10-Q 1 d10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q ---------------- (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended September 30, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________ to ____________. Commission file number: 0-27207 VITRIA TECHNOLOGY, INC. (Exact Name of Registrant as Specified in Its Charter) Delaware 77-0386311 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 945 Stewart Drive Sunnyvale, California 94086 (408) 212-2700 (Address, including Zip Code, of Registrant's Principal Executive Offices and Registrant's Telephone Number, including Area Code) ---------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] The number of shares of Vitria's common stock, $0.001 par value, outstanding as of October 31, 2001 was 130,169,038 shares. 1 VITRIA TECHNOLOGY, INC.
Index Page PART I: FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements and Notes Condensed Consolidated Balance Sheets at September 30, 2001 and December 31, 2000 3 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2001 and September 30, 2000 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and September 30, 2000 5 Notes to the Condensed Consolidated Financial Statements 6 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3: Quantitative and Qualitative Disclosures About Market Risk 21 PART II: OTHER INFORMATION Item 1: Legal Proceedings 31 Item 2: Changes in Securities and Uses of Proceeds 31 Item 3: Defaults Upon Senior Securities 31 Item 4: Submission of Matters to a Vote of Security Holders 31 Item 5: Other Information 31 Item 6: Exhibits and Reports on Form 8-K 32 Signature 33
2 PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements
Vitria Technology, Inc. Condensed Consolidated Balance Sheets (in thousands) September 30, December 31, 2001 2000 ------------------- -------------------- (unaudited) (See Note 1) Assets Current Assets: Cash and cash equivalents $ 59,871 $ 154,826 Short-term investments 109,875 69,312 Accounts receivable, net 32,576 36,889 Other current assets 12,014 9,138 ------------------- -------------------- Total current assets 214,336 270,165 Restricted investments 18,444 18,757 Property and equipment, net 16,501 15,164 Intangible assets 4,310 - Goodwill 7,249 - Other assets 3,005 6,106 ------------------- -------------------- Total assets $ 263,845 $ 310,192 =================== ==================== Liabilities and Stockholders' Equity Current Liabilities: Accounts payable $ 3,723 $ 1,396 Accrued payroll and related 17,432 14,882 Other accrued liabilities 10,775 10,158 Deferred revenue 30,111 46,611 ------------------- -------------------- Total current liabilities 62,041 73,047 Commitments Stockholders' Equity: Common Stock 130 128 Additional paid-in capital 269,341 266,591 Accumulated other comprehensive income (loss) 32 (68) Unearned stock-based compensation (1,931) (3,603) Notes receivable from stockholders (193) (291) Accumulated deficit (65,575) (25,612) ------------------- -------------------- Total stockholders' equity 201,804 237,145 ------------------- -------------------- Total liabilities and stockholders' equity $ 263,845 $ 310,192 =================== ====================
The accompanying notes are an integral part of these condensed consolidated financial statements. 3
Vitria Technology, Inc. Condensed Consolidated Statement of Operations (In thousands, except per share amounts) (unaudited) Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 --------------- ------------- ------------- ----------------- Revenues: License $ 15,763 $ 32,676 $ 56,566 $ 74,267 Service and other 14,324 8,935 43,260 19,632 --------------- ------------- ------------- ----------------- Total revenues 30,087 41,611 99,826 93,899 Cost of revenues: License 420 114 1,042 802 Service and other 7,050 6,977 22,637 15,240 --------------- ------------- ------------- ----------------- Total cost of revenues 7,470 7,091 23,679 16,042 --------------- ------------- ------------- ----------------- Gross profit 22,617 34,520 76,147 77,857 Operating expenses: Sales and marketing 23,615 23,521 73,929 55,042 Research and development 10,914 8,647 31,723 20,144 General and administrative 4,082 4,609 12,489 10,025 Amortization of stock-based compensation 403 733 1,469 2,773 Amortization of goodwill 723 - 1,360 - Amortization of intangible assets 529 - 995 - Acquired in-process technology - - 1,500 - --------------- ------------- ------------- ----------------- Total operating expenses 40,266 37,510 123,465 87,984 --------------- ------------- ------------- ----------------- Loss from operations (17,649) (2,990) (47,318) (10,127) Interest income 1,920 3,887 7,945 9,306 Other income (expenses), net 19 (118) 219 (130) --------------- ------------- ------------- ----------------- Net (loss) income before income taxes (15,710) 779 (39,154) (951) Provision for income taxes 398 86 809 153 --------------- ------------- ------------- ----------------- Net (loss) income $ (16,108) $ 693 $ (39,963) $ (1,104) =============== ============= ============= ================= Basic net (loss) income per share $ (0.13) $ 0.01 $ (0.32) $ (0.01) =============== ============= ============= ================= Diluted (loss) income per share $ (0.13) $ 0.00 $ (0.32) $ (0.01) =============== ============= ============= ================= Weighted average shares used in calculating basic net (loss) income per share 127,368 123,361 126,383 121,713 =============== ============= ============= ================= Weighted average shares used in calculating diluted net (loss) income per share 127,368 139,431 126,383 121,713 =============== ============= ============= =================
The accompanying notes are an integral part of these condensed consolidated financial statements. 4
Vitria Technology, Inc. Condensed Consolidated Statements of Cash Flows (in thousands) (unaudited) Nine months ended September 30, 2001 2000 -------------------- ----------------------- Operating activities: Net loss $ (39,963) $ (1,104) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Amortization of goodwill and intangible assets 2,355 - Acquired in-process technology 1,500 - Recognized gain on equity investments, net (760) - Loss on disposal of fixed assets 491 - Depreciation 4,801 2,045 Amortization of deferred stock-based compensation 1,469 2,773 Provision for doubtful accounts 78 2,285 Changes in assets & liabilities: Accounts receivable 5,005 (34,774) Other current assets (2,754) (10,261) Other assets (139) (209) Accounts payable 468 728 Accrued liabilities (2,459) 21,999 Deferred revenue (17,167) 40,351 -------------------- ----------------------- Net cash (used in) provided by operating activities (47,075) 23,833 -------------------- ----------------------- Investing activities: Acquisition of subsidiary, net of cash acquired (8,869) - Purchases of property and equipment (5,913) (10,766) Purchases of investments (318,703) (189,938) Maturities of investments 278,670 113,106 Purchases of equity investments 4,000 (5,100) -------------------- ----------------------- Net cash used in investing activities (50,815) (92,698) -------------------- ----------------------- Financing activities: Collection of note receivable 98 - Issuance of common stock, net 2,954 173,473 -------------------- ----------------------- Net cash provided by financing activities 3,052 173,473 -------------------- ----------------------- Effect of exchange rates on changes on cash and cash equivalents (117) (73) -------------------- ----------------------- Net (decrease) increase in cash and cash equivalents (94,955) 104,535 Cash and cash equivalents at beginning of period 154,826 52,218 -------------------- ----------------------- Cash and cash equivalents at end of period $ 59,871 $ 156,753 ==================== =======================
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1) Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim consolidated financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. In the opinion of the management of Vitria Technology, Inc., these unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, which we consider necessary to fairly state Vitria's financial position and the results of its operations and its cash flows. The balance sheet at December 31, 2000 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in Vitria's Annual Report on Form 10-K for the year ended December 31, 2000. The results of Vitria's operations for any interim period are not necessarily indicative of the results of the operations for any other interim period or for a full fiscal year. Certain prior period amounts have been reclassified to conform to the current period presentation. Such reclassifications did not change the previously reported operating loss or net (loss) income amounts. 2) Net (Loss) Income Per Share Basic (loss) earnings per share is calculated by dividing net (loss) income by the weighted-average number of shares of common stock outstanding. Basic (loss) earnings per share does not include shares subject to Vitria's right of repurchase, which lapses ratably over the related vesting term. Diluted (loss) earnings per share is calculated by dividing net (loss) income by the weighted-average number of shares of common stock outstanding plus shares of potential common stock. Shares of potential common stock are composed of shares of common stock subject to Vitria's right of repurchase and shares of common stock issuable upon the exercise of stock options (using the treasury stock method). The calculation of diluted net (loss) income per share excludes shares of potential common stock if the effect is anti-dilutive. The following table sets forth the computation of basic and diluted net (loss) income per share for the periods indicated (in thousands, except per share amounts):
Three months ended Nine months ended September 30, September 30, September 30, September 30, 2001 2000 2001 2000 -------------- --------------- -------------- -------------- Numerator for basic and diluted net (loss) income per share: Net (loss) income $ (16,108) $ 693 $ (39,963) $ (1,104) ============== =============== ============== ============== Denominator for basic net (loss) income per share: Weighted average shares available to common stock 129,568 127,805 129,075 126,893 Less shares subject to repurchase (2,200) (4,444) (2,692) (5,180) -------------- --------------- -------------- -------------- Denominator for basic net (loss) income per share 127,368 123,361 126,383 121,713 Dilutive potential common shares, using treasury stock method - 16,070 - - -------------- --------------- -------------- -------------- Denominator for diluted net (loss) income per share 127,368 139,431 126,383 121,713 ============== =============== ============== ============== Basic net (loss) income per share $ (0.13) $ 0.01 $ (0.32) $ (0.01) ============== =============== ============== ============== Diluted net (loss) income per share $ (0.13) $ 0.00 $ (0.32) $ (0.01) ============== =============== ============== ==============
