-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VqpfVwhnmiS6zekYpR5c/orD/9n/rZLqvqCEmbteAiYI6SEm3xIuA/9OQDl4Pf0N 90g7eZlYgAWZ0gWWiDaB4w== 0000898430-01-501053.txt : 20010619 0000898430-01-501053.hdr.sgml : 20010619 ACCESSION NUMBER: 0000898430-01-501053 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010618 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RATIONAL SOFTWARE CORP CENTRAL INDEX KEY: 0000722056 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 541217099 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-12167 FILM NUMBER: 1662707 BUSINESS ADDRESS: STREET 1: 18880 HOMESTEAD RD CITY: CUPERTINO STATE: CA ZIP: 95014 BUSINESS PHONE: 4088639900 MAIL ADDRESS: STREET 1: 18880 HOMESTEAD RD CITY: CUPERTINO STATE: CA ZIP: 95014 FORMER COMPANY: FORMER CONFORMED NAME: VERDIX CORP DATE OF NAME CHANGE: 19920703 10-K 1 d10k.txt FORM 10-K (3/31/01) - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended March 31, 2001 [_] 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 0-12167 RATIONAL SOFTWARE CORPORATION (Exact name of Registrant as specified in its charter) Delaware 54-1217099 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 18880 Homestead Road, Cupertino, CA 95014-0721 (Address of principal executive offices) (Zip Code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01 per share (Title of Class)
408-863-9900 (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 periods as the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] At May 31, 2001, the aggregate market value of Registrant's voting stock held by nonaffiliates was $4,753,011,230. For the purposes of the preceding sentence only, "affiliates" is deemed to consist of executive officers and directors. At May 31, 2001, there were 203,190,957 shares of the Registrant's Common Stock, $0.01 par value, outstanding. Unless indicated otherwise, all Common Stock share numbers and prices have been adjusted to reflect Rational Software Corporation's May 1995 1:3 reverse stock split, July 1996 2:1 forward stock split, accomplished by means of a stock dividend, and September 2000 2:1 forward stock split, accomplished by means of a stock dividend. Certain sections of the Registrant's definitive Proxy Statement for the 2001 Annual Meeting of Stockholders to be held on July 19, 2001, are incorporated by reference in Part III of this Form 10-K to the extent stated herein. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- An Index to Exhibits Begins on Page 61 This annual report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements include without limitation statements regarding our expectations and beliefs about the market and industry, our goals, plans, and expectations regarding our products and services and product development, our intentions and strategies regarding customers and customer relationships, our relationships with the software development community, our intent to continue to invest significant resources in research and development, our expectations regarding the impact of the acquisitions of Catapulse Inc., Attol Testware and ObjecTime Limited and related product and service offerings, our intent to acquire or invest in other technologies, our intent to develop long-term relationships and strategic alliances, our beliefs regarding the future success of our products and services, our intent to extend and strengthen our life cycle support for team-based development, our expectations and beliefs regarding competition, competitors, the bases of competition and our ability to compete, our beliefs regarding trademark and copyright protections, our beliefs and expectations regarding infringement claims, our expectations and beliefs regarding our ability to hire and retain personnel, our beliefs regarding period to period results of operations, our expectations regarding future growth and financial performance, our beliefs regarding the development of industry standards, our expectations regarding international sales and our revenues, our expectations regarding the conversion to the Euro currency, our expectations and beliefs regarding revenue growth, our expectations regarding our strategies and long-term strategic relationships, our expectations regarding defects in products, our expectations regarding fluctuations in revenues and operating results, our beliefs and expectations regarding our existing facilities and the availability of additional space in the future, our intent to use all available funds for the development and the operation of our business and not to declare or pay any cash dividends, our expectations regarding software development costs, our beliefs and expectations regarding our results of operations and financial position, our beliefs regarding estimates in valuing in-process research and development, our intentions and expectations regarding deferred tax assets, our beliefs and expectations regarding liquidity and capital resources and that cash flow from operations, existing cash and cash equivalents and short-term investments will be sufficient to meet our cash requirements, and our expectations regarding the impact of recent accounting pronouncements and revenue recognition matters relating to Catapulse. These statements are subject to risks and uncertainties that could cause actual results and events to differ materially. These risks and uncertainties include without limitation those identified in the section of this annual report on Form 10-K entitled "Factors That May Affect Future Results" below. Rational undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this annual report on Form 10-K. As used in this annual report on Form 10-K, unless the context otherwise requires, the terms "we," "us," "the Company," and "Rational" refer to Rational Software Corporation, a Delaware corporation, and its subsidiaries. PART I ITEM 1--BUSINESS Overview We were incorporated under the laws of Delaware in July 1982. We are a leading provider of integrated solutions that automate the software development process. Our integrated solutions include unified tools, software engineering best practices, and services that allow customers to successfully and efficiently develop and deploy software. Our solutions help customers organize, automate, and simplify the software development process and enable them to gain a competitive advantage by being able to more quickly develop and deploy high-quality, mission-critical software. The focus of our business is e-development, that is, helping customers rapidly develop high-quality software for the Internet-connected global economy. We serve customers in three principal categories that we refer to as business applications, infrastructure, and embedded systems and devices: . business applications customers include organizations that are leveraging the power of the Internet to improve their businesses by building business-to-business and/or business-to-consumer software. Our business applications customers include Charles Schwab & Co., E*Trade, i2 Technologies, Merrill Lynch, and Siebel Systems. 2 . infrastructure customers are building the physical and software infrastructure for the Internet and include communications as well as operating system and "middleware" software vendors. Our infrastructure customers include America Online, Cisco, Ericsson, IBM, Lucent, Microsoft, Nokia and Sun Microsystems. . embedded systems and devices customers are building devices with embedded software that provide connectivity to the Internet and other specialized networks. Our customers for embedded systems and devices include Hewlett-Packard, Motorola, Palm, Phillips, and Sony. Industry Background The rapid growing use of technology in business and everyday life is driving an increasing demand for software development. Software is essential in the development of Web sites and related business systems, plays a central role in the communication networks, and is embedded in physical devices such as routers, hubs, and switches, as well as everyday devices such as mobile phones, hand-held computing devices, and automobiles. The challenge many companies face is that their demand for software outpaces their ability to design and build that software. Traditionally, organizations have been able to trade off speed for quality. However, in today's rapidly changing business environment, organizations must increase the speed and quality of their software development; they can no longer afford to trade one off for the other. This "software development paradox" becomes increasingly prevalent as software becomes more business-critical. Accordingly, it is becoming increasingly important for businesses to adopt more effective approaches to software development. In addition, software is becoming more complex, requiring coordinated teams of professionals to develop and deploy it. These teams comprise software professionals numbering overall in the millions and spanning multiple software engineering disciplines. These teams must work in unison to meet today's increased speed and quality needs. An increasing number of organizations are seeking to improve the efficiency of their software teams by addressing the fundamentals of software development at every stage: inception, analysis, design, development, test, and deployment. Organizations are finding that they can improve their software development by upgrading their best practices, applying advanced tools, and leveraging the expertise of experienced vendors. Our target users are professionals on software development teams employed by businesses across a variety of industries. These software professionals span multiple software engineering disciplines--such as analysis, design, programming, and testing--and now number in the millions. The Rational Solution Our integrated e-development solution includes software development tools, software engineering best practices, and services that unify cross-functional software teams while also addressing the unique needs of each member of the team. Our solution covers the crucial phases of the software development life cycle and automates proven software development best practices. We also offer a range of services to our customers to help them better implement our solution. Our goal is to help organizations increase both the speed and quality of their software development. Our products and services: . Reduce time-to-market. Our products help organizations improve both individual and team productivity, reducing the time required to develop and deploy quality software. . Improve software quality. Our solution allows testers and developers to more quickly verify the reliability and functionality of their software. Using our solution, teams can apply more automated testing techniques earlier in the product development cycle to uncover errors when they are significantly less costly to fix. . Improve application performance. We help customers identify performance bottlenecks and understand the impact of alternative deployment scenarios. Users of our solutions can estimate the performance of Internet and other applications under a variety of potential operating conditions. 3 . Improve process maturity. Our integrated solution helps customers improve both the predictability and repeatability of their software development processes. Our products encourage teams to adopt proven software engineering best practices, which we deliver in an easy-to- access format directly from our tools. . Manage change more effectively. Our products help teams track project status and manage changes to evolving source code. Our solution helps organizations leverage technical resources wherever they are located, and allows multiple team members to work on the same project simultaneously. Our Strategy Our mission is to ensure the successful software development efforts of our customers. Our strategy is to build customer relationships by offering comprehensive solutions to the software management problem through an integrated set of tools, best practices, and services. Key components of our strategy include: . Increasing adoption of our integrated solution. While we are the leading provider of integrated solutions that automate the software development process, we believe we are currently only serving a small portion of our potential market. We intend to continue to target new customers based on the proven benefits of our integrated solution. In addition, we intend to increase penetration of our existing customers by demonstrating the benefits of our additional products and services. . Extending product leadership. We intend to continuously improve the functionality of our products and services to meet the evolving needs of our customers. We intend to continue to leverage our strong relationship with the software development community as well as use our industry knowledge and expertise to ensure that we maintain our product leadership. In addition, we will continue to invest significant resources in research and development to improve our existing products and develop new products. . Acquiring or investing in complementary products. To achieve our objective of providing the most comprehensive software development solution, we have from time to time acquired businesses, products, or technologies that are complementary to our business. For example, our acquisition of Catapulse Inc. extends our capabilities in a hosted development service, which is designed to be delivered to users over the Internet, and our acquisition of Attol Testware extends our product line for our embedded systems and devices customers. We intend to acquire or invest in other leading technologies that address the needs of our customers and that we can integrate into our product family. . Continuing to form key strategic alliances. We intend to continue to develop long-term strategic relationships with leading software and hardware vendors to increase our exposure to potential users and thereby expand our customer base. Consistent with this strategy, we have entered into strategic alliances with companies such as IBM, Microsoft, Intel, Hewlett-Packard, Sun Microsystems, and Vignette Corporation. Our strategic alliances provide for such things as technology cross- licensing, joint development projects, and joint marketing programs. Products and Services Rational Unified Process Rapid delivery of high-quality software requires cohesive teamwork and a predictable, well-understood process. We satisfy this need with the Rational Unified Process, a set of software engineering best practices optimized for rapid development of high-quality software. The Rational Unified Process combines lessons learned from thousands of customer engagements with the expertise of industry thought leaders. Its entire contents--including prescriptive guidelines, templates, and examples--can be directly accessed from any Rational tool through seamless integrations that make the process practical. When combined with our comprehensive services and team unifying tools, the Rational Unified Process serves as a recipe for rapid delivery of high-quality software. 