,156
Payroll and related liabilities 7,294 4,629
Deferred revenue 2,321 2,238
Other accrued liabilities 6,203 4,208
Income taxes payable 6,926 7,733
------------ -------------
Total current liabilities 29,720 21,964
Deferred income taxes 2,618 7,159
Long-term obligations 1,428 530
------------ -------------
Total liabilities 33,766 29,653
Commitments - -
Stockholders' equity:
Preferred stock, $.10 par value, 500 shares
authorized, none issued - -
Common stock, $.001 par value, 60,000 shares
authorized, 26,286 and 25,399 shares issued
and outstanding at September 30, 1998 and 1997 26 25
Additional paid-in capital 99,940 93,588
Retained earnings 25,269 28,686
Unrealized gain on available-for-sale securities 2,046 12,570
Accumulated translation adjustment (1,945) (1,330)
------------ -------------
Total stockholders' equity 125,336 133,539
------------ -------------
Total liabilities and stockholders' equity $ 159,102 $ 163,192
------------ -------------
------------ -------------
|
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED SEPTEMBER 30,
1998 1997 1996
------------- ------------ -----------
Revenue:
License fees $ 100,344 $ 89,884 $ 75,366
Services 22,541 15,612 10,841
------------- ------------ -----------
Total revenue 122,885 105,496 86,207
Cost of revenue:
License fees 7,828 7,795 8,061
Services 16,224 10,844 7,661
------------- ------------ -----------
Total cost of revenue 24,052 18,639 15,722
------------- ------------ -----------
Gross margin 98,833 86,857 70,485
Operating expenses:
Research and development 40,476 32,920 24,826
Sales and marketing 27,771 22,363 18,377
General and administrative 16,287 15,167 11,756
Merger, acquisition and restructuring charges 14,730 - 889
------------- ------------ -----------
Total operating expenses 99,264 70,450 55,848
------------- ------------ -----------
Income (loss) from operations (431) 16,407 14,637
Interest income, net 4,659 4,049 2,723
Other income, net 1,505 9,348 73
------------- ------------ -----------
Income before income taxes 5,733 29,804 17,433
Provision for income taxes 5,011 9,469 5,501
------------- ------------ -----------
Income before discontinued operations 722 20,335 11,932
Gain on discontinued operations (after income taxes) - - 3,752
------------- ------------ -----------
Net income $ 722 $ 20,335 $ 15,684
------------- ------------ -----------
------------- ------------ -----------
Basic earnings per share:
Earnings from continuing operations $ 0.03 $ 0.80 $ 0.53
Earnings from discontinued operations - - 0.17
------------- ------------ -----------
Earnings per share $ 0.03 $ 0.80 $ 0.70
------------- ------------ -----------
------------- ------------ -----------
Diluted earnings per share:
Earnings from continuing operations $ 0.03 $ 0.74 $ 0.48
Earnings from discontinued operations - - 0.15
------------- ------------ -----------
Earnings per share $ 0.03 $ 0.74 $ 0.63
------------- ------------ -----------
------------- ------------ -----------
Weighted average number of shares used in computation:
Basic 25,543 25,293 22,375
------------- ------------ -----------
------------- ------------ -----------
Diluted 27,009 27,464 24,902
------------- ------------ -----------
------------- ------------ -----------
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SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RETAINED UNREALIZED
ADDITIONAL EARNINGS/ GAIN ON ACCUMULATED TOTAL
COMMON STOCK PAID-IN (ACCUMULATED AVAILABLE-FOR- TRANSLATION STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT) SALE SECURITIES ADJUSTMENT EQUITY
---------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1995 19,546 $ 20 $ 59,664 $ (1,987) $ - $ (110) $ 57,587
Stock purchases under option and
purchase plans 1,088 1 3,696 - - - 3,697
Effect of pooling of interests 658 1 6 (39) - - (32)
Sale of common stock and warrant,
net of costs 3,474 3 27,840 - - - 27,843
Exercise of warrants 132 - 644 - - - 644
Conversion of notes receivable 206 - 706 - - - 706
Repurchase of common stock (458) - (3,090) (1,415) - - (4,505)
Deferred compensation, net - - 124 - - - 124
Unrealized gain/(loss) on
investments - - - - 13,098 - 13,098
Net income - - - 15,684 - - 15,684
Translation adjustment - - - - - (178) (178)
---------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1996 24,646 25 89,590 12,243 13,098 (288) 114,668
Stock purchases under option and
purchase plans 871 - 4,275 - - - 4,275
Effect of pooling of interests 268 - 35 (490) - - (455)
Tax benefit on exercise of stock
options - - 1,160 - - - 1,160
Repurchase of common stock (386) - (1,612) (3,402) - - (5,014)
Deferred compensation, net - - 140 - - - 140
Unrealized gain/(loss) on
investments - - - - (528) - (528)
Net income - - - 20,335 - - 20,335
Translation adjustment - - - - - (1,042) (1,042)
---------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1997 25,399 25 93,588 28,686 12,570 (1,330) 133,539
Stock purchases under option and
purchase plans 681 1 3,055 - - - 3,056
Issuance of common shares and
stock options related to
purchase of Sand 464 - 4,372 - - - 4,372
Effect of Award fiscal year
conversion - - - (1,660) - - (1,660)
Note receivable from stockholder - - (123) - - - (123)
Repurchase of common stock (258) - (1,074) (2,479) - - (3,553)
Deferred compensation, net - - 122 - - - 122
Unrealized gain/(loss) on
investments - - - - (10,524) - (10,524)
Net income - - - 722 - - 722
Translation adjustment - - - - - (615) (615)
---------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1998 26,286 $ 26 $ 99,940 $ 25,269 $ 2,046 $ (1,945) $ 125,336
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
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SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED SEPTEMBER 30,
1998 1997 1996
----------- ---------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 722 $ 20,335 $ 15,684
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 8,124 8,210 5,274
Effect of Award fiscal year conversion (1,660) - -