6 For the three months ended September 30, 2001 and September 30, 2000, shares of potential common stock totalled 5,312,000 and 16,070,000 respectively. For the nine months ended September 30, 2001 and September 30, 2000 shares of potential common stock totalled 7,727,000 and 17,877,000 respectively. Shares of potential common stock are excluded from the determination of diluted net loss per share as the effect of such shares on a weighted average basis is anti-dilutive. 3) Comprehensive (Loss) Income Comprehensive (loss) income is comprised of net (loss) income and other comprehensive earnings such as foreign currency translation gains (losses) and unrealized gains (losses) on available-for-sale marketable securities. Vitria's total comprehensive (loss) income was as follows (in thousands):
Three months ended Nine months ended September 30, September 30, September 30, September 30, 2001 2000 2001 2000 ----------------- ---------------- ---------------- ---------------- Net (loss) income $ (16,108) $ 693 $ (39,963) $ (1,104) Other comprehensive income: Foreign currency translation adjustment 12 (91) (117) (73) Unrealized gain (loss) on securities 114 (79) 217 (16) ----------------- ---------------- ---------------- ---------------- Comprehensive (loss) income $ (15,982) $ 523 $ (39,863) $ (1,193) ================= ================ ================ ================
4) Unearned Stock-Based Compensation The breakdown of the amortization of stock-based compensation is as follows (in thousands):
Three months ended Nine months ended September 30, September 30, September 30, September 30, 2001 2000 2001 2000 ----------------- ---------------- --------------- ---------------- Cost of revenues $ 32 $ 58 $ 116 $ 220 Sales and marketing 151 280 557 1,057 Research and development 145 265 526 993 General and administrative 75 130 270 503 ----------------- ---------------- --------------- ---------------- Total amortization of stock-based compensation $ 403 $ 733 $ 1,469 $ 2,773 ================= ================ =============== ================
5) Accounts Receivable At September 30, 2001 our gross accounts receivable balance was $35.9 million. Of this balance, 27.8%, or $10.0 million represents revenue that has not yet been recognized and is included in the deferred revenue balance. At September 30, 2001, our deferred revenue balance was $30.1 million. Of this balance, 3.3%, or $988,000 has been deferred due to customer credit issues. In accordance with the provisions of SOP 97-2, Vitria records revenue from software licenses when the following criteria have been met: a license agreement has been signed by both parties, the 7 fee is fixed or determinable, collection of the fee is probable and delivery of the product has occurred. In those cases where all other elements for revenue recognition have been met except customer credit criteria, we defer recognizing revenue until the customer pays or other evidence of probability of collection is obtained. 6) Stock Option Exchange Program On February 28, 2001, Vitria's Board of Directors approved a voluntary stock option exchange program for certain employees. Under the program, employees had the opportunity to cancel outstanding stock options granted to them on or after September 17, 1999 in exchange for a new option grant for an equal number of shares which were to be granted on or after October 5, 2001. A total of 4,470,350 options were cancelled in connection with the option exchange. A total of 3,799,775 new options were granted on October 5, 2001 with an exercise price of $2.18 per share. Members of our Board of Directors, executive officers and vice presidents were not eligible to participate in this program. 7) Equity Investments At December 31, 2000, Vitria held approximately $5.1 million of common stock of various private companies. These investments, classified as long-term investments, are accounted for using the cost method as we have an ownership interest of less than twenty percent and do not have the ability to exercise significant influence. These investments are reviewed each reporting period for an other-than-temporary decline in value and, if appropriate, written down to their estimated fair value. In the quarter ended June 30, 2001, we sold all of the common stock of a private company and recognized a gain of $860,000, net of an impairment charge of $1.1 million for an other-than-temporary decline in value in another investment. In the quarter ended September 30, 2001, we recorded an additional impairment charge of $100,000 for an other-than-temporary decline in value in another investment. 8) Acquisition On April 11, 2001 Vitria acquired XMLSolutions Corporation, a provider of XML (extended markup language) transformation technology headquartered in McLean, Virginia. The transaction was accounted for using the purchase method of accounting. The cost to acquire XMLSolutions is set forth below and has been allocated to the assets acquired and liabilities assumed according to their respective fair values, with the excess purchase price being allocated to goodwill. The fair value of the acquired assets and liabilities is based upon an independent valuation. The total consideration to acquire XMLSolutions is as follows (in thousands): Cash paid to shareholders $ 7,000 Cash advanced to fund expenses 1,271 Transaction costs and expenses 839 --------- $ 9,110 ========= The purchase price allocation is as follows (in thousands): 8
Annual Useful Life amortization Amount in Years of intangibles ---------------------------------------------------------- Tangible assets acquired $ 1,849 Liabilities assumed (including XMLSolutions transaction costs and other liabilities resulting from the acquisition) (8,153) Intangible assets acquired Developed technology 2,500 3 $ 833 In-process technology 1,500 N/A N/A Trademarks 800 3 267 Assembled workforce 2,000 2 1,000 Goodwill 8,614 3 2,871 ------------ ----------- $ 9,110 $ 4,971 ============ ===========
An independent valuation specialist performed an allocation of the total purchase price of XMLSolutions to its individual assets. The purchase price was allocated to XMLSolutions' tangible assets and specific intangible assets such as developed technology, in-process technology, trademarks and assembled workforce. In-process technology represents that portion of the purchase price of an acquisition related to the research and development activities which have not demonstrated their technological feasibility and have no alternative future uses. Accordingly, Vitria recognized an expense of $1.5 million during the quarter ending June 30, 2001 in conjunction with this acquisition. Goodwill, which represents the excess of the purchase price of an investment in an acquired business over the fair value of the underlying net identifiable assets, is being amortized on a straight-line basis over its estimated remaining useful life of 3 years under the current accounting guidelines at September 30, 2001. As of January 1, 2002, the amortization of any remaining book value of goodwill will cease and the new impairment-only model will apply. (See Note 10.) If the acquisition had occurred as of January 1, 2000, Vitria's unaudited pro forma information for the nine months ended September 30, 2001 and September 30, 2000 would have been as follows (in thousands, except per share amounts):
Pro forma Pro forma Nine months ended, Nine months ended, September 30, 2001 September 30, 2000 ----------------------- ----------------------- (unaudited) (unaudited) Net revenue $ 101,259 $ 98,044 ============== =============== Net loss $ (49,440) $ (16,443) ============== =============== Basic and diluted net loss per share $ (0.39) $ (0.14) ============== ===============
9 The unaudited pro forma combined results for the nine months ended September 30, 2001 exclude the effect of the write-off of acquired in-process technology cost of $1.5 million, as such amount is non-recurring. The unaudited pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have occurred had the transaction been completed at the beginning of the period indicated, nor is it necessarily indicative of future operating results. 9) Derivative Financial Instruments Vitria adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, on January 1, 2001, and its adoption has not had a material effect on our financial statements. SFAS 133 requires companies to recognize all of their derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value (i.e., unrealized gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and on the type of hedging relationship. Derivatives that are not hedges must be adjusted to fair value through current earnings. To protect against possible changes in values of certain foreign currency denominated receivables, primarily resulting from sales outside the United States, we enter into foreign currency forward contracts which qualify and are designated as fair value hedges. The gains and losses on these forward contracts as well as the offsetting losses and gains on the hedged receivables are recognized in current earnings. The effectiveness test for these contracts is determined by using the forward-to-forward rate comparison for currency forward contracts, which makes same-currency hedges perfectly effective. During the three months and nine months ended September 30, 2001, gains and losses on the portions of these forward contracts that were excluded from the assessment of hedge effectiveness, as well as the ineffective portion of these hedging instruments, were not material. 10) Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Financial Instruments and Hedging Activities," or "SFAS 133," which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. SFAS 133, as amended, was adopted by Vitria on January 1, 2001 and did not have a material impact on our results of operations, financial position or cash flows. In July 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, ("SFAS 141"), Business Combinations and No. 142, ("SFAS 142"), Goodwill and Other Intangible Assets. SFAS 141 requires that all business combinations be accounted for under the purchase method only and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS 142 requires that goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to impairment tests in accordance with the Statements at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. SFAS 141 is effective for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS 142 will be effective for fiscal years beginning after December 15, 2001. We do not expect the adoption of SFAS 142 to have a material impact on the our results of operations, financial position or cash flows. 10 In August 2001, the Financial Accounting Standards Board issued Satement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", ("SFAS 144"), which is effective for fiscal periods beginning after December 15, 2001 and interim periods within those fiscal years. SFAS 144 establishes an accounting model for impairment or disposal of long-lived assets to be disposed of by sale. We are currently evaluating the potential impact, if any, the adoption of FAS 144 will have on our financial position and results of operations. 11 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are subject to the "safe harbor" created by those sections. These forward-looking statements are generally identified by words such as "expect," "anticipate," "intend," "plan," "believe," "hope," "assume," "estimate" and other similar words and expressions. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks outlined under "Business Risks" in this report on Form 10-Q. These business risks should be considered in evaluating our prospects and future financial performance. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We do not undertake an obligation to update these forward looking statements. OVERVIEW We are a leading provider of integration and collaboration solutions. Our flagship product, the BusinessWare(TM) integration server, provides the infrastructure that enables incompatible information technology, or IT, systems to exchange information automatically, without human intervention, over corporate networks and the Internet. This eliminates manual entry of information into multiple IT systems and eliminates the need to manually exchange information with customers and business partners. In addition, we provide collaborative solutions for organizations in the telecommunications, manufacturing, financial services, energy, insurance and healthcare industries that automate mission critical business processes, integrate existing infrastructure and manage information flow between internal systems and external trading partners. BusinessWare combines in a single solution the four elements that we believe are essential for ebusiness infrastructure software: (1) Business Process Management (BPM): BPM provides control and coordination of business processes spanning a wide combination of systems, people and corporate boundaries. It uses graphical process models to seamlessly define, automate and manage transactions and the exchange of information between internal business applications, people and external trading partner systems. (2) Business-to-Business Integration (B2Bi): B2Bi enables the secure and reliable completion of transactions and the exchange of business information between customers and partners over the Internet to support collaborative processes. B2Bi helps companies manage their value chain interactions end to end. (3) Enterprise Application Integration (EAI): EAI enables secure and reliable movement of information in and out of internal business applications. By enabling internal applications to communicate with each other, EAI helps unify and improve extended enterprise processes. (4) Real-Time Analysis (RTA): RTA provides real-time monitoring and analysis of running business processes thereby enabling optimization of operational efficiency. Our two key RTA components - Process Analyzer and Business Cockpit(TM) - continuously gather working business process data, analyze and visualize it in real time, and enable process owners to proactively identify and respond to problems or opportunities as they occur. We derive revenues primarily from two sources: licenses and services. Since the introduction of our product in 1997, licenses have become our primary source of revenues. Our product is typically licensed directly to customers for a perpetual term, with pricing based on the instances of the software deployed. We record license revenues when a license agreement has been signed by both parties, the fee is fixed or determinable, collection of the fee is probable, and delivery of our product has occurred. For electronic transmissions, we consider our product to have been delivered when the access code to download the software from the Internet has been provided to the customer. Service and other revenues include product support and maintenance, consulting and training. Customers who license BusinessWare normally purchase maintenance contracts. These contracts provide for unspecified software upgrades and technical support over a specified term, typically twelve months. Maintenance contracts are usually paid in advance, and revenues from these contracts are recognized ratably over the term of the contract. A majority of our customers use third-party system integrators to implement our products. Customers typically purchase additional consulting services from us to support their implementation activities. These consulting services are generally sold on a time and materials basis; consulting revenue is recognized as the services are performed. We also offer training services which are sold on a per student basis; training revenue is recognized as the classes are attended. 12 We market our product through our direct sales force and augment our sales efforts through relationships with system integrators, value-added resellers and technology vendors. While our revenues to date have been derived primarily from accounts in the United States, we opened offices in Switzerland, Singapore, Korea, Taiwan, Spain and Brazil in the first nine months of 2001 and in Japan, Australia, France, Germany, Italy and The Netherlands in 2000, and the United Kingdom in 1999. We recognized approximately 31% of our revenues from customers outside the United States in the three months ended September 30, 2001 and approximately 25% from customers outside the United States in the nine months ended September 30, 2001, compared to approximately 13% during fiscal year 2000. We believe international revenues will become a more significant component of our total revenue as our operations grow. To date, we have not experienced significant seasonality of revenues. We expect future results may be affected by the fiscal or quarterly budget cycle of our customers. Sales to our ten largest customers accounted for 42% of total revenues in the three months ended September 30, 2001 and 30% of total revenues in the nine months ended September 30, 2001. One customer, BP, accounted for 15% of our revenues in the three month period ended September 30, 2001 and 6% of our revenues in the nine month period ended September 30, 2001. Sales to our ten largest customers accounted for 35% of total revenues in the three months ended September 30, 2000 and 27% of total revenues in the nine months ended September 30, 2000. With the exception of the current quarter, our dependence on any single customer has been declining gradually over the past three years. However, we expect that revenues from a limited number of customers will continue to account for a large percentage of total revenues in future quarters. As a result, the loss or delay of individual orders can have a significant impact on our revenues. Our ability to attract new customers will depend on a variety of factors, including the reliability, security, scalability and cost-effectiveness of our products. For the next quarter, revenues are expected to remain approximately level with the quarter ended September 30, 2001 due to a deterioration in the macroeconomic climate which has resulted in a general slowdown in IT spending in our vertical markets. On April 11, 2001, Vitria acquired XMLSolutions, a provider of XML transformation technology. The cost to acquire XMLSolutions was $7.0 million in cash, $2.1 million in transaction costs and expenses and the assumption of $8.2 million of XMLSolutions' liabilities. The acquisition was accounted for as a purchase. An independent valuation specialist performed an allocation of the total purchase price of XMLSolutions to its individual assets. The purchase price was allocated to XMLSolutions' tangible assets, specific intangible assets such as developed technology, trademarks, assembled workforce and in-process technology. We have a limited operating history that makes it difficult to predict future operating results. We believe our success requires expanding our customer base and continuing to enhance our BusinessWare products. We intend to continue to invest selectively in sales, marketing and research and development and expect to incur operating losses for at least the next three quarters. Our revenues and operating results depend upon the volume and timing of customer orders and payments and the date of product delivery. Historically, a substantial portion of revenues in a given quarter have been recorded in the third month of that quarter, with a concentration of these revenues in the last two weeks of the third month. We expect this trend to continue and, therefore, any failure or delay in the closing of orders would have a material adverse effect on our quarterly operating results. Since our operating expenses are based on anticipated revenues and because a high percentage of these expenses are relatively fixed, a delay in the recognition of revenue from one or more license transactions could cause significant variations in operating results from quarter to quarter and cause unexpected financial results. Revenues from contracts that do not meet our revenue recognition policy requirements for which we have been paid or have a valid receivable are recorded as deferred revenues. While a portion of our revenues each quarter is recognized from deferred revenue, our quarterly performance will depend 13 primarily upon entering into new contracts or new orders from existing customers to generate revenues for that quarter. New contracts and new orders may not result in revenue during the quarter in which the contract was signed, and we may not be able to predict accurately when revenues from these contracts will be recognized. Our future operating results will depend on many factors, including, but not limited to, the following: o size and timing of customer orders and product and service delivery; o level of demand for our professional services; o changes in the mix of our products and services; o ability to protect our intellectual property; o actions taken by our competitors, including new product introductions and pricing changes; o costs of maintaining and expanding our operations; o introduction of new products; o timing of our development and release of new and enhanced products; o costs and timing of hiring qualified personnel; o success in maintaining and enhancing existing relationships and developing new relationships with system integrators; o technological changes in our markets, including changes in standards for computer and networking software and hardware; o deferrals of customer orders in anticipation of product enhancements or new products; o delays in our ability to recognize revenue as a result of the decision by our customers to postpone software delivery; o customer budget cycles and changes in these budget cycles; o external economic conditions; o availability of customer funds for software purchases given external economic factors; o costs related to acquisition of technologies or businesses; o ability to successfully integrate acquisitions; and o changes in strategy and capability of our competitors. As a result of these factors, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. It is possible that in some future quarter our operating results will be below the expectations of public market analysts and investors. In this event, the price of our common stock would likely decline. For a more comprehensive discussion of risks, see "Business Risks" immediately following Item 3 in Part I hereof. 14 RESULTS OF OPERATIONS For the three and nine months ended September 30, 2001 and 2000 The following table sets forth the results of operations for the three and nine months ended September 30, 2001 and September 30, 2000, expressed as a percentage of total revenues.