4 Rational Integrated Solutions Our products span the software development life cycle. They are available in individual editions that address the unique needs of specific software engineering disciplines, such as system definition, software design and development, content management, system testing, change management, and defect tracking. In addition, many of our products are available in tightly integrated suite editions. Our suite editions unify cross-functional teams by automating the flow of project artifacts and providing shared access to common data. They provide an easy way for customers to acquire and deploy complete software development solutions. Rational Suite The Rational Suite product family provides tightly integrated solutions that make it easy for customers to acquire and deploy complete software development solutions. We design each suite around the needs of the various software engineering disciplines that are part of every software development team. Each suite also includes a core set of team-unifying tools to improve the productivity of the entire team. . Rational Suite AnalystStudio is an answer to the problems facing today's analysts. Analysts are responsible for collecting, managing, and communicating project requirements to the entire team. Rational Suite AnalystStudio optimizes the analyst's effectiveness by combining powerful tools that collect enhancement requests, manage requirements information, and visually model use cases for better communication. . Rational Suite DevelopmentStudio is a complete solution for software architects and developers. Architects and developers are responsible for designing software systems and developing code. Rational Suite DevelopmentStudio combines the power of visual modeling for software design and automated testing to improve the quality of the code before it is handed off to quality assurance professionals. . Rational Suite DevelopmentStudio RealTime Edition provides an integrated solution for software teams developing complex, real-time embedded software applications used in cell phones, pagers, routers, hubs, and other products fueling the Internet economy. It combines the power of visual modeling and automated testing with advanced features optimized for the unique challenges of real-time engineering. . Rational Suite TestStudio is a fully integrated suite of testing tools that automates test planning, test developments, test execution, and defect tracking. Designed for testing and quality assurance professionals who ensure that software systems meet quality standards as well as end-user requirements, it ensures that a common set of testing tools, methods, metrics, and data are used by the entire project team. . Rational Suite ContentStudio combines software development solutions from Rational with content management tools from Vignette Corporation, a market leader in Web content management and a Rational strategic alliance partner -- in one integrated solution. Rational Suite ContentStudio makes it possible for development teams to more easily manage the development of sophisticated e-business applications, typically consisting of significant amounts of both software application code and content. . Rational Suite Enterprise combines all of the tools of Rational Suite AnalystStudio, DevelopmentStudio, and TestStudio. Rational Suite Enterprise provides a complete software development solution in one easy-to-acquire package. Configuration and Change Management Solutions Our configuration and change management products unify software teams by providing comprehensive support for development teams working in parallel on shared project artifacts, such as source code, binary files, software models, requirements documents, test cases, and project reports. . Rational ClearCase is our software configuration management solution. ClearCase accelerates development cycles, ensures the accuracy of releases, and enables teams to reliably build and patch 5 previously shipped products. It provides secure and reliable access to project artifacts, allowing teams to share their work. ClearCase maintains a full audit trail of who changed what, when, where, and why, manages multiple versions of software artifacts, and reliably performs "builds" of software systems. Rational ClearCase MultiSite supports geographic distribution of software development teams working on shared sets of artifacts. . Rational ClearQuest is a flexible defect tracking/change request management system for tracking and reporting on defects and other types of change requests throughout the development life cycle. ClearQuest provides reliable project metrics and is fully customizable. ClearQuest helps project teams ensure that change occurs in a managed fashion. Combined, Rational ClearCase and Rational ClearQuest offer Unified Change Management (UCM), an automated process for managing changes to project activities and artifacts. UCM helps teams get up and running quickly by providing built-in project workflow and change management support. Its activity-based approach helps teams work more intuitively by focusing on high- level activities instead of individual changes to files. Requirements Management Solutions Rational RequisitePro is the flagship member of the Rational Requisite family. This family of tools is designed to make requirements management intrinsic to the development process by making requirements easy to document, organize, and track as changes are made throughout the project life cycle. Rational RequisitePro enables team-based requirements management. RequisitePro is supplemented with RequisiteEnterprise, which adds support for enterprise databases, and RequisiteWeb, which provides a Web interface for viewing and editing RequisitePro requirements. Visual Modeling Solutions . Rational Rose is a Unified Modeling Language (UML)-based software modeling tool for designing component-based applications. The UML, pioneered by Rational and officially adopted as a standard by the Object Management Group (OMG), is the industry-standard language for specifying, visualizing, constructing, and documenting the artifacts of a software system. COM, ActiveX, and JavaBean components can be reverse engineered to derive interfaces and determine the interrelationships of all components within a model. Rose gives developers the ability to mix and match multiple languages, such as C++, Visual Basic, and Java, within the same model. . Rational Rose RealTime is a visual modeling environment designed specifically to address the needs of software teams that manage and deliver real-time software applications. Rational Rose RealTime combines market-leading visual modeling technology with advanced model execution and code generation technology. Rose RealTime also supports the UML. Automated Testing Solutions Our solutions for automated testing help testers and developers verify the reliability and functionality of their software and improve its performance. . Rational Robot lets the user create, modify, and run automated tests on Web, Enterprise Resource Planning (ERP), and client/server applications. This test automation solution offers reusability and portability of test recordings across Windows platforms to provide one recording that plays back on all Windows platforms. Rational TestFactory automates the creation of test scripts--so testers do not have to invest significant amounts of time developing test scripts. Robot and TestFactory are key components of Rational Suite TestStudio. Rational LoadTest offers load, stress, and multi-user testing of client/server applications. It automates the use of multiple transactions from a single test script, the creation of workloads for 10 or 10,000+ users, and the insertion of production-level timing characteristics. 6 . Rational Test RealTime is designed specifically for teams creating complex, cross-platform software for embedded systems. Built specifically for testing real-time and embedded by Attol Testware, a company we recently acquired, Rational Test RealTime provides system, unit, functional, and performance testing and supports over 100 of the industry's most popular host and target environments. . Rational Visual Test, an automated, language-independent, software- testing tool, is designed to test proper software functionality by rapidly creating tests for applications of virtually any size and created in any implementation language by capturing those tests for later reuse. . Rational Purify, Rational PureCoverage, and Rational Quantify are designed to help developers and testers verify the reliability of their software. Purify employs patented object-code insertion (OCI) technology to executable code and automatically detects many common runtime errors. PureCoverage also employs OCI technology to analyze executable code and to report which parts of the code have not been executed and tested. Quantify helps developers verify software performance by measuring where time is spent during software execution and by providing users with accurate data on potential performance bottlenecks. This data tells users what portions of the application need to be tuned or revised to improve performance. Integrated Development Environment Solutions Rational Apex is a software-engineering environment for control of software projects. It effectively controls large-scale development efforts, helping customers improve time-to-market while reducing risk and cost. It also makes large-scale software reuse possible by directly managing software architecture, significantly improving the efficiency of the overall software development process. Rational Apex runs on UNIX platforms and is available in versions that support the C/C++ and Ada programming languages for UNIX, Windows NT, and embedded applications. Technical Consulting and Customer Support Services We offer our customers the benefits of 20 years of experience in developing and applying tools and proven best practices for software development. This experience is drawn from hundreds of our software consultants working directly with customers, and from extensive internal use of our tools. Our professional services facilitate customer adoption of these tools and best practices, maximizing the probability of project success. Customers are able to take full advantage of our experience, avoid common pitfalls, and get maximum value from their investment in our solution. Our partners and we offer a wide range of professional services. These include tool and technology training delivered onsite or in public classes, onsite implementation planning, software engineer mentoring, and architecture and process consulting. We also offer a support program that entitles a licensee to receive all enhancements and upgrades to the licensed product that are published in the succeeding 12-month period, as well as certain other support services. Business Alliances We work with numerous strategic partners for business applications, embedded systems and devices, and infrastructure platforms and applications. In this context, we work with vendors such as Microsoft, IBM, Intel, Sun Microsystems, Vignette Corporation, Peoplesoft, Oracle, Hewlett-Packard, SGI, and others. These relationships may include technology cross-licensing arrangements and cooperative marketing relationships as well as exchange of development plans and strategic directions. Our relationship with Microsoft includes, among other things, Rational providing certain visual modeling technology to Microsoft that has been included in Microsoft's Visual Studio Products. 7 Product Development We believe that our success will depend largely on our ability to enhance existing products and develop new products that meet the needs of a rapidly evolving marketplace and increasingly sophisticated and demanding customers. We intend to extend and strengthen our life cycle support for team-based development by expanding our product offerings, introducing new products, and offering higher levels of integration among our products. We use our own software processes and tools extensively in our own software development activities. Although we have primarily developed products internally, we may, based on timing and cost considerations, acquire technologies or products from third parties. Our research and development staff, including product development, product support, and technical writing personnel, consisted of 1,241 employees as of May 31, 2001. Our total research and development expenses excluding related amortization of deferred stock based compensation were approximately $183.5 million, $102.6 million, and $71.9 million in fiscal years 2001, 2000, and 1999, respectively. Customers and Applications More than 917,000 licenses of our software products, exclusive of Rational Visual Test, have been sold to more than 52,000 customers worldwide. No single customer accounted for 10% or more of revenues in fiscal 2001. Our comprehensive solution of software development tools and professional services is used by major organizations in many industry segments to design, build, and maintain complex software systems. Sales and Marketing We market and sell our products and services directly through our field sales organizations, the World Wide Web, and indirectly through channels such as value-added resellers (VARs) and distributors. Our direct selling approach couples sales of our integrated software development tools with high-value technical consulting services. We have established a major-account direct sales and technical consulting organization in the United States, Canada, Europe, Latin America, and the Asia/Pacific region. In most regions this direct sales organization includes a telesales operation to augment its direct sales presence. Our sales, marketing, and professional services organization consisted of 2,248 employees as of May 31, 2001. This organization operates out of corporate headquarters in Cupertino, California, operations in Lexington, Massachusetts, and from field offices in other locations throughout North America, Europe, and the Asia/Pacific region. Our direct international operations are staffed almost exclusively by local personnel. Additionally, we also have distributors and resellers in the same regions. In support of our sales efforts, our marketing department conducts comprehensive programs, which include: . maintenance of an extensive World Wide Web site; . an electronic subscription service for news announcements about us; . print and Web advertising; . public relations and industry analyst communications; . trade shows, technical seminars, webinars, and the annual international Rational User Conference; . direct mail promotions and other mailings to keep our prospects and customers informed; . creation of sales brochures, multi-media CDs, and technical papers; . management of marketing activities and promotions with members of the Rational Unified Partners program; and . internal sales product training. 