Asset write-offs related to merger activities 3,434 - -
Write-off of in-process research and development 4,250 - -
Gain on recovery of assets previously written off - - (6,051)
Realized gain on sale of marketable securities (1,507) (3,217) (294)
Gain on sale of equity investment - (6,247) -
Other non-cash charges (credits) - 268 (231)
Change in operating assets and liabilities:
Accounts receivable (256) (7,365) (5,362)
Related party receivable - 449 (347)
Other current assets and other assets (1,545) (1,989) (803)
Deferred income taxes - (1,450) 540
Accounts payable 2,455 276 979
Accrued payroll 1,265 188 788
Other accrued liabilities 1,852 426 1,519
Income taxes payable (3,820) 2,152 1,234
Discontinued operations (135) (1,200) 611
----------- ---------- -----------
Total adjustments 12,457 (9,499) (2,143)
----------- ---------- -----------
Net cash provided by operating activities 13,179 10,836 13,541
----------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of short-term and long-term investments 58,430 56,156 21,261
Purchases of short-term and long-term investments (58,085) (55,813) (45,401)
Proceeds from sale of marketable securities 1,570 3,217 -
Purchases of property and equipment (5,454) (7,731) (4,907)
Additions to computer software costs (5,198) (6,825) (2,889)
Proceeds from recovery on assets previously written off - - 6,774
Acquisition of Sand, net of cash acquired (15,573) - -
Proceeds from sale of equity investment 7,500 - -
Proceeds from collection of note receivable 2,310 - -
Other investing activities - (511) (32)
----------- ---------- -----------
Net cash used in investing activities (14,500) (11,507) (25,194)
----------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock - 482 27,843
Proceeds from issuance of convertible debt securities - - 706
Net proceeds from stock purchases under option plans,
purchase plans and warrants 2,930 4,331 4,341
Repurchase of common stock (3,553) (5,014) (4,505)
Repayment under note obligations - (390) -
----------- ---------- -----------
Net cash provided by (used in) financing activities (623) (591) 28,385
----------- ---------- -----------
Effect of exchange rate changes on cash and equivalents (622) (938) (27)
----------- ---------- -----------
Increase (decrease) in cash and cash equivalents (2,566) (2,200) 16,705
Cash and cash equivalents at beginning of fiscal year 46,800 49,000 32,295
----------- ---------- -----------
Cash and cash equivalents at end of fiscal year $ 44,234 $ 46,800 $ 49,000
----------- ---------- -----------
----------- ---------- -----------
|
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. DESCRIPTION OF OPERATIONS
Phoenix designs, develops, markets and supports standards-based system and chip level software for information platforms, including personal computers, servers, embedded systems, information appliances and peripherals. The Company's software provides compatibility, connectivity and manageability of the various components and technologies used in such devices. The Company provides these products primarily to the platform or peripheral manufacturer (collectively, "OEMs"). Phoenix provides training, consulting, maintenance and engineering services to its customers. The Company markets and licenses its products and services worldwide to OEMs that range from large PC manufacturers to small system integrators. The majority of the Company's revenue consists of license and engineering fees. Phoenix markets its products and services primarily through a direct sales force, but also through regional distributors and sales representatives.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FINANCIAL STATEMENT PRESENTATION. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in the financial statements. Certain amounts in the prior years' financial statements have been reclassified to conform to the fiscal 1998 presentation.
FOREIGN CURRENCY TRANSLATION. The Company has determined that the functional currency of its foreign operations is the local currency. Therefore, assets and liabilities are translated at year-end exchange rates and income statement items are translated at average exchange rates prevailing during each period. Such translation adjustments are recorded in stockholders' equity.
USE OF ESTIMATES. The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Such estimates include the allowance for doubtful accounts, sales returns and customer credits, net realizable value of capitalized computer software costs, and the valuation allowance on deferred tax assets.
REVENUE RECOGNITION. The Company's revenue is derived from license fees and engineering services sold primarily to OEMs. Revenue from software license fees is recognized when the software has been delivered, providing that no significant vendor obligations remain outstanding, customer acceptance is reasonably assured and collectibility is deemed probable. Revenue recognized from software licenses with initial or minimum guaranteed payments is limited to amounts due within 90 days. Additional software license fees are recognized as per unit royalties exceed the initial or minimum guaranteed payments. Insignificant vendor obligations, if any, remaining after contract execution and shipment are accounted for by accruing the costs related to the remaining obligations.
Customers entering into license agreements with the Company for engineering services are typically charged fees that vary according to the amount of engineering work performed. Engineering fees are recognized as revenue on a time and materials basis or when contractual milestones are met. Maintenance revenues are generally recognizable ratably over the contract period.
Allowances for estimated returns and customer credits are recorded in the same period as the
No customer accounted for more than 10% of revenue in fiscal 1998, 1997 or 1996.
CASH EQUIVALENTS. All highly liquid securities purchased with a maturity of less than three months are considered cash equivalents.