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 --------------------------- -------------------------- Revenues License 52% 79% 57% 79% Service and other 48% 21% 43% 21% ------------ ------------- ------------ ------------ Total revenues 100% 100% 100% 100% Cost of revenues License 1% 0% 1% 1% Service and other 24% 17% 23% 16% ------------ ------------- ------------ ------------ Total cost of revenues 25% 17% 24% 17% ------------ ------------- ------------ ------------ Gross profit 75% 83% 76% 83% Operating expenses Sales and marketing 78% 56% 74% 59% Research and development 36% 21% 32% 21% General and administrative 14% 11% 13% 11% Amortization of stock-based compensation 1% 2% 1% 3% Amortization of goodwill 2% 0% 1% 0% Amortization of intangibles 2% 0% 1% 0% Acquired in-process research and development 0% 0% 2% 0% ------------ ------------- ------------ ------------ Total operating expenses 133% 90% 124% 94% ------------ ------------- ------------ ------------ Loss from operations (58%) (7%) (48%) (11%) Other income, net 6% 9% 8% 10% Net (loss) income before income taxes (52%) 2% (40%) (1%) Provision for income taxes 1% 0% 1% 0% ------------ ------------- ------------ ------------ Net (loss) income (53%) 2% (41%) (1%) ============ ============= ============ ============
15 REVENUES LICENSE. License revenues decreased 52% to $15.8 million in the three months ended September 30, 2001 from $32.7 million in the three months ended September 30, 2000. License revenues decreased 24% to $56.6 million in the nine months ended September 30, 2001 from $74.3 million in the nine months ended September 30, 2000. These decreases were the result of a decrease in the number of licenses and to an average transaction size on the lower end of our historic $500,000 to $700,000 range. For the next quarter, we expect license revenues to remain approximately level with the quarter ended September 30, 2001. This is primarily due to a deterioration in the macroeconomic climate which has resulted in a general slowdown in IT spending in our vertical markets. SERVICE AND OTHER. Service and other revenues increased 60% to $14.3 million in the three months ended September 30, 2001 from $8.9 million in the three months ended September 30, 2000. Service and other revenues increased 120% to $43.3 million in the nine months ended September 30, 2001 from $19.6 million in the nine months ended September 30, 2000. These increases are primarily due to the growth of maintenance, support and consulting revenues associated with license agreements signed in earlier periods. All components of service and other revenues increased. However, the largest increase was in support revenue, which is due to a larger installed base of licenses with support agreements and an increase in support renewals. For the next quarter, we expect service revenues to remain approximately level with the quarter ended September 30, 2001. COST OF REVENUES LICENSE. Cost of license revenues consists of royalty payments to third parties for technology incorporated into our products. These costs vary from quarter to quarter. These variations are due to fluctuations in the level of sales of products which incorporate third-party technology. As a percentage of license revenues, cost of license revenues increased to 3% in the three months ended September 30, 2001 from less than 1% for the three months ended September 30, 2000 and increased to 2% from 1% for the nine months ended September 30, 2001 as compared to the nine months ended September 30, 2000. As a percentage of license revenues, we do not expect any significant variation in the cost of license revenues from the past two years. SERVICE AND OTHER. Cost of service and other revenues consists of salaries, facility costs, travel expenses and third party consultants fees incurred in providing customer support, training and implementation related services. Cost of service and other revenues were $7.1 million in the three months ended September 30, 2001, an increase of 1% over cost of service and other revenues of $7.0 million in the three months ended September 30, 2000. The minimal increase in the current quarter was the result of a decrease in the use of outside consultants, and a decrease in external recruiting expenditures offset by an increase in salary costs from increased headcount over the same quarter a year ago. Cost of service and other revenues were $22.6 million in the nine months ended September 30, 2001, an increase of 49% over cost of service and other revenues of $15.2 million in the nine months ended September 30, 2000. The increase resulted from hiring additional service personnel, including the addition of employees that resulted from acquiring XMLSolutions during the quarter ended June 30, 2001, and increased facility costs associated with additional personnel, partially offset by a decrease in the use of outside consultants. For the next quarter, we expect that cost of service and other revenues will be approximately level with that of the current quarter. The ratio of cost of service and other revenues as a percentage of total revenues increased to 24% in the three months ended September 30, 2001 from 17% in the three months ended September 30, 2000. This is mainly due to an increase in service and other revenues in the quarter ended September 30, 2001. 16 OPERATING EXPENSES SALES AND MARKETING. Sales and marketing expenses consist of salaries, commissions, field office expenses, travel and promotional expenses. During the three months ended September 30, 2001, sales and marketing expenses were $23.6 million, an increase of less than 1% over sales and marketing expenses of $23.5 million for the three months ended September 30, 2000. The increase in salary and related expenses in the three months ended September 30, 2001 was offset by a decrease in commission expense due to lower revenues, a decrease in advertising expense and a decrease in recruiting expense. These expense offsets resulted in a small change in sales and marketing expenses from the three month period ended September 30, 2001 as compared to the three months ended September 30, 2000. During the nine months ended September 30, 2001, sales and marketing expenses were $73.9 million, an increase of 34% over sales and marketing expenses of $55.0 million for the nine months ended September 30, 2000. This increase was the result of increased salary costs from hiring additional sales and marketing personnel, increased facilities costs as we expanded our domestic and international field offices, and higher travel expenses associated with our expanded sales force, offset by a decrease in advertising expenses and a decrease in commission expense. As a percentage of revenue, sales and marketing expenses increased to 78% in the three months ended September 30, 2001 from 56% in the three months ended September 30, 2000 and to 74% in the nine months ended September 30, 2001 from 59% in the nine months ended September 30, 2000. These increases as a percentage of revenues are due to the fact that our sales and marketing structure has been established to support a higher revenue base than we actually experienced in both the three and nine month periods ended September 30, 2001. These increases were partially offset by decreased commission expense in both periods. At anticipated revenue levels, we expect that sales and marketing expenses will decline slightly as a percentage of revenue over the next quarter. RESEARCH AND DEVELOPMENT. Research and development expenses include costs associated with the development of new products, enhancements to existing products, and quality assurance activities. These costs consist primarily of employee salaries, benefits, and the cost of consulting resources that supplement the internal development team. Costs of developing software for external use that may have been eligible for capitalization have not been material and we have expensed all of these costs as incurred. During the three months ended September 30, 2001, research and development expenses were $10.9 million, an increase of 26% over research and development expenses of $8.6 million for the three months ended September 30, 2000. This increase was primarily the result of higher salary expenses related to additional research and development personnel, including the addition of XMLSolutions employees, and offset by a decrease in recruiting expense. During the nine months ended September 30, 2001, research and development expenses were $31.7 million, an increase of 57% over research and development expenses of $20.1 million for the nine months ended September 30, 2000. This increase was primarily the result of higher salary expenses related to additional research and development personnel, including the addition of XMLSolutions employees, and higher facilities and overhead costs associated with the increase in personnel. At anticipated revenue levels, we expect research and development expenses will decline slightly as a percentage of revenue over the next quarter. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist of salaries for administrative, executive and finance personnel, information systems costs, outside professional service fees and our provision for doubtful accounts. During the three months ended September 30, 2001, general and administrative expenses were $4.1 million, a decrease of 11% over general and administrative expenses of $4.6 million for the three months ended September 30, 2000. The decrease is primarily attributable to a decrease in our provision for doubtful accounts, and a decrease in the use of outside consultants, partially offset by an increase in salary expense and associated overhead. During the nine months ended September 30, 2001, general and administrative expenses were $12.5 million, an increase of 25% over general and administrative expenses of $10.0 million for the nine months ended September 30, 2000. This increase was attributable to a worldwide increase in salary expense and an increase in outside professional services hired to support our expanding operations, offset by a decrease in our provision for doubtful accounts. At 17 anticipated revenue levels, we expect that our general and administrative expenses will decline slightly as a percentage of revenue over the next quarter. AMORTIZATION OF STOCK-BASED COMPENSATION. Deferred stock-based compensation primarily represents the difference between the exercise price and the deemed fair value of our common stock on the date certain stock options were granted. This difference is amortized using the multiple option approach over a five year period starting on the date the options were granted. Unearned compensation expense will be reduced in future periods to the extent that options are terminated prior to full vesting. During the three months ended September 30, 2001, amortization of stock-based compensation was $403,000, a decrease of 45% over amortization of stock-based compensation of $733,000 for the three months ended September 30, 2000. During the nine months ended September 30, 2001, amortization of stock-based compensation was $1.5 million, a decrease of 47% over amortization of stock-based compensation of $2.8 million