8 International sales accounted for approximately 41%, 41%, and 40% of our revenues in fiscal 2001, 2000, and 1999, respectively, and we expect that international sales will continue to account for a significant portion of our revenues in the future. International sales are subject to inherent risks, including: . unexpected changes in regulatory requirements and tariffs; . unexpected changes in global economic conditions; . difficulty in staffing and managing foreign operations; . longer payment cycles; . potentially adverse tax consequences; . price controls or other restrictions on foreign currency; . difficulty in obtaining export and import licenses; . costs of localizing products for some markets; . lack of acceptance of localized products in international markets; and . the effects of high local wage scales and other expenses. Any material adverse effect on our international business would likely materially and adversely affect our business, operating results, and financial condition as a whole. There can be no assurance that we will not experience a material adverse impact on our financial condition and results of operations from fluctuations in foreign currencies or from macroeconomic problems in various markets or geographies in the future. Product Pricing Our software licenses are generally perpetual, fully paid-up floating or node-locked licenses. Floating licenses limit the number of simultaneous users on a network instead of being associated with a specific user or computer. Node-locked licenses limit a software license to a single computer. We also offer other kinds of licenses, such as project licenses that provide selected Rational tools to all the developers working on a specific project. We also offer a support program that entitles a licensee to receive all enhancements and upgrades to the licensed product that are published in the succeeding 12-month period, as well as certain other support services. Annual fees for support generally range from 15% to 25% of the software license fee. Our packaged training courses are offered in the form of open-enrollment public courses and in-house courses at customer facilities. Additionally, we offer packaged consulting services that are generally priced on a time-and- materials basis. Competition The industry for automating software application development and management is extremely competitive and rapidly changing. We expect to continue to experience significant and increasing levels of competition in the future. Bases of competition include: . corporate and product reputation; . innovation with frequent product enhancement; . breadth of integrated product lines and the availability of integrated suites and bundles; . product architecture, functionality, and features; . product quality, performance, and ease of use; 9 . quality of support and availability of technical consulting services; and . price. We face intense competition for each product in our product lines, generally from both Windows and UNIX vendors. Because individual product sales are often the first step in a broader customer relationship, our success will depend in part on our ability to successfully compete with numerous competitors at each point in their product lines. We face competition from software development tools and processes developed internally by customers, including ad hoc integrations of numerous stand-alone development tools. Customers may be reluctant to purchase products offered by independent vendors such as ours. As a result, we must educate prospective customers about the advantages of our products versus internally developed software quality systems. We face competition from, among others, Aonix, Compaq, Computer Associates, Compuware, Continuus Software Corporation, Cyrano, GEC-Marconi, Green Hills Software, Hewlett-Packard, Merant, plc, Mercury Interactive Corporation, Microsoft, Oracle, Mortice Kern Systems (MKS), Perforce Software, Princeton Softech, Inc., Segue Software, Inc., SGI, SQL Software LTD., StarBase Corporation, Sun Microsystems, Sybase Inc., Telelogic, Teradyne, and True Software, as well as numerous other public and privately held software application development and tools suppliers. We expect additional competition from other established and emerging companies. We believe we are well-positioned to compete due to the combination of our: . integrated family of products supporting component-based development throughout the software development life cycle; . emphasis on controlled iterative development and visual modeling; . architecture-driven process; . extensive major-account direct sales and technical consulting organization; and . supporting channels such as telesales, VARs, distributors, and the World Wide Web. We believe that the increased level of competition we observed in fiscal 2001 will continue to increase. Certain of our competitors are more experienced than we in the development of software engineering tools, databases, or software development products. Some of our competitors have, and new competitors may have, larger technical staffs, more established distribution channels, and greater financial resources than we do. There can be no assurance that either existing or new competitors will not develop products that are superior to our products or that achieve greater market acceptance. Our future success will depend in large part on our ability to increase our share of target markets and to license additional products and product enhancements to existing customers. Future competition may result in price reductions, reduced margins, or loss of sales, which in turn would have a material adverse effect on our business, results of operations, and financial condition. Intellectual Property We regard our software as proprietary and attempt to protect it under a combination of copyright, trademark, patent, and trade-secret laws, employee and third-party nondisclosure agreements, and other methods of protection. Despite these precautions, it may be possible for unauthorized third parties to copy certain portions of our products or to reverse-engineer or obtain and use information we regard as proprietary. Although our competitive position may be affected by our ability to protect our proprietary information, we believe that trademark and copyright protections are less significant to our success than are other factors, such as trade-secret protection, the knowledge, ability, and experience of our personnel, name recognition, and ongoing product development and support. 10 Our software products are generally licensed to end users on a right-to-use basis pursuant to a perpetual license. We license our products primarily under "shrink-wrap" licenses (that is, licenses included as part of the product packaging). Shrink-wrap licenses are not negotiated with or signed by individual licensees and purport to take effect upon the opening of the product package. Certain provisions of such licenses, including provisions protecting against unauthorized use, copying, transfer, and disclosure of the licensed program, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some countries do not protect our proprietary rights to the same extent as do the laws of the United States. As the number of software products in the industry increases and the functionality of these products further overlaps, we believe that software programs will increasingly become subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against us in the future with respect to current or future products. Any such assertion could require us to enter into royalty arrangements or result in costly litigation. Employees We believe our success will depend in part on our continued ability to attract and retain highly qualified personnel in a competitive market for experienced and talented software engineers and sales and marketing personnel. Our employees are not represented by any collective bargaining organization, and we have never experienced a work stoppage. As of May 31, 2001, our employee base was as follows: . product development and support, 1,241 employees; . sales, marketing, and technical consulting, 2,248 employees; . finance and administration, 410 employees; . total full-time personnel, 3,899 employees. 11 EXECUTIVE OFFICERS The following table sets forth certain information with respect to our executive officers as of the date hereof.
Name Position - ---- -------- Paul D. Levy............ Founder and Chairman of the Board Michael T. Devlin....... Founder, Chief Executive Officer and Director Thomas F. Bogan......... President and Chief Operating Officer David H. Bernstein...... Senior Vice President and General Manager, Products Kevin J. Haar........... Senior Vice President, Worldwide Field Operations Timothy A. Brennan...... Senior Vice President, Chief Financial Officer and Secretary
Mr. Levy, age 45, co-founded Rational in 1981 and has served as Chairman of the Board since September 1996. Prior to April 1999, Mr. Levy also served as Chief Executive Officer of Rational. Mr. Devlin, age 46, co-founded Rational in 1981, has served as Chief Executive Officer since April 1999, and is a Director. From September 1996 until April 1999, Mr. Devlin served as President of Rational. Prior to September 1996, Mr. Devlin served as Chairman of the Board of Rational. Mr. Bogan, age 49, has served as Rational's President and Chief Operating Officer since April 2000. From April 1999 until April 2000, Mr. Bogan served as Senior Vice President and Chief Operating Officer. From March 1997 until April 1999, he served as Vice President and General Manager, Automated Test. From July 1996 until March 1997, Mr. Bogan served as Senior Vice President, Finance and Administration, Chief Financial Officer, Treasurer, and Assistant Secretary of SQA, Inc. From 1993 to 1996, Mr. Bogan was President and Chief Executive Officer of Pacific Data Products, Inc., a printer peripherals and networking vendor. Mr. Bernstein, age 49, joined the Company in 1982 and has served as Senior Vice President and General Manager, Products, since 1996. Prior to this, he held various management positions with the Company, most recently Senior Vice President and General Manager, Object Technology Products. Mr. Haar, age 44, joined the Company in 1986 and has served as Senior Vice President, Worldwide Field Operations since April 2000. Prior to April 2000, he held various management positions with the Company, most recently Senior Vice President, The Americas Field Operations. Mr. Brennan, age 45, joined the Company in 1994 and has served as Senior Vice President, Chief Financial Officer, and Secretary since January 1998. From 1995 until 1998, Mr. Brennan served as Vice President, Finance and Administration. From 1994 until 1995, he served as the Company's Controller. Factors That May Affect Future Results Significant unanticipated fluctuations in our quarterly revenues and operating results may cause us not to meet securities analysts' or investors' expectations and may result in a decline in the prices of our Common Stock and our Convertible Notes. Our net revenues and operating results are difficult to predict and may fluctuate significantly from quarter to quarter. If our revenues, operating results, earnings, or future projections are below the levels expected by securities analysts, the prices of our Common Stock and Convertible Notes are likely to decline. Factors that may cause quarterly fluctuations in our operating results include, but are not limited to: . the discretionary nature of our customers' purchase and budget cycles; . difficulty predicting the size and timing of customer orders; . long sales cycles; 12 . seasonal variations in operating results; . introduction or enhancement of our products or our competitors' products; . changes in our pricing policies or the pricing policies of our competitors; . an increase in our operating costs; . whether we are able to expand our sales and marketing programs; . the mix of our products and services sold; . the level of sales incentives for our direct sales force; . the mix of sales channels through which our products and services are sold; . the mix of our domestic and international sales; . an increase in the level of our product returns; . unfavorable economic conditions in the technology industry; . decreased spending on technology due to adverse economic conditions; . fluctuations in foreign currency exchange rates; . changes in accounting pronouncements applicable to us; . costs associated with acquisitions; and . global economic conditions. In addition, the timing of our product revenues is difficult to predict because our sales cycles vary substantially from product to product and customer to customer. We base our operating expenses on our expectations regarding future revenue levels. As a result, if total revenues for a particular quarter are below our expectations, we could not proportionately reduce operating expenses for that quarter. Therefore, a revenue shortfall would have a disproportionate effect on our operating results for that quarter. In addition, because our service revenues are largely correlated with our license revenues, a decline in license revenues could also cause a decline in our service revenues in the same quarter or subsequent quarters. Although we have experienced growth in revenues in recent years, there can be no assurance that, in the future, we will sustain revenue growth or be profitable on a quarterly or annual basis. Further, the revenues and operating income (exclusive of nonrecurring operating and acquisition related expenses) experienced by us in recent quarters are not necessarily indicative of future results. As a result of these and other factors, our operating results are subject to significant variation from quarter to quarter, and we believe that period-to-period comparisons of our results of operations are not necessarily useful. If our operating results are below investors' or securities analysts' expectations, the prices of our Common Stock and Convertible Notes could decline significantly. There may be a possible effect from the acquisition of Catapulse on our future revenue recognition policy. Our primary revenue recognition model is to recognize license revenues upon delivery of a software license. Catapulse's anticipated revenue recognition model will recognize revenue based on delivery of a service over time. We offer for sale both licenses and hosted development services as a combined company. If the hosted development service is sold in conjunction with, or as an option to, Rational's license, there could be an impact on our revenue recognition policy. If market acceptance of our sophisticated software development tools fails to grow adequately, our business may suffer. Our future growth and financial performance will depend in part on broad market acceptance of off-the-shelf products that address critical elements of the software development process. Currently, the number of software 13 developers using our products is relatively small compared with the number of developers using more traditional technology and products, internally developed tools, or manual approaches. Potential customers may be unwilling to make the significant capital investment needed to purchase our products and retrain their software developers to build software using our products rather than traditional techniques. Many of our customers have purchased only small quantities of our products, and these or new customers may decide not to broadly implement or purchase additional units of our products. If industry standards relating to our business do not gain general acceptance, we may be unable to continue to develop and market our products and our business may suffer. Our future growth and financial performance depends on the development of industry standards that facilitate the adoption of component-based development, as well as enhance our ability to play a leading role in the establishment of those standards. For example, we developed the Unified Modeling Language for visual modeling, which was adopted by the Object Management Group, or OMG, a software industry consortium, for inclusion in its object analysis and design facility specification. The official sanction in the future of a competing standard by the OMG or the promulgation of a competing standard by one or more major platform vendors could harm our marketing and sales efforts and, in turn, our business. If we do not develop and enhance new and existing products to keep pace with technological, market, and industry changes, our revenues may decline. The industry for tools automating software application development and management is characterized by rapid technological advances, changes in customer requirements, and frequent new product introductions and enhancements. If we fail to anticipate or respond adequately to technology developments, industry standards, or practices and customer requirements, or if we experience any significant delays in product development, introduction, or integration, our products may become obsolete or unmarketable, our ability to compete may be impaired, and our revenues may decline. We must respond rapidly to developments related to Internet and intranet applications, hardware platforms, operating systems, and programming languages. These developments will require us to make substantial product-development investments. In addition, rapid growth of, interest in, and use of Internet and intranet environments are recent and emerging phenomena. Our success may depend, in part, on the compatibility of our products with Internet and intranet applications. We may fail to effectively adapt our products for use in Internet or intranet environments, or to produce competitive Internet and intranet applications. If we do not effectively compete with new and existing competitors, our revenues and operating margins will decline. The industry for tools that automate software development and management is extremely competitive and rapidly changing. We expect competition to intensify in the future. We believe our continued success will become increasingly dependent on our ability to: . support.multiple platforms, including Microsoft Windows and Windows NT, IBM, commercial UNIX, and Linux; . use the latest technologies to support Web-based development of business-critical applications; . develop