SHORT-TERM INVESTMENTS AND OTHER MARKETABLE SECURITIES. Short-term investment securities consist of U.S. government agency obligations, bankers' acceptances, corporate debt securities and commercial paper with original maturities generally ranging from three months to one year. Short-term investments are classified as held-to-maturity, as the Company has the intent and the ability to hold them until maturity. Such investments are recorded at amortized cost. At September 30, 1998, 1997 and 1996, the fair value of such short-term investments approximated amortized cost and gross unrealized holding gains and losses were not material.
Other marketable securities consist of shares of Xionics Document Technologies, Inc. ("Xionics") common stock and U.S. government agency obligations and corporate debt securities with maturities greater than one year. The shares of Xionics common stock are recorded at fair value based on quoted market prices and classified as available-for-sale. The unrealized gain on the Xionics investment, less deferred income taxes, has been recorded as a separate component of stockholders' equity. The carrying value of the Xionics shares and the related deferred income taxes and unrealized gain are adjusted to the current market value each period.
The U.S. government agency obligations and corporate debt securities are recorded at amortized cost, as the Company has the intent and ability to hold them until maturity. At September 30, 1998 and 1997, the fair value of such securities approximated amortized cost and gross unrealized holding gains were not material.
CREDIT RISK. Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments with high credit qualified financial institutions. The Company extends credit on open accounts to its customers and does not require collateral. The Company performs ongoing credit evaluations of all customers and establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. At September 30, 1998, one customer accounted for 10% of accounts receivable, and at September 30, 1997, another customer accounted for 13% of accounts receivable.
PROPERTY AND EQUIPMENT. Property and equipment are carried at cost and depreciated using the straight-line method over their estimated useful lives, typically three to five years. Leasehold improvements are recorded at cost and amortized over the lesser of their useful lives or the remaining term of the related lease.
COMPUTER SOFTWARE COSTS. Computer software costs consist of internally developed and purchased software capitalizable under the provisions of Statement of Financial Accounting Standards No. 86, "Computer software to be sold, leased or otherwise marketed." Costs incurred in the research and development of new software products and enhancements to existing products are expensed as incurred until technological feasibility has been established, at which time, such costs are capitalized. Capitalized computer software costs are amortized over the economic life of the product, generally three years, using the straight-line method or a ratio of current revenues to total anticipated revenues.
The Company evaluates the net realizable value and amortization periods of computer software costs on an ongoing basis, relying on a number of factors including operating results, business plans, budgets and economic projections. In addition, the Company's evaluation considers non-financial data such as market trends and customer relationships, buying patterns and product development cycles.
STOCK-BASED COMPENSATION. The Company accounts for its stock option plans and employee stock purchase plan in accordance with provisions of the Accounting Principles Board's Opinion No. 25 ("APB 25"), "Accounting for stock issued to employees." The Company has adopted disclosure only criteria, described in Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for stock-based compensation". See Note 12 of Notes to Consolidated Financial Statements.
NEW ACCOUNTING PRONOUNCEMENTS. In June 1997, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting comprehensive income," and Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about segments of an enterprise and related information". SFAS 130 establishes standards for the reporting of comprehensive income, and will require the Company to disclose comprehensive income to supplement the current reporting of income. SFAS 131 sets forth standards for the disclosure of certain information by segments, such as products or services, geographic regions or major customers. The Company will adopt SFAS 130 in its first quarter of fiscal 1999. SFAS 131 will be effective for fiscal 1999 year-end reporting, and will apply to both annual and interim financial reporting subsequent to that date.
In October 1997 and March 1998, the Accounting Standards Executive Committee issued Statement of Position 97-2 ("SOP 97-2"), "Software revenue recognition," and SOP 98-4, "Deferral of the effective date of a provision of SOP 97-2, software revenue recognition," respectively. These standards provide guidance on applying generally accepted accounting principles in recognizing revenue on software transactions. The adoption of both SOP 97-2 and SOP 98-4, which is required in the first quarter of fiscal 1999, is not expected to have a significant impact on the Company's consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for derivative instruments and hedging activities". SFAS 133 establishes new standards of accounting and reporting for derivative instruments and hedging activities. The Company will adopt SFAS 133 in the first quarter of fiscal 2000. The adoption of SFAS 133 is not expected to have a material impact on the Company's consolidated financial statements.
CASH FLOW INFORMATION. Supplemental cash flow information is as follows:
YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS) 1998 1997 1996
-------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Income taxes paid during the year, net of refunds $ 8,165 $ 8,673 $ 3,901
Supplemental schedule of non-cash investing and financing activities:
Issuance of common shares and stock options related to the purchase
of Sand 4,372 - -
Conversion of debt securities to common stock - - 706
|
Short-term investments and other marketable securities were as follows:
OTHER MARKETABLE
SHORT-TERM INVESTMENTS SECURITIES
SEPTEMBER 30, SEPTEMBER 30,
(IN THOUSANDS) 1998 1997 1998 1997
----------------------------------------------------------------------------------------------
U.S. government agency obligations $ 15,062 $ 17,388 $ 3,535 $ 5,574
Xionics common stock - - 3,409 20,950
Commercial paper 5,745 3,957 - -
Bankers' acceptances 4,241 1,985 - -
Corporate debt securities 2,015 2,038 838 -
------------ ----------- ---------- -----------
$ 27,063 $ 25,368 $ 7,782 $ 26,524
------------ ----------- ---------- -----------
------------ ----------- ---------- -----------
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NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
SEPTEMBER 30,
(IN THOUSANDS) 1998 1997
-------------------------------------------------------------------------------
Equipment $ 11,995 $ 10,550
Leasehold improvements 6,292 3,844
Furniture and fixtures 3,075 2,498
------------ -----------
21,362 16,892
Less accumulated depreciation and amortization (8,118) (5,918)
------------ -----------
$ 13,244 $ 10,974
------------ -----------
------------ -----------
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Depreciation and amortization expense related to property and equipment totaled $3,971,000, $2,501,000 and $2,048,000 for fiscal 1998, 1997 and 1996, respectively.