for the nine months ended September 30, 2000. The decrease of this expense is due to the timing of the option grants, the use of the multiple option approach and employee terminations. This expense is expected to continue to decrease in future periods. AMORTIZATION OF GOODWILL AND OTHER PURCHASED INTANGIBLES. Amortization of goodwill associated with the acquisition of XMLSolutions Corporation resulted in charges to earnings of $723,000 and $1.4 million in the three and nine months ended September 30, 2001, respectively. Amortization of purchased intangible assets associated with the acquisition resulted in charges to earnings of $529,000 and $995,000 in the three months and nine months ended September 30, 2001, respectively. In accordance with SFAS 141 and 142 as referenced in Note 10, goodwill will no longer be amortized after December 31, 2001 but will be subject to a test of impairment at least annually. The purchased intangible assets will continue to be amortized over their estimated useful lives. There were no acquistions in fiscal 2000. ACQUIRED IN-PROCESS TECHNOLOGY. In-process technology represents that portion of the purchase price of an acquisition related to the research and development activities which have not demonstrated their technological feasibility and have no alternative future uses. Accordingly, Vitria recognized an expense of $1.5 million in the quarter ended June 30, 2001 in conjunction with the completion of the acquisition of XMLSolutions Corporation for in-process technology relating to XMLSolutions' Collaborative Enablement Program. No expense was recognized in the quarter ended September 30, 2001. There were no acquisitions in fiscal 2000. Actions and comments from the Securities and Exchange Commission have indicated that they are reviewing the current valuation methodology of purchased in-process technology relating to acquisitions. The Commission is concerned that some companies are allocating more than a reasonable amount to in-process technology, thereby reducing future amortization charges of other intangibles acquired. We believe that we are in compliance with all of the rules and related guidance as they currently exist. However, the Commission may seek to reduce the amount of purchased in-process technology previously expensed by Vitria. This would result in the restatement of previously filed financial statements of Vitria and could have a negative impact on the financial results for the period subsequent to the acquisition. INTEREST AND OTHER INCOME. Interest and other income decreased by 49% to $1.9 million in the three months ended September 30, 2001 from $3.8 million in the three months ended September 30, 2000. The decrease is primarily attributable to lower interest income earned from our short-term investments due to lower interest rates on investments and lower cash balances in the three months ended September 30, 2001. Interest and other income decreased by 11% to $8.2 million in the nine months ended September 30, 2001 from $9.2 million in the nine months ended September 30, 2000. This decrease is due to a write-off of $1.1 million from one of our equity investments in a private company and disposal of $400,000 of fixed assets, offset by a gain of $2.0 million from the sale of another equity investment in a private company. Lower interest rates on our short-term investments were also a contributing factor to this decrease in interest income. 18 PROVISION FOR INCOME TAXES We recorded an income tax provision of $398,000 and $809,000, respectively, for the three-month and nine-month periods ended September 30, 2001. The provisions relate to income taxes currently payable on income generated in non-U.S. tax jurisdictions, state income taxes, and foreign withholding taxes incurred on software license revenue. We recorded income tax provisions of $86,000 and $153,000, respectively, for the three-month and nine-month periods ended September 30, 2000. The 2000 provisions relate to income taxes payable on income generated in non-U.S. jurisdictions. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2001, we had $59.9 million in cash and cash equivalents, $109.9 million in short-term investments, and $152.3 million in working capital with no outstanding long-term debt, compared to $156.8 million in cash and cash equivalents, $71.6 million in short-term investments and $196.8 million in working capital with no outstanding long term debt at September 30, 2000. Net cash used in operating activities was $47.1 million for the nine months ended September 30, 2001 and was primarily due to our net loss, and a decrease in deferred revenue, partially offset by a decrease in accounts receivable. This includes the effect from paying down liabilities assumed (including XMLSolutions transaction costs and other liabilities resulting from the acquisition) from $8.2 million at acquisition to approximately $1.6 million at September 30, 2001. Net cash provided by operating activities was $23.8 million for the nine months ended September 30, 2000, which primarily reflected a decrease in net loss and increases in deferred revenue and accrued liabilities, partially offset by increases in accounts receivable and deferred commission expense, included within other current assets. Net cash used in investing activities was $50.8 million in the nine months ended September 30, 2001 and was primarily due to purchases of investments and the acquisition of XMLSolutions, partially offset by maturities of investments. Net cash used in investing activities was $92.7 million in the nine months ended September 30, 2000, primarily due to purchasing investments from cash received from our initial and follow-on public offerings. Net cash provided by financing activities was $3.0 million in the nine months ended September 30, 2001. Net cash provided by financing activities was $173.5 million in the nine months ended September 30, 2000. Net cash provided by financing activities for both periods was primarily from the issuance of common stock. Net cash provided by financing activities in the nine months ended September 30, 2000 was higher because of cash received from our follow-on offering in February 2000. At September 30, 2001, we had operating lease commitments of approximately $41.3 million. On April 11, 2001, we completed the acquisition of XMLSolutions Corporation, a Virginia corporation. The total purchase price was approximately $17.3 million, of which approximately $7.0 million was paid to preferred shareholders, approximately $2.1 million was related to transaction costs and expenses, and approximately $8.2 million was related to the assumption of XMLSolutions liabilities. In the past, we have invested significantly in our operations. For the next quarter, we expect that operating expenses will decline slightly as a percentage of revenue. However, we anticipate that operating expenses and planned capital expenditures will continue to constitute a material use of our cash resources. We expect that our capital expenditures in the next quarter to be at approximately the same level of spending as in the quarter ended September 30, 2001. In addition, we may utilize cash resources to fund acquisitions or investments in other businesses, technologies or product lines. We believe that available cash, cash equivalents and investments will be sufficient to 19 meet our working capital and operating expense requirements for at least the next twelve months. At some point in the future we may require additional funds to support our working capital and operating expense requirements or for other purposes and may seek to raise these additional funds through public or private debt or equity financings. If we ever needed to seek additional financing, there is no assurance that this additional financing will be available, or if available, will be on reasonable terms and not dilutive to our stockholders. 20 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK In the normal course of business, the financial position of Vitria is routinely subjected to a variety of risks, including market risk associated with interest rate movements and collectibility of accounts receivable. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, we do not anticipate material losses in these areas. As we expand our operations internationally, we will also become subject to risks associated with currency rate movements on non-U.S. dollar denominated assets and liabilities. We are exposed to interest rate risk on our investments of cash, cash equivalents and marketable debt securities. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in highly liquid and high quality debt securities. To minimize the exposure due to adverse shifts in interest rates, we invest in short-term securities with maturities of less than one year. If a one percentage point change in interest rates were to have occurred on September 30, 2001 or September 30, 2000, such a change would not have had a material effect on the fair value of our investment portfolio as of that date. Due to the nature of our short-term investments, we have concluded that we do not have a material financial market risk exposure. Business Risks Since our short operating history makes it difficult to evaluate our prospects, our future financial performance may disappoint securities analysts or investors and result in a decline in our stock price. We were incorporated in October 1994. Until November 1997, we were engaged primarily in research and development of our initial product. We licensed our first product in November 1997. Because of our limited operating history, we have limited insight into trends that may emerge in our market and affect our business. The revenue and income potential of our market are unproven. As a result of our limited operating history, we have limited financial data that you can use to evaluate our business. You must consider our prospects in light of the risks, expenses and challenges we might encounter because we are in the early stages of development in a new and rapidly evolving market. Although we have in the past reported net income, we cannot guarantee we will do so in the future. We have incurred substantial losses since inception as we funded the development of our products and the growth of our organization. We have an accumulated deficit of $65.6 million as of September 30, 2001. We are likely to report future operating losses and cannot guarantee we will report net income in the future. Our operating results fluctuate significantly and an unanticipated decline in revenue may disappoint securities analysts or investors and result in a decline in our stock price. Although we have had significant revenue growth in previous quarters, our growth rates may not be sustainable and prospective investors should not use these past results to predict future operating margins or results. Our quarterly operating results have fluctuated significantly in the past and may vary significantly in the future. If our operating results are below the expectations of securities analysts or investors, our stock price is likely to decline. Period-to-period comparisons of our historical results of operations are not necessarily a good