and market a broader line of products for programming languages such as C++, Visual Basic, Java, Visual Java++, and Java Beans; and . continually support the rapidly changing standards and technologies used in the development of Web-based applications as well as off-the-shelf products. We face intense competition for each of our products, generally from both Windows and UNIX vendors. Because individual product sales often lead to a broader customer relationship, each of our products must be 14 able to successfully compete with numerous competitors' offerings. Many of our competitors or potential competitors are much larger than we are and may have significantly more resources and more experience. Moreover, many of our strategic partners compete with each other and this may adversely impact our relationship with an individual partner or a number of partners. If we are unable to manage our growth or our announced workforce reduction, our business will suffer. We have experienced rapid growth in recent years. This growth has placed a significant strain on our financial, operational, management, marketing, and sales systems and resources. If we are unable to effectively manage growth, our business, competitive position, results of operations, and financial condition could suffer. To achieve and manage continued growth, we must continue to expand and upgrade our information-technology infrastructure and its scalability, including improvements to various operations, financial, and management information systems, and expand, train, and manage our work force. We may not be successful in implementing these initiatives effectively and in a timely fashion. In April 2001, we announced and subsequently completed a reduction to our workforce, which affected all parts of our organization. If we are unable to effectively manage this workforce reduction, our business operations could be subject to disruption and our business and results of operations could suffer. Our international operations expose us to greater management, collections, currency, intellectual property, regulatory, and other risks. International sales accounted for approximately 41%, 41%, and 40% of our revenues in fiscal 2001, 2000, and 1999, respectively. We expect that international sales will continue to account for a significant portion of our revenues in future periods. Our business would be harmed if our international operations experienced a material downturn. In addition, international sales are subject to inherent risks, including: . unexpected changes in regulatory requirements and tariffs; . unexpected changes in global economic conditions; . difficulties in staffing and managing foreign operations; . longer payment cycles; . potentially adverse tax consequences; . price controls or other restrictions on foreign currency; . difficulties in obtaining export and import licenses; . costs of localizing products for some markets; . lack of acceptance of localized products in international markets; and . the effects of high local wage scales and other expenses. Our international sales are generally transacted through our international sales subsidiaries. The revenues generated by these subsidiaries, as well as their local expenses, are generally denominated in local currencies. Accordingly, the functional currency of each international sales subsidiary is the local currency. We have engaged in limited hedging activities to protect us against losses arising from remeasuring assets and liabilities denominated in currencies other than the functional currency of the related subsidiary. We are also exposed to foreign exchange rate fluctuations as the financial results of international subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact our overall expected profitability. We currently do not hedge against this exposure. Fluctuations in foreign currencies could harm our financial condition and operating results. 15 We are subject to risks associated with the European monetary conversion. In January 1999, the new "Euro" currency was introduced in certain European countries that are part of the European Monetary Union, or EMU. During 2002, all EMU countries are expected to begin operating with the Euro as their single currency. A significant amount of uncertainty exists as to the effect the Euro will have on the marketplace generally and, additionally, all of the final rules and regulations have not yet been defined and finalized by the European Commission with regard to the Euro currency. We are currently assessing the effect the introduction of the Euro will have on internal accounting systems and the sales of products. We are not aware of any material operational issues or costs associated with preparing internal systems for the Euro. However, we do utilize third-party vendor equipment and software products that may or may not be EMU-compliant. The failure of any critical components to operate properly after introduction of the Euro may harm our business or results of operations or require additional costs to remedy these problems. If we lose key personnel or cannot hire enough qualified personnel, our ability to manage our business, develop new products, and increase our revenues will suffer. We believe that the hiring and retaining of qualified individuals at all levels in our organization will be essential to our ability to sustain and manage growth successfully. Competition for highly qualified technical personnel is intense, and we may not be successful in attracting and retaining the necessary personnel, which may limit the rate at which we can develop products and generate sales. We will be particularly dependent on the efforts and abilities of our senior management personnel. The departure of any of our senior management members or other key personnel could harm our business. In addition, merger activities can be accompanied or followed by the departure of key personnel, which could compound the difficulty of integrating the operations of the parties to the business combination and adversely affect our business. If we fail to maintain and expand our distribution channels, our business will suffer. We currently distribute our products primarily through field sales personnel teamed with highly trained technical support personnel, as well as through our telesales organizations, our Web site, and indirectly through channels such as value-added resellers and distributors. Our ability to achieve revenue growth in the future will depend in large part on our success in expanding our direct sales force and in maintaining a high level of technical consulting, training, and customer support. We depend on strategic relationships and business alliances for continued growth of our business. Our development, marketing, and distribution strategies rely increasingly on our ability to form long-term strategic relationships with major software and hardware vendors, many of whom are substantially larger than Rational. These business relationships often consist of cooperative marketing programs, joint customer seminars, lead referrals, or joint development projects. Although certain aspects of some of these relationships are contractual in nature, many important aspects of these relationships depend on the continued cooperation of each party with us. Merger activity, such as the acquisitions of Catapulse Inc. and Attol Testware, may disrupt these relationships or activities, and some companies may reassess the value of their relationship with us as a result of such merger activity. Divergence in strategy or change in focus or competitive product offerings by any of these companies may interfere with our ability to develop, market, sell, or support our products, which in turn could harm our business. In addition, one or more of these companies may use the information they gain from their relationship with us to develop or market competing products. Our products could contain software defects that could reduce our revenues and make it more difficult for us to achieve market acceptance of our products. Complex software products such as ours often contain undetected errors, or "bugs," or performance problems. These defects are most frequently found during the period immediately following the introduction of new products or enhancements to existing products. Despite extensive product testing prior to introduction, our 16 products have in the past contained software errors that were discovered after commercial introduction. Errors or performance problems may also be discovered in the future. Any future software defects discovered after shipment of our products could result in loss of revenues or delays in market acceptance, which could harm our business. Further, because we rely on our own products in connection with the development of our software, these errors may make it more difficult to sell our products in the future. If we fail to adequately protect our intellectual property rights, competitors may use our technology and trademarks, which could weaken our competitive position, reduce our revenues, and increase our costs. We rely on a combination of copyright, trademark, patent, and trade-secret laws, employee and third-party nondisclosure agreements, and other arrangements to protect our proprietary rights. Despite these precautions, it may be possible for unauthorized third parties to copy our products or obtain and use information that we regard as proprietary to create products that compete against ours. In addition, some license provisions protecting against unauthorized use, copying, transfer, and disclosure of our licensed programs may be unenforceable under the laws of certain jurisdictions and foreign countries. In addition, the laws of some countries do not protect proprietary rights to the same extent as do the laws of the United States. To the extent that we increase our international activities, our exposure to unauthorized copying and use of our products and proprietary information will increase. The scope of United States patent protection in the software industry is not well defined and will evolve as the United States Patent and Trademark Office grants additional patents. Because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed that would relate to our products. We rely on software licensed from third parties that is used in our products. We also rely on some software that we license from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. These third-party software licenses may not be available to us on commercially reasonable terms or at all. Further, the software may not be appropriately supported, maintained, or enhanced by the licensors. The loss of licenses to or the inability to support, maintain, and enhance any of this software could result in increased costs or in delays or reductions in our product shipments until equivalent software could be developed, identified, licensed, and integrated. Third parties could assert that our software products and services infringe on their intellectual property rights, which could expose us to increased costs and litigation. We expect that we will be increasingly subject to infringement claims as the number of products and competitors grows and the functionality of products in different industry segments overlaps. Third parties may assert infringement claims against us in the future and their claims may or may not be successful. We could incur substantial costs in defending ourselves and our customers against their claims. Parties making their claims may be able to obtain injunctive or other equitable relief that could effectively block our ability to sell our products in the United States and abroad and could result in an award of substantial damages against us. In the event of a claim of infringement, we may be required to obtain one or more licenses from third parties. We cannot be sure that we can obtain necessary licenses from third parties at a reasonable cost, or at all. Defense of any lawsuit or failure to obtain any required license could delay shipment of our products and increase our costs. Promotional product versions may adversely impact our actual product sales. Our marketing strategy relies in part on making elements of our technology available for no charge or at a very low price, either directly or by incorporating these elements into products offered by third parties, such as Microsoft, with whom we have strategic alliances. This strategy is designed to expose our products to a broader customer base than to our historical customer base and to encourage potential customers to purchase an upgrade 17 or other higher-priced products from us. We may not be able to introduce enhancements to our full-price products or versions of our products with intermediate functionality at a rate necessary to adequately differentiate them from the promotional versions, particularly in cases where our partners are distributing versions of our products with other desirable features, which could reduce sales of our products. If we cannot successfully integrate our past and future acquisitions and achieve intended financial or strategic benefits, our revenues may decline and our expenses may increase. We have acquired a number of businesses, technologies, and products, most recently in March 2001. If we fail to achieve the intended financial or strategic benefits of past and future acquisitions, including the acquisitions of Attol Testware and Catapulse Inc., our operating results will suffer. Acquisitions entail numerous risks, including: . difficulty with the assimilation of acquired operations and products; . failure to achieve targeted synergies; . inability to retain key employees of the acquired companies; . loss of key business relationships of the acquired company; and . diversion of the attention of our management team. In addition, if we undertake future acquisitions, we may issue dilutive securities, assume or incur additional debt obligations, incur large, one-time expenses, or acquire intangible assets that would result in significant future amortization expense. Any of these events could harm our business. Business interruptions could adversely affect our business. Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. Our facilities in the State of California are currently subject to electrical blackouts as a consequence of a shortage of available electrical power. In the event these blackouts continue or increase in severity, they could disrupt the operations of our affected facilities. ITEM 2--PROPERTIES Our headquarters are located in a leased facility, in Cupertino, California, consisting of approximately 218,000 square feet of office space occupied under leases expiring from 2006 to 2010. We also lease approximately 266,000 square feet of office space in Lexington, Massachusetts, under multiple leases expiring in 2004 and 2005. We have large leased facilities for field sales and software development offices in Redmond, Washington; Boulder, Colorado; and Ottawa, Canada. We have additional leased field sales and software development offices in the Americas, Europe, and Asia/Pacific regions. We believe that our existing facilities are adequate to meet current requirements, and that additional space will be available as needed to accommodate any future expansion of the corporate locations and for any sales and software development offices. ITEM 3--LEGAL PROCEEDINGS We are not a party to any material legal proceedings. From time to time, we are subject to legal claims. Historically, the cost of resolution of the claims has not been significant. However, any adverse outcome to future lawsuits against us may result in a material adverse effect on our financial condition. 18 ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On February 5, 2001, we held a special meeting of stockholders. The following item was submitted to a vote of the stockholders: To approve the issuance of Rational Software Corporation Common Stock pursuant to a merger agreement in which Catapulse Inc. will merge with and into Rational and as a result of which, Catapulse stockholders will become stockholders of Rational.