NOTE 5. COMPUTER SOFTWARE COSTS
Costs associated with the purchase or internal development of computer software of $5,636,000, $7,214,000 and $2,885,000, were capitalized during fiscal 1998, 1997 and 1996, respectively. In addition, the Company capitalized approximately $12,790,000 of software costs in conjunction with its September 1998 acquisition of Sand Microelectronics, Inc. ("Sand"). Amortization charged to cost of revenue was $4,325,000, $5,049,000 and $3,224,000, during fiscal 1998, 1997 and 1996, respectively. Accumulated amortization of capitalized computer software costs was $5,043,000 and $2,265,000 at September 30, 1998 and 1997, respectively.
NOTE 6. EARNINGS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share," which required the Company to change the method it used to compute earnings per share. Under SFAS 128, primary and fully diluted earnings per share have been replaced with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported primary earnings per share. All earnings per share amounts for prior periods have been restated to conform to the new SFAS 128 requirements. The following table presents the calculation of basic and diluted earnings per share
YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996
--------------------------------------------------------------------------------------------------------------------
Numerator:
Income before discontinued operations $ 722 $ 20,335 $ 11,932
Gain on discontinued operations (after income taxes) - - 3,752
------------ ----------- -----------
Net income $ 722 20,335 15,684
------------ ----------- -----------
------------ ----------- -----------
Denominator:
Weighted average common shares outstanding -
denominator for basic earnings per share 25,543 25,293 22,375
Effect of dilutive securities:
Stock options 1,202 1,011 1,446
Warrants 264 1,160 1,081
------------ ----------- -----------
Total dilutive securities 1,466 2,171 2,527
------------ ----------- -----------
Weighted average common and equivalent shares
outstanding - denominator for diluted earnings per share 27,009 27,464 24,902
------------ ----------- -----------
------------ ----------- -----------
Basic earnings per share:
Earnings from continuing operations $ 0.03 $ 0.80 $ 0.53
Earnings from discontinued operations - - 0.17
------------ ----------- -----------
Earnings per share $ 0.03 $ 0.80 $ 0.70
------------ ----------- -----------
------------ ----------- -----------
Diluted earnings per share:
Earnings from continuing operations $ 0.03 $ 0.74 $ 0.48
Earnings from discontinued operations - - 0.15
------------ ----------- -----------
Earnings per share $ 0.03 $ 0.74 $ 0.63
------------ ----------- -----------
------------ ----------- -----------
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Options to purchase 2,012,934 shares of common stock at a weighted average price of $14.65 per share and warrants to purchase 1,073,965 shares of common stock at a weighted average price of $12.88 per share were outstanding at September 30, 1998, but were not included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive.
NOTE 7. BUSINESS COMBINATIONS AND RESTRUCTURING CHARGES
In September 1998, Phoenix completed a merger with Award Software International, Inc. ("Award"), a leading provider of system enabling and management software for personal computers. Phoenix exchanged approximately 8.8 million shares of its common stock for all of the common stock of Award. Each share of Award was exchanged for 1.225 shares of Phoenix common stock. In addition, outstanding Award employee stock options were converted at the same exchange factor into options to purchase approximately 2.3 million shares of Phoenix common stock. The merger was accounted for as a pooling of interests, and accordingly, the Company's consolidated financial statements have been restated to include the combined results of operations and financial position of Award for all periods and dates presented.
Prior to the merger, Award's fiscal year ended on December 31. The Award statements of income for the years ended December 31, 1997 and 1996, have been combined with the Phoenix statements of income for the years ended September 30, 1997 and 1996, respectively. In order to conform Award's year-end to the year-end of Phoenix, the Company's fiscal 1997 operating results include a three-month period (ended December 31, 1997) that is also included in the fiscal 1998 operating results. During this three-
The results of operations for the separate companies prior to the merger and the combined amounts included in the consolidated financial statements were as follows:
NINE-MONTHS
ENDED YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS) JUNE 30, 1998 1997 1996
--------------------------------------------------------------------------------
(UNAUDITED)
Net Revenue:
Phoenix $ 73,655 $ 82,129 $ 72,136
Award 20,142 23,367 14,071
---------------- ------------ ------------
Combined $ 93,797 $ 105,496 $ 86,207
---------------- ------------ ------------
---------------- ------------ ------------
Net Income:
Phoenix $ 7,403 $ 15,655 $ 12,799
Award 3,992 4,680 2,885
---------------- ------------ ------------
Combined $ 11,395 $ 20,335 $ 15,684
---------------- ------------ ------------
---------------- ------------ ------------
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On September 24, 1998, the Company acquired Sand, a leading supplier of standards-based system software and semiconductor intellectual property for PCs and information appliances. The purchase price consisted of approximately $18.6 million in cash, 464,000 shares of Phoenix common stock, approximately 264,000 stock options issued in exchange for Sand stock options, and up to $3.7 million in performance incentives to be paid through fiscal 2001. The acquisition was accounted for using the purchase method of accounting. Accordingly, the assets and liabilities of the acquired business are included in the consolidated balance sheet as of September 30, 1998. The results of operations of Sand from the date of acquisition through September 30, 1998, were included in the accompanying Consolidated Statement of Income for the year ended September 30, 1998.