predictor of our future performance. Our revenues for the quarter ended September 30, 2001 reflected a sequential decline from our revenues in the previous two quarters ended March 31, 2001 and June 30, 2001, which were down sequentially from our revenues in the fourth quarter ended December 31, 2000. For the next quarter, we expect revenues to be approximately level with 21 revenues reported in the quarter ended September 30, 2001. This is due primarily to a deterioration in the general macroeconomic environment which has resulted in a general slowdown in IT spending in our vertical markets. Our revenues and operating results depend upon the volume and timing of customer orders and payments and the date of product delivery. Historically, a substantial portion of revenues in a given quarter have been recorded in the third month of that quarter, with a concentration of these revenues in the last two weeks of the third month and we expect this trend to continue. Possible future terrorist incidents or other external events may shutdown or impair our operations or those of our customers thereby limiting our ability to close orders. Any failure or delay in closing orders would have a material adverse effect on our quarterly operating results. Since our operating expenses are based on anticipated revenues and because a high percentage of these expenses are relatively fixed, a delay in the recognition of revenue from one or more license transactions could cause significant variations in operating results from quarter to quarter and cause unexpected results. Our quarterly results will depend primarily upon entering into new or follow-on contracts to generate revenues for that quarter. New contracts may not result in revenue in the quarter in which the contract was signed, and we may not be able to predict accurately when revenues from these contracts will be recognized. Our operating results are also dependent upon our ability to manage our cost structure. Our product may not achieve market acceptance, which could cause our revenues to decline. Deployment of our product requires interoperability with a variety of software applications and systems and, in some cases, the ability to process a high number of transactions per second. If our product fails to satisfy these demanding technological objectives, our customers will be dissatisfied and we may be unable to generate future sales. Failure to establish a significant base of customer references will significantly reduce our ability to license our product to additional customers. Our revenues will likely decline if we do not develop and maintain successful relationships with system integrators. System integrators install and deploy our products and those of our competitors, and perform custom integration of systems and applications. Some system integrators engage in joint marketing and sales efforts with us. If these relationships fail, we will have to devote substantially more resources to the sales and marketing, and implementation and support of our product than we would otherwise have to, and our efforts may not be as effective as those of the system integrators. In many cases, these parties have extensive relationships with our existing and potential customers and influence the decisions of these customers. We rely upon these firms for recommendations of our product during the evaluation stage of the purchasing process, as well as for implementation and customer support services. A number of our competitors have strong relationships with these system integrators and, as a result, these system integrators may recommend competitors' products and services. In addition, a number of our competitors have relationships with a greater number of these system integrators and, therefore, have access to a broader base of enterprise customers. Our failure to establish or maintain these relationships would significantly harm our ability to license and successfully implement our software product. In addition, we rely on the industry expertise and reach of these firms. Therefore, this failure would also harm our ability to develop industry-specific products. We are currently investing, and plan to continue to invest, significant resources to develop and maintain these relationships. Our operating results could be adversely affected if these efforts do not generate license and service revenues necessary to offset this investment. We may suffer product deployment delays, a lower quality of customer service and increased expenses if sufficient system integrator implementation teams are not available. System integrators help our customers install and deploy our product. These system integrators are not contractually required to implement our product, and competition for these resources may preclude us from obtaining sufficient resources to provide the necessary implementation services to support our needs. If the number of 22 installations of our product exceeds our access to the resources provided by these system integrators, we could be required to provide these services internally, which would significantly limit our ability to meet our customers' implementation needs and increase our expenses. In addition, we cannot control the level and quality of service provided by our current and future implementation partners. Because a small number of customers have in the past accounted for a substantial portion of our revenues, our revenues could decline due to the loss or delay of a single customer order. Sales to our ten largest customers accounted for 42% of total revenues in the three months ended September 30, 2001 and 30% of total revenues in the nine months ended September 30, 2001. One customer, BP, accounted for 15% of our revenues in the three month period ended September 30, 2001 and 6% of our revenues in the nine month period ended September 30, 2001. Sales to our ten largest customers accounted for 35% of total revenues in the three months ended September 30, 2000 and 27% in the nine months ended September 30, 2000. Our license agreements do not generally provide for ongoing license payments. Therefore, we expect that revenues from a limited number of customers will continue to account for a significant percentage of total revenues in future quarters. Our ability to attract new customers will depend on a variety of factors, including the reliability, security, scalability, breadth and depth of our products, and cost-effectiveness of our products. The loss or delay of individual orders could have a significant impact on revenues and operating results. Our failure to add new customers that make significant purchases of our product and services would reduce our future revenues. Our sales are concentrated in the telecommunications, manufacturing, financial services, energy, insurance and healthcare industries, and if our customers in these markets decrease their information technology spending, or we fail to penetrate other industries, our revenues may decline. We expect to continue to direct our sales and marketing efforts toward companies in the telecommunications, manufacturing, financial services, energy, insurance and healthcare industries. Given the high degree of competition and the rapidly changing environment in these industries, there is no assurance that we will be able to continue sales in these industries at current levels. In addition, we intend to market our product in new vertical markets. Customers in these new vertical markets are likely to have different requirements and may require us to change our product design or features, sales methods, support capabilities or pricing policies. If we fail to successfully address these new vertical markets we may experience decreased sales in future periods. During the fourth quarter of 2000, companies in the telecommunications industry began sharply decreasing their capital expenditures as the U.S. economy contracted. This decrease in spending and the overall slowdown in the U.S. economy continues to negatively impact our revenues in 2001 and may continue to negatively impact our revenues for the foreseeable future. Failure of our current or potential Internet customers to receive necessary funding could harm our business. Some of our customers include Internet companies. Most privately and publicly held Internet companies require outside cash sources to continue operations. To the extent additional funding is less available for Internet companies as a result of a stock market decline or other factors, demand for our products may decline significantly, thereby reducing our sales. On sales we do generate from Internet companies, we may need to defer recognizing revenue until payment is received. The prolonged downturn in the U.S. economy may continue to cause a decline in capital allocations, thus reducing our revenue and affecting our accounts receivable. The prolonged downturn in the U.S. economy may continue to cause a decline in capital allocations for software purchases. The delay in capital expenditures may cause a decrease in sales, may cause an increase in our accounts receivable and may make collection of license and support payments from our customers more difficult. In 23 addition, if our customers seek protection from creditors through formal bankruptcy filings, or if our customers encounter funding problems, we may experience an increase in delinquent accounts receivable. Our markets are highly competitive and, if we do not compete effectively, we may suffer price reductions, reduced gross margins and loss of market share. The market for our product is intensely competitive, evolving and subject to rapid technological change. The intensity of competition is expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could significantly reduce our future revenues. Our current competitors include: B2Bi, EAI and BPM Vendors. We face direct and indirect competition from vendors offering Business-to-Business Integration ("B2Bi"), Enterprise Application Integration ("EAI"), and Business Process Management ("BPM") as well as other aspects of our products. Some of these vendors include BEA Systems, Inc., CrossWorlds Software, Inc., IBM Corporation, IONA, Mercator Software, Peregrine Systems, Inc., Sterling Commerce, Sybase, Inc., SeeBeyond Technology Corporation, Tibco Software, Inc., and webMethods, Inc. In the future, some of these companies may expand their products to enhance existing, or to provide, process automation and real-time analysis functionality. Additionally, in this fast-growing market, these or other competitors may merge to attempt the creation of a more competitive entity, or one that offers a broader solution than we provide. Internal IT Departments. "In house" information technology departments of potential customers have developed or may develop systems that provide for some or all of the functionality of our BusinessWare product. We expect that internally developed application integration and process automation efforts will continue to be a principal source of competition for the foreseeable future. In particular, it can be difficult to sell our product to a potential customer whose internal development group has already made large investments in and progress towards completion of systems that our product is intended to replace. Other Software Vendors. We may in the future also encounter competition from major enterprise software developers including Oracle Corporation, PeopleSoft, Inc., and SAP AG. In addition, Microsoft Corporation has introduced products that could compete with some aspects of our product. Other companies that target the enterprise software market may also try to expand into the integration market. Many of our competitors have more resources and broader customer relationships than we do. In addition, many of these competitors have extensive knowledge of our industry. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to offer a single solution and increase the ability of their products to address customer needs. Although we believe that our solutions generally compete favorably with respect to these factors, our market is relatively new and is evolving rapidly. We may not be able to maintain our competitive position against current and potential competitors, especially those with significantly greater resources. We experience long and variable sales cycles, which could have a negative impact on our results of operations for any given quarter. Our product is often used by our customers to deploy mission-critical solutions used throughout their organization. Customers generally consider a wide range of issues before committing to purchase our product, including product benefits, ability to operate with existing and future computer systems, ability to accommodate increased transaction volume and product reliability. Many customers will be addressing these issues for the first time. As a result, we or other parties, including system integrators, must educate potential customers on the use and benefits of our product and services. In addition, the purchase of our product generally involves a significant commitment of 24 capital and other resources by a customer. This commitment often requires significant technical review, assessment of competitive products, and approval at a number of management levels within the customer's organization. Because of these issues, our sales cycle has ranged from two to nine months and is difficult to predict for any particular license transaction. The cost and difficulty in implementing our product could significantly harm our reputation with customers, diminishing our ability to license additional products to our customers. Our product is often purchased as part of large projects undertaken by our customers. These projects are complex, time consuming and expensive. Failure by customers to successfully deploy our product, or the failure by us or third-party consultants to ensure customer satisfaction, could damage our reputation with existing and future customers and reduce future revenues. In many cases, our customers must interact with, modify, or replace significant elements of their existing computer systems. The costs of our product and services represent only a portion of the related hardware, software, development, training and consulting costs. The significant involvement of third parties, including system integrators, reduces the control we have over the implementation of our product and the quality of customer service provided to organizations which license our software. If we are not successful in continuing to develop industry specific solutions based on our product, our ability to increase future revenues could be harmed. We have developed and intend to continue to develop solutions based on BusinessWare which incorporate business processes, connectivity and document transformations specific to the needs of particular industries, including telecommunications, manufacturing, financial services, energy, insurance and healthcare. This presents technical challenges and will require collaboration with system integrators and the commitment of significant resources. If we are not successful in developing these targeted solutions or these solutions do not achieve market acceptance, our ability to generate future revenues could be harmed. Our operating results are substantially dependent on license revenues from one product and our business could be materially harmed by factors that adversely affect the pricing and demand for our product. Since 1998, a majority of our total revenues has been, and is expected to be, derived from the license of our BusinessWare product. Accordingly, our future operating results will depend on the demand for BusinessWare by future customers, including new and enhanced releases that are subsequently introduced. If our competitors release new products that are superior to BusinessWare in performance or price, or we fail to enhance BusinessWare and introduce new products in a timely manner, demand for our product may decline. A decline in demand for BusinessWare as a result of competition, technological change or other factors would significantly reduce our revenues. If our product does not operate with the many hardware and software platforms used by our customers, our business may fail. We currently serve a customer base with a wide variety of constantly changing hardware, packaged software applications and networking platforms. If our product fails to gain broad market acceptance, due to its inability to support a variety of these platforms, our operating results may suffer. Our business depends, among others, on the following factors: o our ability to integrate our product with multiple platforms and existing, or legacy, systems and to modify our product as new versions of packaged applications are introduced; o the portability of our product, particularly the number of operating systems and databases that our product can source or target; o our ability to anticipate and support new standards, especially Internet standards; o the integration of additional software modules under development with our existing product; and 25 o our management of software being developed by third parties for our customers or use with our product. If we fail to introduce new versions and releases of our product in a timely manner, our revenues may decline. We may fail to introduce or deliver new products on a timely basis, if at all. In the past, we have experienced delays in the commencement of commercial shipments of our BusinessWare product. To date, these delays have not had a material impact on our revenues. If new releases or products are delayed or do not achieve market acceptance, we could experience a delay or loss of revenues and cause customer dissatisfaction. In addition, customers may delay purchases of our product in anticipation of future releases. If customers defer material orders in anticipation of new releases or new product introductions, our revenues may decline. Our product relies on third-party programming tools and applications. If we lose access to these tools and applications, or are unable to modify our product in response to changes in these tools and applications, our revenues could decline. Our programs utilize Java programming technology provided by Sun Microsystems. We also depend upon access to the interfaces, known as "APIs," used for communication between external software products and packaged application software. Our access to APIs of third-party applications are controlled by the providers of these applications. If the application provider denies or delays our access to APIs, our business may be harmed. Some application providers may become competitors or establish alliances with our competitors, increasing the likelihood that we would not be granted access to their APIs. We also license technology related to the connectivity of our product to third-party database and other applications and we incorporate some third-party technology into our product offerings. Loss of the ability to use this technology, delays in upgrades, failure of these third parties to support these technologies, or other difficulties with our third-party technology partners could lead to delays in product shipment and could cause our revenues to decline. We could suffer losses and negative publicity if new versions and releases of our product contain errors or defects. Our product and its interactions with customers' software applications and IT systems are complex and, accordingly, there may be undetected errors or failures when products are introduced or as new versions are released. We have in the past discovered software errors in our new releases and new products after their introduction which has resulted in additional research and development expenses. To date, these additional expenses have not been material. We may in the future discover errors in new releases or new products after the commencement of commercial shipments. Since many customers are using our product for mission- critical business operations, any of these occurrences could seriously harm our business and generate negative publicity. If we fail to develop the management system and infrastructure to support our growth, our ability to market and sell our product and develop new products may be harmed. We must plan and manage our growth effectively in order to offer our product and services and achieve revenue growth and profitability in a rapidly evolving market. For us to effectively manage our growth, we must continue to do the following: o install new management and information control systems; and o expand, train and motivate our workforce. In particular, we continue to add new software systems to complement and enhance our existing accounting, human resource and sales and marketing software systems. If we fail to install these software systems in an efficient 26 and timely manner, or if the new systems fail to adequately support our level of operations, then we could incur substantial additional expenses to remedy these failures. If we do not keep pace with technological change, our product may be rendered obsolete and our operating results may suffer. Our industry is characterized by very rapid technological change, frequent new product introductions and enhancements, changes in customer demands and evolving industry standards. Our existing product will be rendered obsolete if we fail to introduce new products or product enhancements that meet new customer demands, support new standards or integrate with new or upgraded versions of packaged applications. We have also found that the technological life cycle of our product is difficult to estimate. We believe that we must continue to enhance our current product while we concurrently develop and introduce new products that anticipate emerging technology standards and keep pace with competitive and technological developments. Failure to do so will harm our ability to compete. As a result, we are required to continue to make substantial product development investments. If we fail to attract and retain qualified personnel, our ability to compete will be harmed. We depend on the continued service of our key technical, sales and senior management personnel. None of these persons are bound by an employment agreement. The loss of senior management or other key research, development, sales and marketing personnel could have a material