Votes ----------- For.......................................................... 134,031,737 Against...................................................... 300,622 Abstain...................................................... 385,369 Broker Non-Vote.............................................. 0
This proposal was approved. 19 PART II ITEM 5--MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our Common Stock is traded on the Nasdaq National Market under the symbol RATL. As of May 31, 2001, there were approximately 1,383 stockholders of record of our Common Stock. We have not, since our formation, declared or paid any cash dividends on our Common Stock. We intend to employ all available funds for the development and operation of our business and, accordingly, do not intend to declare or pay any cash dividends in the foreseeable future. The following table sets forth the range of high and low bids for our Common Stock as quoted on the Nasdaq National Market for Rational Common Stock for the periods indicated, as adjusted for a two-for-one stock split in September 2000:
High Low ------ ------ Fiscal Year Ended March 31, 2001: Fourth Quarter................................................ $55.25 $17.25 Third Quarter................................................. 70.31 25.25 Second Quarter................................................ 70.63 42.63 First Quarter................................................. 49.31 27.00 Fiscal Year Ended March 31, 2000: Fourth Quarter................................................ $52.50 $21.16 Third Quarter................................................. 26.84 13.94 Second Quarter................................................ 20.00 13.19 First Quarter................................................. 18.75 10.94
The foregoing reflects interdealer prices without retail markup, markdown, or commissions and may not necessarily reflect actual transactions. 20 ITEM 6--SELECTED FINANCIAL DATA
Fiscal Year Ended March 31, ---------------------------------------------------- 2001 2000 1999 1998 1997 ---------- ---------- -------- -------- -------- (in thousands, except per share data) Consolidated Statements of Operations Data: Net product revenues.... $ 477,726 $ 354,497 $259,335 $184,953 $185,133 Consulting and support revenues............... 337,209 217,693 152,481 125,717 92,735 ---------- ---------- -------- -------- -------- Total revenues...... 814,935 572,190 411,816 310,670 277,868 ---------- ---------- -------- -------- -------- Cost of product revenues............... 32,817 27,297 22,020 19,709 11,777 Cost of consulting and support revenues....... 89,227 59,607 40,848 43,356 38,305 ---------- ---------- -------- -------- -------- Total cost of revenues........... 122,044 86,904 62,868 63,065 50,082 ---------- ---------- -------- -------- -------- Gross margin............ 692,891 485,286 348,948 247,605 227,786 ---------- ---------- -------- -------- -------- Operating expenses: Research and development.......... 183,509 102,565 71,869 61,560 47,239 Sales and marketing... 330,128 220,529 172,448 138,709 108,403 General and administrative....... 48,567 47,124 33,910 29,092 27,267 Amortization of goodwill and purchased intangibles.......... 22,370 3,120 -- -- -- Amortization of stock based compensation... 14,020 281 -- -- -- Charges for acquired in-process research and development...... 15,822 3,529 -- -- 56,798 Merger and integration costs................ -- -- (1,200) 63,759 42,456 ---------- ---------- -------- -------- -------- Total operating expenses........... 614,416 377,148 277,027 293,120 282,163 ---------- ---------- -------- -------- -------- Operating income (loss)................. 78,475 108,138 71,921 (45,515) (54,377) Other income, net....... 34,709 12,857 12,721 16,689 11,586 ---------- ---------- -------- -------- -------- Income (loss) from continuing operations before income taxes.... 113,184 120,995 84,642 (28,826) (42,791) Provision for income taxes.................. 56,363 36,765 25,393 9,447 6,820 Minority interest....... (15,323) (1,084) -- -- -- ---------- ---------- -------- -------- -------- Net income (loss)... $ 72,144 $ 85,314 $ 59,249 $(38,273) $(49,611) ========== ========== ======== ======== ======== Net income (loss) per common share: Basic................. $ 0.38 $ 0.49 $ 0.35 $ (0.22) $ (0.31) Diluted............... $ 0.35 $ 0.45 $ 0.32 $ (0.22) $ (0.31) Shares used in computing per share amounts: Basic................. 188,566 175,458 171,394 175,150 159,262 Diluted............... 206,211 191,274 183,698 175,150 159,262 Consolidated Balance Sheet Data: Cash, cash equivalents, and short-term investments............ $1,040,821 $ 906,311 $259,830 $289,470 $327,395 Working capital......... 925,974 831,858 228,366 228,397 282,974 Total assets............ 1,709,323 1,225,776 453,956 445,205 456,740 Long-term obligations... 583,494 501,668 3,696 6,492 3,192 Stockholders' equity.... 766,254 456,307 294,372 287,176 330,109
21 ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview General Our revenues are derived from product license fees and charges for services, including technical consulting, training, and customer support. In accordance with generally accepted accounting principles, our software license revenues are generally recognized when a customer purchase order has been received and accepted, the software product has been shipped, there are no uncertainties surrounding product acceptance, the fees are fixed or determinable, and collection is considered probable. For customer license agreements that meet these recognition criteria, the portion of the fees related to software licenses will generally be recognized in the current period, while the portion of the fees related to services is recognized as the services are performed. Revenues from consulting and training are recognized when earned. Our license agreements do not provide a right of return, and reserves are maintained for potential credit losses, of which there have been only immaterial amounts. International sales accounted for 41%, 41%, and 40% of our revenues in fiscal 2001, 2000, and 1999, respectively. We expect that international sales will continue to account for a significant portion of our revenues in future periods. In the fiscal year ended March 31, 2001, our revenues from product sales grew 35%, while revenues from consulting and support grew 55%, resulting in a net overall increase in revenues of 42%. There can be no assurance that this revenue mix or growth in revenues trend will continue in future periods. Although we have experienced increasing revenues in each of the past five fiscal years, our sales compensation structure has historically contributed to revenues for the first quarter of a fiscal year being lower than revenues for the fourth quarter of the prior fiscal year. There can be no assurance that we will continue to experience sequentially increasing revenues or that such seasonal fluctuations will not become more pronounced in the future. Acquisitions We completed a business combination with ObjecTime Limited in January 2000, which was accounted for under the purchase method of accounting. Additionally, we completed business combinations with Catapulse Inc. and Attol Testware in 2001, which were accounted for under the purchase method of accounting. See Note 3 of Notes to Consolidated Financial Statements for details of these combinations. 22 Results of Operations The following table sets forth the percentage of total revenues represented by certain line items from our consolidated statements of operations for the periods indicated:
Fiscal Year Ended March 31, ---------------- 2001 2000 1999 ---- ---- ---- Net product revenues...................................... 59% 62% 63% Consulting and support revenues........................... 41 38 37 --- --- --- Total revenues........................................ 100 100 100 --- --- --- Cost of product revenues.................................. 4 5 5 Cost of consulting and support revenues................... 11 10 10 --- --- --- Total cost of revenues................................ 15 15 15 --- --- --- Gross margin.............................................. 85 85 85 --- --- --- Operating expenses: Research and development................................ 23 18 18 Sales and marketing..................................... 41 38 42 General and administrative.............................. 5 8 8 Amortization of goodwill and purchased intangibles...... 3 1 -- Amortization of deferred stock based compensation....... 1 -- -- Charges for acquired in-process research and development............................................ 2 1 -- --- --- --- Total operating expenses.............................. 75 66 68 --- --- --- Income from continuing operations......................... 10 19 17 Other income, net......................................... 4 2 3 --- --- --- Income before provision for income taxes.................. 14 21 20 Provision for income taxes................................ 7 6 6 Minority interest......................................... (2) -- -- --- --- --- Net income............................................ 9% 15% 14% === === ===
Fiscal Years Ended March 31, 2001 and 2000 Revenues Total revenues increased 42% in fiscal 2001 compared with fiscal 2000. Net product revenues. Net product revenues increased $123.2 million or 35%, in fiscal 2001 compared with fiscal 2000. This increase was a result of continued strong customer acceptance of our existing products, including the Rational Suite family of products, products for requirements management, modeling, testing, change and configuration management, increased sales capacity, and increased sales activity with customers across the majority of our products. Consulting and support revenues. Consulting and support revenues increased $119.5 million, or 55%, in fiscal 2001 compared with fiscal 2000. This increase reflects increased revenues related to maintenance contracts, growing demand for our consulting expertise in advanced software development practices and continued strong sales and renewals for customer support. International sales. During fiscal 2001 and 2000, international revenues from product sales and related consulting and customer support were $335.0 million and $233.0 million, respectively, representing 41% of total revenues in both fiscal 2001 and 2000. The 44% growth in international sales during fiscal 2001 was due 23 principally to increase sales and marketing activities in international markets from all regions. Revenues from Europe increased $53.8 million, or 32%, in fiscal 2001, while revenues from the Asia/Pacific and other international regions increased $48.1 million, or 73%. Our international sales are principally priced in local currencies. We enter into short-term forward currency contracts to hedge against the impact of foreign currency exchange rate fluctuations on balance sheet exposures denominated in currencies other than the local, or "functional," currency of our subsidiaries or us. The total amount of these contracts is approximately offset by the underlying assets and liabilities denominated in nonfunctional currencies and such contracts are carried at fair market value. The associated gains and losses were not material to our results of operations in any period presented. Cost of Revenues Cost of product revenues. Cost of product revenues consists principally of materials, packaging and freight, amortization of purchased technology, and royalties. Cost of product revenues increased 20% in fiscal 2001 compared with fiscal 2000. These costs represented 7% and 8% of net product revenues in fiscal 2001 and 2000, respectively. In fiscal 2001, the decrease in cost of product revenues as a percentage of product sales was primarily a result of increased efficiencies achieved in the current year by outsourcing fulfillment activities and a reduction of printing costs for materials currently being delivered electronically. Cost of consulting and support revenues. Cost of consulting and support revenues consists principally of personnel costs for training, consulting, and customer support. Cost of consulting and support revenues increased 50% in fiscal 2001 compared with fiscal 2000. These costs represented 26% and 27% of consulting and support revenues in fiscal 2001 and 2000, respectively. In fiscal 2001, the increase in cost was primarily a result of increased personnel costs necessary to support the growing demand for consulting, support and education and correlates to the increase in consulting and support revenues. The increase is in line with our increase in consulting and support revenues in fiscal 2001. Operating Expenses Research and development. Total expenditures for research and development (R&D) increased 79% in fiscal 2001 compared with fiscal 2000. Research and development costs represented 23% and 18% of total revenues in fiscal 2001 and 2000, respectively. The increase in fiscal 2001 over fiscal 2000 was due to the cost of additional personnel and related costs incurred in maintaining existing products and developing new product releases. Additionally, the increase was attributable to additional costs incurred by Catapulse Inc. (Catapulse). The costs incurred by Catapulse increased to $31.9 million in fiscal 2001 from $3.9 million in fiscal 2000. We did not capitalize any software development costs for our software to be sold or marketed in fiscal 2001 and 2000 because eligible costs were not material. We expect the amount of software development costs capitalized in future periods will be immaterial to our results of operations and financial position because the time period and the engineering effort required between demonstration of a product's economic and technological feasibility and the date of product release has been very short. Sales and marketing. Sales and marketing expenses increased 50% in fiscal 2001 compared with fiscal 2000. These expenses represented 41% and 38% of total revenues in fiscal 2001 and 2000, respectively. The fiscal 2001 increase in sales and marketing expenses reflected the additional personnel, commissions, and related costs required in sales and marketing departments to expand our sales channels, penetrate new markets, and increase our market share in core markets and sales and marketing costs incurred by Catapulse. General and administrative. General and administrative expenses increased 3% in fiscal 2001 compared with fiscal 2000. General and administrative expenses represented 5% and 8% of total revenues in fiscal 2001 and 2000, respectively. The fiscal 2001 increase in general and administrative expenses resulted from increased employee-related expenses associated with staffing requirements needed to support our expanding business. 