The total purchase cost of approximately $33.7 million exceeded the assets acquired as follows (in thousands):
Total consideration $ 24,494
Liabilities assumed 7,749
Acquisition costs 1,465
--------------
Total purchase cost 33,708
Less: Assets acquired (19,831)
Less: Acquired in-process research and development (4,250)
--------------
Excess of purchase cost over assets acquired $ 9,627
--------------
--------------
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The assets acquired include $12.8 million of software development costs (that are being amortized on a straight-line basis over six years) and $2.8 million of other intangible assets (that are being amortized on a straight-line basis over three to six years). The $9.6 million of excess of purchase cost over assets acquired was recorded as goodwill, and is being amortized on a straight-line basis over six years.
PRO FORMA, UNAUDITED
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996
------------------------------------------------------------------------------------------------------
Revenue $ 129,145 $ 110,520 $ 88,029
Net income (loss) (2,508) 17,401 11,537
Diluted earnings (loss) per share (0.10) 0.62 0.45
Weighted average number of shares used in computation 26,007 27,928 25,366
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In May 1997, a subsidiary of the Company merged with Unicore Software, Inc. ("Unicore"), a privately held company providing basic input/output software upgrades for personal computers and embedded systems. The Company issued 267,749 shares of common stock for all of the outstanding stock of Unicore in a transaction accounted for as a pooling of interests. The historical operations of Unicore were not material and, as a result, the business combination has been reported by restating the Company's consolidated financial statements to include the consolidated financial statements of Unicore effective January 1, 1997.
In August 1996, the Company acquired all of the outstanding capital stock of Virtual Chips, Inc. ("Virtual Chips") in exchange for 1,241,842 shares of the Company's common stock. Virtual Chips is a leading supplier of synthesizable cores for the computer industry. The Company also assumed Virtual Chips' outstanding stock options, which were converted to options to purchase approximately 147,959 shares of the Company's common stock. The merger was accounted for as a pooling of interests and, accordingly, the consolidated financial statements of the Company for fiscal 1996 were restated to include the operations of Virtual Chips.
Merger, acquisition and restructuring charges during the three years ended September 30, 1998, were as follows:
YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS) 1998 1997 1996
---------------------------------------------------------------------------------------------------
Out-of-pocket merger and acquisition costs $ 5,677 $ - $ 889
Restructuring 1,369 - -
Asset write-offs 3,434 - -
In-process research and development 4,250 - -
------------ ---------- ----------
$ 14,730 $ - $ 889
------------ ---------- ----------
------------ ---------- ----------
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Nearly all of the merger, acquisition and restructuring costs incurred in fiscal 1998 were related to the acquisitions of Award and Sand. The costs in fiscal 1996 were due to the acquisition of Virtual Chips. Out-of-pocket merger and acquisition costs include legal, accounting and investment banking fees. Restructuring costs are almost entirely severance-related. These employee separations have affected or will affect several business functions, job classes and geographies, with a majority of the reductions occurring in North America. Asset write-offs include the carrying value of assets that were determined to be redundant as a result of merger activities. The asset write-offs in fiscal 1998 were primarily related to capitalized software costs that were determined to be redundant as a result of the Award and Sand
The in-process research and development charge in fiscal 1998 was an allocation of a portion of the purchase price for Sand for projects that were not yet capitalizable under the provisions of Statement of Financial Accounting Standards No. 86, "Computer software to be sold, leased or otherwise marketed." The allocation was based upon an independent appraisal. The appraised value was determined by estimating the future net cash flows from such projects, and discounting the net cash flows back to their present value. The discount rate applied includes a factor that takes into account the uncertainty surrounding the successful development of the purchased in-process technology. If these projects are not successfully developed, future revenue and profitability of the Company may be adversely affected. Additionally, the value of other intangible assets acquired may become impaired.
In June 1998, the Company implemented a restructuring plan to reduce costs. The Company's restructuring actions consisted primarily of the elimination of approximately 20 positions in engineering, sales, marketing, and administration. The elimination of positions was the result of consolidating certain functions and eliminating certain management positions. The restructuring resulted in a charge to operations of approximately $750,000 for employee severance and severance related items.
NOTE 8. DISCONTINUED OPERATIONS AND DIVESTITURES
PRINTER SOFTWARE DIVISION. In fiscal 1994, the Company sold all the assets of its Printer Software Division to Xionics Document Technologies, Inc. ("Xionics") in return for a promissory note and shares of Xionics common stock. In September 1996, Xionics completed an initial public offering of its common stock and repaid the net amount due to the Company. The Company sold 500,000 shares of Xionics stock in the offering. The amounts received were recorded as a gain on disposal of discontinued operations, net of income taxes, to the extent such amounts were previously written off by a charge to discontinued operations. The balance of the amount received of $294,000 represented investment income and was recorded as other income. In fiscal 1998 and 1997, the Company sold 156,500 and 250,000 shares of Xionics common stock for realized gains of approximately $1.5 million and $3.2 million, respectively, which were recorded as other income. At September 30, 1998, the Company held 1,048,881 shares of Xionics stock with a market value of $3.25 per share, which represents approximately 9% of the total outstanding Xionics common stock.
PUBLISHING DIVISION. In fiscal 1994, the Company sold 80% of its Publishing Division to Softbank Corporation of Japan ("Softbank"). On September 30, 1997, Phoenix sold the remaining 20% to Softbank for $7,500,000 and recorded a gain of $6,247,000, which is included in other income in fiscal 1997. At September 30, 1997, a receivable from Softbank in the amount of $7,500,000 was included in other current assets, and in October 1997, payment was received.