adverse effect on our future operating results. In particular Dr. JoMei Chang, our President and Chief Executive Officer, and Dr. M. Dale Skeen, our Chief Technology Officer, would be difficult to replace. In addition, we must attract, retain and motivate highly skilled employees. We face significant competition for individuals with the skills required to develop, market and support our products and services. We cannot assure that we will be able to recruit and retain sufficient numbers of these highly skilled employees. We depend on the increasing use of the Internet and on the growth of electronic commerce. If the use of the Internet and electronic commerce does not grow as anticipated, our revenues could decline and our business will be seriously harmed. We depend on the increased acceptance and use of the Internet as a medium for electronic commerce and the adoption by businesses of ebusiness solutions. Rapid growth in the use of the Internet is a recent occurrence. As a result, acceptance and use may not continue to develop at historical rates and a sufficiently broad base of business customers may not adopt or continue to use the Internet as a medium of commerce. Demand and market acceptance for recently introduced services and products over the Internet are subject to a high level of uncertainty, and there exist few proven services and products. Our future results may depend significantly on the use of our electronic commerce platform in electronic marketplaces. We have entered into agreements with licensees who are forming networks that will be powered by our business-to-business electronic commerce platform. These networks have been recently formed and are at an early stage of development. There is no guarantee regarding the level of activity of different companies in these networks, the effectiveness of the interaction among companies using our business-to-business electronic commerce platform and 27 of the attractiveness of offerings of our competitors. If these networks are not successful, our business, operating results and financial position could be affected. If we fail to adequately protect our proprietary rights, we may lose these rights and our business may be seriously harmed. We depend upon our ability to develop and protect our proprietary technology and intellectual property rights to distinguish our product from our competitor's products. The use by others of our proprietary rights could materially harm our business. We rely on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We have no issued patents. Despite our efforts to protect our proprietary rights, existing laws afford only limited protection. Attempts may be made to copy or reverse engineer aspects of our product or to obtain and use information that we regard as proprietary. Accordingly, there can be no assurance that we will be able to protect our proprietary rights against unauthorized third-party copying or use. Furthermore, policing the unauthorized use of our product is difficult, and expensive litigation may be necessary in the future to enforce our intellectual property rights. If our source code is released to our customers, our ability to protect our proprietary rights could be jeopardized and our revenues could decline. Some of our license agreements require us to place the source code for our product in escrow. These agreements generally provide these customers with a limited, non-exclusive license to use this code if: o we fail to provide the product or maintenance and support; o we cease to do business without a successor; or o there is a bankruptcy proceeding by or against Vitria. Our revenues could decline and our business could be seriously harmed if customers were granted this access. Our product could infringe the intellectual property rights of others causing costly litigation and the loss of significant rights. Software developers in our market will increasingly be subject to infringement claims as the number of products in different software industry segments overlap. Any claims, with or without merit, could be time-consuming, result in costly litigation, prevent product shipment or cause delays, or require us to enter into royalty or licensing agreements, any of which could harm our business. Patent litigation in particular has complex technical issues and inherent uncertainties. In the event an infringement claim against us is successful and we cannot obtain a license on acceptable terms or license a substitute technology or redesign our product to avoid infringement, our business would be harmed. Furthermore, former employers of our current and future employees may assert that our employees have improperly disclosed to us or are using confidential or proprietary information. We may not successfully enter international markets or generate significant product revenues abroad, which could result in slower revenue growth and harm our business. We have opened international offices in countries including the United Kingdom, Japan, Germany, France, Italy, Canada, Australia, The Netherlands, Singapore, Korea, Taiwan, Switzerland, Spain and Brazil and intend to establish additional international offices. We anticipate devoting significant resources and management attention to expanding international opportunities. There are a number of challenges to establishing operations outside of the United States and we may be unable to successfully generate significant international revenues. If we fail to successfully establish our products in international markets, we could experience slower revenue growth and our business could be harmed. It may be difficult to protect our intellectual property in certain international jurisdictions. 28 We may not be able to efficiently integrate the operations of our acquisitions which may harm our business. We acquired XMLSolutions Corporation in April 2001. We may make additional acquisitions of, or significant investments in, businesses that offer complementary products, services, technologies or market access. If we are to realize the anticipated benefits of these acquisitions, the operations of these companies must be integrated and combined efficiently. Customer relationships and strategic partnerships may be disrupted during the integration process which could result in lost sales and lost customers, and could harm our business. We may also incur significant expenses during the integration process. In addition, the dedication of management resources to integration may detract attention from our day-to-day business. The successful integration of any acquisition will also depend in part on the retention of key personnel. There can be no assurance that the integration process will be successful or that the anticipated benefits of any business integration will be fully realized. Achieving the benefits of any acquisition will depend in part on our ability to continue to successfully develop and sell our products and integrate new technologies to develop new products and product features, in a timely and efficient manner. If we are not successful in these efforts, our business may be harmed. Failure to raise additional capital or generate the significant capital necessary to expand our operations and invest in new products could reduce our ability to compete and result in lower revenues. We may need to raise additional funds, and we cannot be certain that we will be able to obtain additional financing on favorable terms, or at all. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things: o develop or enhance our products and services; o acquire technologies, products or businesses; o expand operations, in the United States or internationally; o hire, train and retain employees; or o respond to competitive pressures or unanticipated capital requirements. Our failure to do any of these things could result in lower revenues and could seriously harm our business. We are at risk of securities class action litigation due to our expected stock price volatility. In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. This risk exists because technology companies have experienced greater than average stock price volatility in recent years. In addition, a number of public companies have recently been named as defendants in law suits related to the alleged practices of investment banks. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources, and could seriously harm our business. We have implemented anti-takeover provisions which could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders. Provisions of our amended and restated certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include: o establishment of a classified Board of Directors requiring that not all members of the Board of Directors may be elected at one time; o authorizing the issuance of "blank check" preferred stock that could be issued by our Board of Directors to increase the number of outstanding shares and thwart a takeover attempt; 29 o prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates; o limitations on the ability of stockholders to call special meetings of stockholders; o prohibiting stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; and o establishing advance notice requirements for nominations for election to the Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings. In addition, Section 203 of the Delaware General Corporations Law and the terms of our stock option plans may discourage, delay or prevent a change in control of Vitria. 30 PART II OTHER INFORMATION Item 1. Legal Proceedings. Vitria is currently a party to various legal actions arising out of the normal course of business, none of which are expected to have a material adverse effect on Vitria's financial position, results of operations, or cash flows. In April 2001, XMLSoutions Corporation received a letter from DISA, the Data Interchange Standards Association, asserting a copyright claim with respect to certain XMLSoutions' technology. Pursuant to a letter dated November 9, 2001, DISA is no longer asserting the claims set forth in the April 2001 letter. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. On October 29, 2001, in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, JoMei Chang, our president and chief executive officer, established a plan to purchase shares of our common stock in the open market. This rule permits our officers, directors and employees to purchase and sell shares of our common stock under written plans adopted at a time when they were not in possession of material non-public information. The plan provides for the purchase over time of up to $2,000,000 of our common stock, subject to certain limitations. As of November 10, 2001, 140,000 of shares had been purchased under the plan. 31 Item 6. Exhibits and Reports on Form 8-K. a) Exhibits 10.13 Employment Agreement between Karen O. Cottle and Vitria dated July 9, 2001. b) Reports on Form 8-K On August 31, 2001, Vitria filed a Current Report on Form 8-K, dated July 30, 2001. 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Vitria Technology, Inc. Date: November 13, 2001 By: /s/ Paul R. Auvil, III Paul R. Auvil, III Vice President, Finance, and Chief Financial Officer (Principal Financial Officer) 33