24 Amortization of goodwill, purchased intangibles, and deferred stock based compensation. In fiscal 2001, we acquired Attol Testware, the remaining outstanding shares of Catapulse not already owned by Rational, and certain other intellectual property and intangible assets, which were accounted for under the purchase method of accounting. Accordingly, we recorded goodwill and purchased intangibles representing the excess of the purchase price paid over the fair value of the net assets acquired. In fiscal 2000, we acquired ObjecTime Limited, which was also accounted for under the purchase method of accounting. The goodwill and purchased intangibles are being amortized over their expected useful lives, which were determined to be from one to four years. The aggregate amortization of goodwill and purchased intangibles was $22.4 million and $3.1 million in fiscal 2001 and 2000, respectively. Also as part of the acquisitions of Attol Testware and the remaining outstanding shares of Catapulse in fiscal 2001, we recorded $295.0 million of deferred compensation relating to the unvested stock options and restricted stock assumed in the acquisitions. The amortization of deferred stock based compensation was approximately $14.0 million during fiscal 2001. In fiscal 2000, in connection with the grant of certain stock options to employees of Catapulse, the results of which were consolidated with Rational's results, we recorded deferred compensation of $3.0 million representing the difference between the deemed value of the Common Stock for accounting purposes and the exercise price of these options at the date of grant. The amortization of deferred stock based compensation in fiscal 2000 was approximately $0.3 million. Charges for acquired in-process research and development. In connection with the acquisitions of Attol Testware and the remaining outstanding shares of Catapulse, we recorded charges for acquired in-process research and development (IPR&D) in the amount of $1.7 million and $14.2 million, respectively, in fiscal 2001. In connection with the acquisition of ObjecTime Limited, we recorded $3.5 million of IPR&D in fiscal 2000. See Note 3 of Notes to Consolidated Financial Statements. . Purchase of the remaining outstanding shares of Catapulse not already owned by Rational In connection with the acquisition of the remaining outstanding shares of Catapulse not already owned by Rational in fiscal 2001, we allocated $14.2 million of the total purchase price of $445.2 million to IPR&D projects. This allocation represented the estimated fair value based on discounted cash flows related to research and development projects. At the date of acquisition, the development of these projects had not reached technological feasibility. Accordingly, these costs were expensed as of the acquisition date. Management is primarily responsible for estimating the fair value of IPR&D, which they also determined with the assistance of an independent appraiser. At the acquisition date, Catapulse was developing a hosted development service to be delivered to users over the Internet. The hosted development service or HDS, includes a set of hosted development tools, Web based collaboration services, a complete infrastructure for the development and reuse of intellectual property and a secure development platform. The technologies under development were approximately 35% complete. We allocated values to IPR&D based on the stage of development of each product and service offering, the time and resources needed to complete each product and service offering, and the expected income and associated risks. The value assigned to acquired IPR&D was determined by estimating the costs to develop the purchased IPR&D into commercially viable products and service offering, estimating the resulting net cash flows from the products and service offering, and discounting the net cash flows to their present value. The revenue projection used to value the IPR&D was based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product and service introductions by Catapulse and its competitors. The resulting net cash flows from such product and service offering are based on management's estimates of cost of sales, operating expenses, and income taxes from such product and service offering. Aggregate revenues for the developmental Catapulse product and service offering were estimated to grow based on forecasted sales for the three years following introduction, assuming the successful completion and 25 market acceptance of the major R&D programs. The estimated revenues for the in-process projects were expected to peak within three years of acquisition and then decline as other new products and technologies are expected to enter the market. The rate utilized to discount the net cash flows to their present value was based on an estimated cost of capital calculation. Due to the nature of the forecast and the risks associated with the projected growth and profitability of the developmental projects, a discount rate of 25% was considered appropriate for the IPR&D. This discount rate was commensurate with Catapulse's stage of development and the uncertainties in the economic estimates described above. The estimates used by us in valuing IPR&D were based upon assumptions we believe to be reasonable but which are inherently uncertain and unpredictable. Our assumptions may be incomplete or inaccurate, and no assurance can be given that unanticipated events and circumstances will not occur. Accordingly, actual results may vary from the projected results. Any such variance may result in a material adverse effect on our financial condition and results of operations. . Purchase of Attol Testware In connection with the acquisition of Attol Testware in fiscal 2001, we allocated $1.7 million of the total purchase price of $30.3 million to IPR&D projects. This allocation represented the estimated fair value based on discounted cash flows related to incomplete research and development projects. At the date of acquisition, the development of these projects had not reached technological feasibility. Accordingly, these costs were expensed as of the acquisition date. Management is primarily responsible for estimating the fair value of IPR&D, which they also determined with the assistance of an independent appraiser. At the acquisition date, Attol Testware developed and marketed test software for the automated testing of software developed for critical systems in the embedded and distributed software markets. The projects under development at the valuation date represented next-generation technologies of Attol Testing Suite, which will include significant functionality increases and continue assurance of compatibility with Rational products. The technologies under development were approximately 30% complete. We allocated values to IPR&D based on the stage of development of each product, the time and resources needed to complete each product, and the expected income and associated risks. The value assigned to acquired IPR&D was determined by estimating the costs to develop the purchased IPR&D into commercially viable products, estimating the resulting net cash flows from the products, and discounting the net cash flows to their present value. The revenue projection used to value the IPR&D was based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by Attol Testware and its competitors. The resulting net cash flows from such products are based on management's estimates of cost of sales, operating expenses, and income taxes from such products. Aggregate revenues for the developmental Attol Testware products were estimated to grow based on forecasted sales for the three years following introduction, assuming the successful completion and market acceptance of the major R&D programs. The estimated revenues for the in-process projects were expected to peak within three years of acquisition and then decline as other new products and technologies are expected to enter the market. The rate utilized to discount the net cash flows to their present value was based on an estimated cost of capital calculation. Due to the nature of the forecast and the risks associated with the projected growth and profitability of the developmental projects, a discount rate of 25% was considered appropriate for the IPR&D. This discount rate was commensurate with Attol Testware's stage of development and the uncertainties in the economic estimates described above. The estimates used by us in valuing IPR&D were based upon assumptions we believe to be reasonable but which are inherently uncertain and unpredictable. Our assumptions may be incomplete or inaccurate, and no 26 assurance can be given that unanticipated events and circumstances will not occur. Accordingly, actual results may vary from the projected results. Any such variance may result in a material adverse effect on our financial condition and results of operations. . Purchase of ObjecTime Limited In connection with the acquisition of ObjecTime Limited in fiscal 2000, we allocated $3.5 million of the total purchase price of $58.8 million to IPR&D projects. This allocation represented the estimated fair value based on discounted cash flows related to incomplete research and development projects. At the date of acquisition, the development of these projects had not reached technological feasibility. Accordingly, these costs were expensed as of the acquisition date. Management is primarily responsible for estimating the fair value of IPR&D, which they also determined with the assistance of an independent appraiser. At the acquisition date, ObjecTime Limited was a developer of visual design and code generation software tools used for development of embedded software. The projects under development at the valuation date represented next- generation products of ObjecTime Limited, which will include making the next releases compatible with Rational products. The technologies under development were on average approximately 60% complete. We allocated values to IPR&D based on the stage of development of each product, the time and resources needed to complete each product, and the expected income and associated risks. The value assigned to acquired IPR&D was determined by estimating the costs to develop the purchased IPR&D into commercially viable products, estimating the resulting net cash flows from the products and discounting the net cash flows to their present value. The revenue projection used to value the IPR&D was based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by ObjecTime Limited and its competitors. The resulting net cash flows from such products are based on management's estimates of cost of sales, operating expenses, and income taxes from such products. Aggregate revenues for the developmental ObjecTime Limited products were estimated to grow based on forecasted sales for the three years following introduction, assuming the successful completion and market acceptance of the major R&D programs. The estimated revenues for the in-process projects were expected to peak within three years of acquisition and then decline as other new products and technologies are expected to enter the market. The rate utilized to discount the net cash flows to their present value was based on an estimated cost of capital calculation. Due to the nature of the forecast and the risks associated with the projected growth and profitability of the developmental projects, a discount rate of 25% was considered appropriate for the IPR&D. This discount rate was commensurate with ObjecTime's stage of development and the uncertainties in the economic estimates described above. The estimates used by us in valuing IPR&D were based upon assumptions we believe to be reasonable but which are inherently uncertain and unpredictable. Our assumptions may be incomplete or inaccurate, and no assurance can be given that unanticipated events and circumstances will not occur. Accordingly, actual results may vary from the projected results. Any such variance may result in a material adverse effect on our financial condition and results of operations. Minority Interest On February 5, 2001, we completed the acquisition of the remaining outstanding shares of Catapulse not already owned by Rational. Catapulse was an entity already consolidated into Rational due to the significant influence Rational exercised over Catapulse prior to February 5, 2001. In fiscal 2001 and 2000, Catapulse incurred $46.1 million and $4.2 million, respectively, of operating expenses and earned $2.9 million and $1.2 million, respectively, of interest income on cash balances. Minority interest, net of tax, for fiscal 2001 and 2000 was approximately $15.3 million and $1.1 million, respectively. 