NOTE 9. UNSECURED LINE OF CREDIT
At September 30, 1998, there were no outstanding borrowings outstanding on the Company's $10,000,000 unsecured bank line of credit. Borrowings on the line bear interest at the bank's prime rate of interest plus 1%. The line of credit agreement contains various covenants that require the Company to operate at a profit and meet certain financial ratios, and it restricts the payment of cash dividends. The line of credit expires in March 1999.
The components of the provision for income taxes from continuing
operations are as follows:
YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS) 1998 1997 1996
-----------------------------------------------------------------------------------------------------
Current:
Federal $ 2,286 $ 1,860 $ 1538
State 561 1,249 766
Foreign 6,287 7,810 4,937
---------- ----------- -----------
Total current 9,134 10,919 7,241
Deferred:
Federal (3,745) (1,297) (1,367)
State (378) (153) (373)
---------- ----------- -----------
Total deferred (4,123) (1,450) (1,740)
---------- ----------- -----------
Provision for income taxes $ 5,011 $ 9,469 $ 5,501
---------- ----------- -----------
---------- ----------- -----------
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YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS) 1998 1997 1996
-----------------------------------------------------------------------------------------------------
Tax at U.S. federal statutory rate $ 2,007 $10,364 $ 6,056
State taxes, net of federal tax benefit 119 698 416
Tax benefit of prior year losses - - (1,328)
Research and development tax credits (605) (1,180) (269)
Nondeductible merger and acquisition costs 3,475 - 311
Foreign earnings taxed at less than U.S. rate (173) (486) (80)
Other 188 73 395
---------- ----------- ----------
Provision for income taxes $ 5,011 $ 9,469 $ 5,501
---------- ----------- ----------
---------- ----------- ----------
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The components of net deferred tax assets and liabilities are as follows:
SEPTEMBER 30,
(IN THOUSANDS) 1998 1997
-------------------------------------------------------------------------------------------------------
Deferred tax assets:
Foreign tax credits $ 2,169 $ 1,710
Research and development tax credits 2,396 2,265
Minimum tax carryforward 667 667
Reserves and accruals 3,435 1,154
Depreciation 1,608 1,542
Other 341 1,455
----------- -----------
Total 10,616 8,793
Less valuation allowance 2,814 2,814
----------- -----------
Net deferred tax assets 7,802 5,979
Deferred tax liabilities:
Capitalized software and other intangibles, net 6,307 1,507
Unrealized gain on available-for-sale securities 1,364 8,394
----------- -----------
Total deferred tax liabilities 7,671 9,901
----------- -----------
Net deferred tax asset (liability) $ 131 $ (3,922)
----------- -----------
----------- -----------
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Net undistributed earnings of certain foreign subsidiaries amounted to approximately $9.5 million at September 30, 1998. These earnings are considered to be indefinitely reinvested, and accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon distribution of these earnings in the form of dividends or otherwise, the Company would be subject to U.S. income taxes (subject to an adjustment for foreign tax credits) of approximately $1.4 million.
At September 30, 1998, the Company had available for federal income tax purposes foreign tax credits of $1,155,000, which expire in 2003, and research and development tax credits of $2,396,000, which expire in the years 2003 through 2013.
NOTE 11. COMMITMENTS
The Company leases office facilities under operating leases. Total rent expense was $5,355,000, $3,940,000 and $2,880,000 in fiscal 1998, 1997 and 1996, respectively.
At September 30, 1998, future minimum operating lease payments are required as follows (IN THOUSANDS):
YEAR ENDING SEPTEMBER 30,
1999 $ 4,729
2000 3,967
2001 3,265
2002 2,573
2003 2,092
2004 and thereafter 1,665
-----------
Total minimum lease payments $ 18,291
-----------
-----------
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NOTE 12. STOCKHOLDERS' EQUITY
PREFERRED STOCK. As of September 30, 1998 and 1997, no preferred stock was issued or outstanding.
SALES OF COMMON STOCK AND ISSUANCE OF WARRANTS. In February 1996, the Company sold 894,971 newly issued, unregistered shares of its common stock and a warrant to purchase 1,073,965 additional shares of the Company's common stock to Intel Corporation for $10.4 million. The purchase rights under the warrant vest annually, beginning in December 1996, in increments of 214,793 shares for each of the first three years and 429,586 shares for the fourth year. The warrant becomes fully exercisable in the event of an acquisition of the Company or termination of a technology agreement between the two parties. The price at which the warrant may be exercised is $13.46 per share at September 30, 1998, increasing in annual increments to $15.22 per share. The warrant expires in April 2001.
In January 1996, the Company sold 698,290 shares of common stock to a customer for $7 million. In June 1996, the Company entered into a joint technology development and support agreement with Advanced Micro Devices, Inc. ("AMD"), to support the design and development of products related to AMD's K6 microprocessor. As part of this relationship, in July 1996, the Company sold to AMD 196,000 shares of common stock at a price of $10.20 per share for approximately $2,000,000 in cash. Also in fiscal 1996, the Company completed a public offering of 1,531,250 shares of its common stock at $6.53 per share. Proceeds to the Company totaled $7,828,000, net of underwriting discounts and issuance costs of $2,172,000.
In connection with the issuance of shares of common stock in 1995, the Company issued 151,083 common stock warrants with an exercise price of $0.82 per share for $0.02 per warrant. The warrants are exercisable at any time up to September 30, 2000. No proceeds were separately allocated to the warrants.
In connection with the issuance and sale of 698,290 shares of common stock in January 1996, the Company issued 333,683 common stock warrants with an exercise price of $10.02 per share for $0.02 per warrant. The warrants are exercisable at any time up to September 30, 2000. No proceeds were separately allocated to the warrants.