27 Interest Expense Interest expense increased $21.1 million in fiscal 2001 compared with fiscal 2000. The increase in interest expense in fiscal 2001 was primarily a result of the Convertible Subordinated Notes, which we sold and on which we began incurring interest expense for the last quarter of fiscal 2000. The total interest expense related to Convertible Subordinated Notes was approximately $25.0 million and $4.0 million, respectively, in fiscal 2001 and 2000. Interest Income Interest income has fluctuated as a result of operating results and the amount of cash available for investment in interest-bearing accounts. Interest income increased $43.0 million to $59.9 million in fiscal 2001. The increase in interest income in fiscal 2001 was due primarily to an increase in cash and cash equivalents as a result of annual operating income, the cash received in connection with the $500.0 million Convertible Subordinated Notes offering in the last quarter of fiscal 2000, and interest earned by Catapulse, offset by a reduction of cash used for repurchase of Company stock. Income Taxes The income tax provisions for fiscal 2001 and 2000 differ from tax computed at the federal statutory income tax rate due to the impact of nondeductible charges for acquired in-process research and development, goodwill, merger- related costs, and foreign losses resulting in no U.S. tax benefit, as well as foreign and state income taxes, offset by earnings permanently reinvested in offshore operations, the realized benefit of net operating loss carryforwards, and research credit carryforwards. Net cumulative undistributed earnings of the foreign subsidiaries considered permanently reinvested amounted to approximately $70.0 million at March 31, 2001. Accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. As of March 31, 2001, we had net operating loss carryforwards for federal income tax purposes of approximately $74.0 million that expire in years 2002 through 2021. We also had tax credit carryforwards for federal and state purposes of approximately $15.0 million and $5.0 million, respectively, that expire in years 2002 through 2021, if not utilized. As a result of various public offerings and business combinations, some of our acquired entities experienced an ownership change as defined in Section 382 of the Internal Revenue Code. Due to the passing of time, our net operating loss carryforwards and tax credit carryforwards are no longer subject to limitation. Under Statement of Financial Accounting Standards (SFAS) No. 109, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. SFAS 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based on the weight of available evidence, we have provided a valuation allowance against the future amortization of certain intangible assets. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. Fiscal Years Ended March 31, 2000 and 1999 Revenues Total revenues increased 39% in fiscal 2000 compared with fiscal 1999. Net product revenues. Net product revenues increased $95.2 million, or 37%, in fiscal 2000 compared with fiscal 1999. This increase was a result of strong customer acceptance of the Rational Suite family of products, 28 continued strong customer acceptance of our existing products, including products for requirements management, modeling, testing, change, and configuration management, increased sales capacity, and increased sales activity with Internet-related customers across the majority of our products. Consulting and support revenues. Consulting and support revenues increased $65.2 million, or 43%, in fiscal 2000 compared with fiscal 1999. This increase reflected increased revenues related to maintenance contracts, higher demand for our consulting expertise in advanced software development practices, and, to a lesser extent, increased training and customer-support revenues. International sales. During fiscal 2000 and 1999, international revenues from product sales and related consulting and customer support were $233.0 million and $165.2 million, representing 41% and 40% of total revenues, respectively. The 41% growth in international sales during 2000 was due principally to increased sales and marketing activities in international markets. Our international sales were principally priced in local currencies. We entered into short-term forward currency contracts to hedge against the impact of foreign currency exchange rate fluctuations on balance sheet exposures denominated in currencies other than the local, or "functional," currency of our subsidiaries or us. The total amount of these contracts was approximately offset by the underlying assets and liabilities denominated in nonfunctional currencies, and such contracts were carried at fair market value. The associated gains and losses were not material to our results of operations in any period presented. Cost of Revenues Cost of product revenues. Cost of product revenues consists principally of materials, packaging and freight, amortization of purchased technology, and royalties. Cost of product revenues increased 24% in fiscal 2000 compared with fiscal 1999. These costs represented 8% of net product revenues in both fiscal 2000 and 1999. In fiscal 2000, the cost of product revenues remained relatively fixed as a percentage of product sales as a result of improved economies of scale associated with materials and packaging costs offset by an increase in royalty expense. Cost of consulting and support revenues. Cost of consulting and support revenues consists principally of personnel costs for training, consulting, and customer support. Cost of consulting and support revenues increased 46% in fiscal 2000 compared with fiscal 1999. These costs represented 27% of consulting and support revenues in both fiscal 2000 and 1999. In fiscal 2000, the increase in cost was primarily due to increased headcount commensurate to the demand of growing support activities. Operating Expenses Research and development. Total expenditures for research and development increased 43% in fiscal 2000 compared with fiscal 1999. Research and development costs represented 18% of total revenues in both fiscal 2000 and 1999. The increase in fiscal 2000 as compared with fiscal 1999 was due primarily to the cost of additional personnel and related costs incurred in maintaining existing products and developing new product releases. Additionally, the fiscal 2000 costs included $3.9 million of costs incurred by Catapulse, the Internet venture in which Rational invested $50.0 million in December 1999. We did not capitalize any software development costs in 2000 and 1999 because eligible costs were not material. We expect that the amount of software development costs capitalized in future periods will be immaterial to our results of operations and financial position because the time period and the engineering effort required between demonstration of a product's economic and technological feasibility and the date of product release have been very short. Sales and marketing. Sales and marketing expenses increased 28% in fiscal 2000 compared with fiscal 1999. These expenses represented 38% and 42% of total revenues in fiscal 2000 and 1999, respectively. The fiscal 2000 increase in sales and marketing expenses reflected the additional personnel, commissions, and related 29 costs required in sales and marketing departments to expand our sales channels, penetrate new markets, and increase our market share in core markets. The fiscal 2000 decrease in sales and marketing expenses as a percentage of total revenues reflected improved economies of scale. General and administrative. General and administrative expenses increased 39% in fiscal 2000 compared with fiscal 1999. General and administrative expenses represented 8% of total revenues in both fiscal 2000 and 1999. The fiscal 2000 increase in general and administrative expenses resulted from increased employee-related expenses associated with staffing requirements needed to support our expanding business. Amortization of goodwill, purchased intangibles, and deferred stock compensation. In fiscal 2000, we acquired ObjecTime Limited, which was accounted for under the purchase method of accounting. The goodwill and other intangibles are being amortized of their respective useful lives, which were determined to be from one to four years. The aggregate amortization of goodwill and purchased intangibles was $3.1 million in fiscal 2000. In connection with the grant of certain stock options to employees of Catapulse, a consolidated subsidiary of Rational during fiscal 2000, we recorded deferred compensation of $3.0 million in fiscal 2000, representing the difference between the deemed value of the Common Stock for accounting purposes and the exercise price of these options at the date of grant. The amortization of deferred stock based compensation associated with Catapulse was approximately $0.3 million in fiscal 2000. Charges for acquired IPR&D. In connection with the acquisition of ObjecTime Limited in fiscal 2000, we allocated $3.5 million of the purchase price to IPR&D projects. This allocation represented the estimated fair value based on discounted cash flows related to incomplete research and development projects. At the date of acquisition, the development of these projects had not reached technological feasibility. Accordingly, these costs were expensed as of the acquisition date. Management is primarily responsible for estimating the fair value of acquired IPR&D, which they also determined with the assistance of an independent appraiser. See Note 3 of Notes to Consolidated Financial Statements. At the acquisition date, ObjecTime Limited was a developer of visual design and code generation software tools used for development of embedded software. The projects under development at the valuation date represented next- generation products of ObjecTime Limited, which will include making the next releases compatible with Rational products. The technologies under development were on average approximately 60% complete. We allocated values to IPR&D based on the stage of development of each product, the time and resources needed to complete each product, and the expected income and associated risks. The value assigned to acquired IPR&D was determined by estimating the costs to develop the purchased IPR&D into commercially viable products, estimating the resulting net cash flows from the products, and discounting the net cash flows to their present value. The revenue projection used to value the IPR&D was based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by ObjecTime Limited and its competitors. The resulting net cash flows from such products are based on management's estimates of cost of sales, operating expenses, and income taxes from such products. Aggregate revenues for the developmental ObjecTime Limited products were estimated to grow based on forecasted sales for the three years following introduction, assuming the successful completion and market acceptance of the major R&D programs. The estimated revenues for the in-process projects were expected to peak within three years of acquisition and then decline as other new products and technologies are expected to enter the market. The rate utilized to discount the net cash flows to their present value was based on an estimated cost of capital calculation. Due to the nature of the forecast and the risks associated with the projected growth and profitability of the developmental projects, a discount rate of 25% was considered appropriate for the IPR&D. This discount rate was commensurate with ObjecTime's stage of development and the uncertainties in the economic estimates described above. 