STOCKHOLDER RIGHTS PLAN. The Company has a stockholder rights plan which provides existing stockholders with the right to purchase one one-hundredth preferred share for each share of common stock held in the event of certain changes in the Company's ownership. These rights may serve as a deterrent to certain abusive takeover tactics that are not in the best interests of stockholders. This plan expires in October 1999.
STOCK REPURCHASE PROGRAM. In fiscal 1997, the Board of Directors of the Company authorized the repurchase of up to 1,000,000 shares of the Company's outstanding common stock. The Company repurchased and retired 644,000 shares under this repurchase program at a cost of approximately $8.6 million. This program was terminated in April 1998. In addition to the repurchases under this program, the Company repurchased 458,000 shares of common stock in fiscal 1996 at a cost of approximately $4.5 million.
STOCK OPTION PLANS. The Company has various incentive stock option plans for employees, officers, consultants and independent contractors. Incentive stock options may not be granted at a price less than 100% (110% in certain cases) of the fair market value of the shares on the date of grant. Nonqualified options may not be granted at a price less than 85% of the fair value of the shares on the date of grant. To date, all grants have been made at fair market value or greater. Options vest over a period determined by the Board of Directors, generally four years, and have a term not exceeding ten years.
In connection with the fiscal 1998 acquisitions of Award and Sand, the Company issued options to purchase 2,273,781 and 264,074 shares of the Company's common stock, respectively, in exchange for options to purchase Award and Sand common stock. The exercise prices of these options ranged from $0.11 to $9.18 per share. The Award and Sand option plans will be terminated in fiscal 1999.
The following table sets forth the option activity under the Company's option plans, including the Award and Virtual Chips activity for all periods presented and the fiscal year 1998 option grants issued in exchange for Sand options:
Weighted Average
Shares Exercise Price
-----------------------------------
Shares under option, September 30, 1995 3,880,961 $ 4.09
Options granted 1,737,402 11.12
Options exercised (865,934) 3.51
Options canceled (236,801) 6.04
-------------
Shares under option, September 30, 1996 4,515,628 6.80
Options granted 2,344,430 11.44
Options exercised (692,802) 3.80
Options canceled (267,346) 11.90
-------------
Shares under option, September 30, 1997 5,899,910 8.77
Options granted 1,954,020 8.84
Options exercised (298,911) 3.62
Options canceled (928,634) 11.79
-------------
Shares under option, September 30, 1998 6,626,385 8.52
-------------
-------------
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At September 30, 1998, the number of shares exercisable under stock option plans was 3,316,876 and 709,420 shares were available for grant.
The following table summarizes information about stock options outstanding at September 30, 1998:
Options Outstanding Options Exercisable
--------------------------------------------------------- -----------------------------------
Number Weighted Number
Range Outstanding Average Weighted Exercisable Weighted
Of at Remaining Average at Average
Exercise Prices Sept. 30, 1998 Contractual Life Exercise Price Sept. 30, 1998 Exercise Price
---------------------------------------------------------------------------------------------------------------------
$ 0.1100-$ 0.8200 598,814 6.61 $ 0.7079 497,272 $ 0.7353
$ 1.0400-$ 2.3800 518,390 3.80 1.9249 363,354 2.3019
$ 3.8750-$ 6.2200 1,494,881 7.13 5.3005 909,209 4.8568
$ 6.7500-$11.1250 1,763,562 8.10 8.4280 810,546 8.3105
$11.3750-$17.0000 1,917,798 8.64 13.5957 590,085 13.8839
$17.1250-$19.8750 332,940 7.89 18.5207 146,410 18.4849
---------------- ------------------- ---------------- --------------- ---------------
$ 0.1100-$19.8750 6,626,385 7.56 $ 8.5198 3,316,876 $ 7.0105
---------------- ------------------- ---------------- --------------- ---------------
---------------- ------------------- ---------------- --------------- ---------------
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STOCK PURCHASE PLAN. The Phoenix Technologies Ltd. 1991 Employee Stock Purchase Plan ("Purchase Plan") allows eligible employees to purchase shares at six month intervals, through payroll deductions, at 85% of the fair market value of the Company's common stock at the beginning or end of the six-month period, whichever is less. The maximum amount each employee may contribute during an offering period is 10% of gross base pay. As of September 30, 1998, 658,316 shares had been issued under the Purchase Plan and 141,684 shares remained reserved for future issuance.
DISCLOSURES OF STOCK-BASED COMPENSATION PLANS. Pro forma information regarding net income and earnings per share is required by SFAS No. 123. This information is required to be determined as if the Company had accounted for its employee stock options granted subsequent to September 30, 1995 under the fair value method of that statement. The fair value of options granted in fiscal 1998, 1997 and 1996 reported below has been estimated as of the date of the grant using a Black-Scholes multiple option pricing model with the following assumptions for the years ended September 30, 1998, 1997 and 1996:
EMPLOYEE STOCK OPTIONS EMPLOYEE STOCK PURCHASE PLAN
1998 1997 1996 1998 1997 1996
--------------------------------------------------------------
Expected life from vest date (in years) 0.70 0.70 0.90 0.50 0.50 0.50
Risk-free interest rate 5-6% 6-7% 5-7% 5-6% 5-6% 5-6%
Volatility 0.57 0.63 0.69 0.57 0.63 0.69
Dividend yield NONE None None NONE None None
|
The weighted average estimated fair value of employee stock options granted during fiscal 1998, 1997 and 1996, was $4.95, $7.01 and $8.74 per share, respectively. The weighted average estimated fair value of shares granted under the Purchase Plan during fiscal 1998, 1997 and 1996 was $3.98, $4.97 and $5.44, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the vesting period of the options. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant date for awards under those plans consistent with the method of SFAS 123, the Company's net income and net income per share would have been as follows:
YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996
--------------------------------------------------------------------------------------
Net income (loss):
As reported $ 722 $ 20,335 $ 15,684
Pro forma (7,583) 16,333 11,287
Basic earnings (loss) per share:
As reported $ 0.03 $ 0.80 $ 0.70
Pro forma (0.31) 0.67 0.52
Diluted earnings (loss) per share:
As reported $ 0.03 $ 0.74 $ 0.63
Pro forma (0.29) 0.61 0.46
|
Because SFAS No. 123 is applicable only to options granted subsequent to September 30, 1995, the pro forma effect will not be fully reflected until fiscal year 2000.
NOTE 13. INTERNATIONAL INFORMATION
The Company licenses its products worldwide. Export revenues were made principally to the following geographic areas:
YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS) 1998 1997 1996
-----------------------------------------------------------------------------------------
Asia/Pacific $ 25,556 $ 28,916 $ 27,880
Europe 11,655 11,538 9,331
----------- --------- ----------
$ 37,211 $ 40,454 $ 37,211
----------- --------- ----------
----------- --------- ----------
|
A summary of foreign operations, principally represented by locations in the Asia/Pacific region, is presented below.
YEAR ENDED SEPTEMBER 30,
(IN THOUSANDS) 1998 1997 1996
--------------------------------------------------------------------------------------
Revenues $34,142 $ 27,179 $ 14,265
Income from operations 7,734 7,978 7,259
Income before income taxes 8,016 8,173 7,335
Identifiable assets 28,662 19,733 12,075
|
The Company has a retirement plan ("401(k) Plan") that is qualified under Section 401(k) of the Internal Revenue Code. This plan covers U.S. employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. In addition, Company contributions to the plan may be made at the discretion of the Board of Directors. In January 1996, the Company began making a matching contribution of 25% of each participant's contribution, up to a match of $1,000 per year per participant. The matching contributions vest over a four-year period which starts with the participant's employment start date with the Company. The Company's contributions to the 401(k) Plan for fiscal 1998 and 1997 were $348,000 and $264,000, respectively.
Balance at Balance at
Beginning of End of
Year Ended Year Provisions Deductions (1) Other Year
---------------------------------------------------------------------------------------------------------------
ALLOWANCE FOR DOUBTFUL ACCOUNTS
September 30, 1998 $ 697 $ 355 $ (39) $ 100 $ 1,113
September 30, 1997 582 148 (33) - 697
September 30, 1996 509 130 (88) 31 582
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(1) Deductions primarily represent the write-off of uncollectable accounts
receivable.
SUBSIDIARY COUNTRY/STATE OF INCORPORATION
WHOLLY OWNED
Phoenix Technologies (Taiwan) Ltd. Delaware
Phoenix Technologies Kabushiki Kaisha Japan
Phoenix Technologies SARL France
Phoenix Technologies GmbH Germany
Phoenix Technologies FSC Ltd. Barbados
Award Software Hong Kong Ltd. Hong Kong
Award Software KK Japan
Phoenix Technologies (Korea) Ltd. Korea
Unicore Software Inc. Delaware
Microid Research Inc.. California
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We consent to the incorporation by reference in the Registration Statements of Phoenix Technologies Ltd. (Form S-8 File Numbers 33-58027, 33-67858, 33-30939, 33-44211, 33-81984, 333-37063, 333-20447, 333-56103 and 333-65291; Form S-3 File Number 333-16309) of our report dated October 21, 1998, with respect to the consolidated financial statements and schedule of Phoenix Technologies Ltd. included in the Annual Report (Form 10-K) for the year ended September 30, 1998.
/s/ ERNST & YOUNG LLP
San Jose, California
December 8, 1998
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We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File Numbers 33-58027, 33-67858, 33-30939, 33-44211, 33-81984, 333-37063, 333-20447, 333-56103 and 333-65291) and on Form S-3 (File Number 333-16309) of Phoenix Technologies Ltd. of our report dated January 29, 1998, relating to the consolidated financial statements of Award Software International, Inc. for the two-year period ended December 31, 1997, which appears on page 29 of this Form 10-K.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
December 8, 1998
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ARTICLE 5
PERIOD TYPE
YEAR
FISCAL YEAR END
SEP 30 1998
PERIOD START
OCT 01 1997
PERIOD END
SEP 30 1998
CASH
44,234
SECURITIES
27,063
RECEIVABLES
29,559
ALLOWANCES
1,113
INVENTORY
0
CURRENT ASSETS
106,863
PP&E
21,362
DEPRECIATION
8,118
TOTAL ASSETS
159,102
CURRENT LIABILITIES
29,720
BONDS
0
PREFERRED MANDATORY
0
PREFERRED
0
COMMON
26
OTHER SE
125,310
TOTAL LIABILITY AND EQUITY
159,102
SALES
122,885
TOTAL REVENUES
122,885
CGS
24,052
TOTAL COSTS
24,052
OTHER EXPENSES
99,264
LOSS PROVISION
0
INTEREST EXPENSE
19
INCOME PRETAX
5,733
INCOME TAX
5,011
INCOME CONTINUING
722
DISCONTINUED
0
EXTRAORDINARY
0
CHANGES
0
NET INCOME
722
EPS PRIMARY
0.03
EPS DILUTED
0.03