30 The estimates used by us in valuing IPR&D were based upon assumptions we believe to be reasonable but which are inherently uncertain and unpredictable. Our assumptions may be incomplete or inaccurate, and no assurance can be given that unanticipated events and circumstances will not occur. Accordingly, actual results may vary from the projected results. Any such variance may result in a material adverse effect on our financial condition and results of operations. Merger and integration costs. In fiscal 1999, we substantially completed certain elements of the organizational integration following the July 1997 Pure Atria merger. This consisted primarily of exiting certain non-strategic consulting activities, realignment of marketing activities, and consolidation of certain sales offices. In the December 1998 quarter, charges related to this activity, totaling approximately $3.3 million, were primarily for severance costs associated with employee terminations, and charges associated with facilities closures. These charges were offset by a reduction of previously accrued facilities expenses related to the Pure Atria merger totaling $4.5 million. The facilities expense reduction was due to greater- than-expected recoveries from subleasing. The net impact in fiscal 1999 was a merger and integration cost reduction of $1.2 million. The net cost reduction of $1.2 million is the result of ongoing assessment and estimation of costs associated with the prior combinations of Rational and other companies. Such assessment will continue until all related costs are incurred or determinable. Minority Interest In fiscal 2000, our subsidiary, Catapulse, incurred $4.2 million of operating expenses and earned $1.2 million of interest income on cash balances. Minority interest, net of tax, for fiscal 2000 was $1.1 million. Interest Expense Interest expense increased $4.1 million in fiscal 2000 compared with fiscal 1999. The increase in interest expense in fiscal 2000 was a result of the Convertible Subordinated Notes, which we sold and on which we began incurring interest expense for the last quarter of fiscal 2000. Interest expense incurred in fiscal 1999 related to interest on capital leases, which have since expired. Interest Income Interest income fluctuated as a result of operating results and the amount of cash available for investment in interest-bearing accounts. Interest income increased $4.2 million to $17.0 million in fiscal 2000. The increase in interest income in fiscal 2000 was due primarily to an increase in cash and cash equivalents as a result of annual operating income, the fourth quarter sale of Convertible Subordinated Notes and interest earned by Catapulse, offset by a reduction of cash used for repurchase of Company stock in the first half of the fiscal year, and an increase in tax exempt investments. Income Taxes The income tax provisions for fiscal 2000 and 1999 differ from tax computed at the federal statutory income tax rate due to the impact of nondeductible charges for acquired in-process research and development, goodwill, merger- related costs, and foreign losses resulting in no U.S. tax benefit, as well as foreign and state income taxes, offset by earnings permanently reinvested in offshore operations, the realized benefit of net operating loss carryforwards, and research credit carryforwards. Net undistributed earnings of the foreign subsidiaries considered permanently reinvested amounted to approximately $24.0 million at March 31, 2000. Accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. 31 As of March 31, 2000, we had net operating loss carryforwards for federal income tax purposes of approximately $83.0 million that expire in years 2001 through 2020. We also had tax credit carryforwards for federal and state purposes of approximately $7.5 million and $4.0 million, respectively, that expire in years 2001 through 2020, if not utilized. As a result of various public offerings and business combinations, some of our acquired entities experienced an ownership change as defined in Section 382 of the Internal Revenue Code. Due to the passing of time, our net operating loss carryforwards and tax credit carryforwards are no longer subject to limitation. Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. SFAS 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based on the weight of available evidence, we have provided a valuation allowance against certain foreign tax credit carryforwards and the future amortization of certain intangible assets. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. Liquidity and Capital Resources at March 31, 2001 As of March 31, 2001, we had cash, cash equivalents, and short-term investments of $1.0 billion and working capital of $926.0 million. Net cash provided by operating activities for the period ended March 31, 2001, was composed primarily of net income plus noncash charges for depreciation and amortization, charges for acquired IPR&D, compensation expenses related to stock options and tax benefits from employee stock plans, and increases in accounts payable, accrued employee benefits and accrued expenses, income taxes payable and deferred revenues. These were offset primarily by the change in minority interest in the loss of Catapulse Inc., increases in accounts receivable, prepaid expenses and other assets, and decreases in accrued merger and integration expenses and net deferred tax liability. Total cash, cash equivalents, and short-term investments for the period ended March 31, 2000, was $906.3 million and working capital was $831.9 million. Net cash provided by operating activities for the period ended March 31, 2000, was composed primarily of net income plus noncash charges for depreciation and amortization, charges for acquired IPR&D, noncash merger and integration costs, tax benefits from employee stock plans, increases in accrued employee benefits and accrued expenses, income taxes payable, and deferred revenues and a decrease in deferred tax assets. These were offset primarily by increases in accounts receivable, and prepaid expenses and a decrease in accounts payable. Net cash used in investing activities resulted primarily from net purchases and maturities and sales of short-term investments of $177.9 million in fiscal 2001, $293.2 million in fiscal 2000, and $36.6 million in fiscal 1999, and expenditures for fixed assets and net changes in other assets of $76.2 million in fiscal 2001, $44.2 million in fiscal 2000, and $23.2 million in fiscal 1999. Net cash used for business and product acquisitions totaled $11.5 million in fiscal 2001 and $13.2 million in fiscal 2000. See Notes 3 and 4 of Notes to Consolidated Financial Statements. Net cash provided by financing activities in fiscal 2001 resulted primarily from net proceeds from issuance of Common Stock under the employee stock plans of $44.5 million, reissuance of treasury stock under employee stock plans of $48.3 million, and proceeds received from minority investors in Catapulse of $1.6 million. This was offset by $54.2 million used to repurchase Common Stock. Net cash provided by financing activities in fiscal 2000 resulted primarily from net proceeds from the sale of Convertible Subordinated Notes of $484.6 million, issuance of Common Stock under the employee stock plans of $74.6 million, and proceeds received from minority investors in Catapulse of $25.6 million. This was offset by $61.4 million used to repurchase Common Stock. In fiscal 1999, net cash used in financing activities resulted primarily from $118.1 million used to repurchase Common Stock and $2.0 million used to decrease long-term debt, offset by $36.0 million received from issuance of Common Stock under the employee stock plans. In April 1998, the Board of Directors authorized the repurchase of up to 12.0 million shares of our Common Stock in the open market to be used for general corporate purposes. We completed that repurchase program 32 during the September 1998 quarter. In October 1998, the Board of Directors authorized the repurchase of an additional 12.0 million shares of our Common Stock in the open market to be used for general corporate purposes. Through March 31, 2001, we had repurchased a total of 20.2 million shares of our Common Stock, including repurchases authorized in April 1998 and October 1998, for a total cash outlay of approximately $233.7 million. In April 2001, the Broad of Directors authorized the purchase of an additional 20.0 million shares of our Common Stock from time to time in the open market. Repurchases help offset dilution from stock issued under our stock option and stock purchase plans. In fiscal 2000, we completed an offering of 5% Convertible Subordinated Notes (the Notes), which mature on February 1, 2007. The interest on the Notes is payable on February 1 and August 1 of each year, commencing August 1, 2000. The Notes are convertible into shares of our Common Stock at any time prior to the close of business on the maturity date, unless previously redeemed, at a conversion price of $35.72 per share, subject to anti-dilution adjustments. We believe that expected cash flow from operations combined with existing cash, cash equivalents, and short-term investments will be sufficient to meet our cash requirements for the next 12 months and the foreseeable future. ITEM 7(A)--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risk, including changes in interest rates and currency exchange rates. To manage the volatility relating to these exposures, we employ established policies and procedures to manage our exposure to fluctuations in interest rates and changes in known or forecasted currency exchange rates. Foreign Currency Risk A portion of our business is conducted in currencies other than the U.S. dollar. Changes in the value of major foreign currencies relative to the local or "functional" currency of our subsidiaries or us may adversely affect operating results. We enter into short-term forward foreign exchange contracts designed to mitigate the impact of foreign currency exchange rate fluctuations on balance sheet exposures denominated in currencies other than the "functional" currency. The total amount of these contracts is approximately offset by the underlying assets and liabilities denominated in nonfunctional currencies. Forward contracts are accounted for on a mark-to-market basis. Gains and losses on forward contracts are recognized in our Consolidated Statements of Operations when the related transactions being hedged are recognized or the contracts mature. Such contracts meet the criteria established in SFAS 52, "Foreign Currency Translation for Hedge Accounting Treatment." We are required to adopt SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" in fiscal 2002. Based on our current hedging activities and the effectiveness of our hedging programs experienced in fiscal 2001, the adoption of SFAS 133 is not expected to have a material impact on our financial position or results of operations. As we find it impractical to hedge all foreign currency exposures, we will continue to experience foreign currency gains and losses. We do not use derivative financial instruments for speculative trading purposes, nor do we hold or issue leveraged derivative financial instruments. At March 31, 2001 and 2000, we had outstanding forward exchange contracts, all having maturities of less than 90 days, to exchange various nonfunctional currencies for U.S. dollars or Euros in the aggregate contracted amounts (U.S. dollar equivalent) of $51.3 million and $47.1 million, respectively. The net gains and losses associated with all forward exchange contracts in fiscal 2001, 2000, and 1999 are not material to the our results of operations. Interest Rate Risk Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. All our short-term investments are classified as available-for-sale and are recorded at amounts that approximate fair value based on quoted market prices at March 31, 2001 and 2000. Realized gains and losses and declines in 33 value judged to be other than temporary on available-for-sale securities are included in interest income. The cost of securities sold is based on the specific identification method. Realized gains and losses on sales of available-for-sale securities were immaterial for the years ended March 31, 2001 and 2000. Unrealized gains on available-for-sale securities are included in accumulated other comprehensive loss, which is a separate component of stockholders' equity, and totaled approximately $3.6 million, net of tax, at March 31, 2001. There were no significant unrealized holding gains or losses on such securities at March 31, 2000. Our Convertible Subordinated Notes were issued at a fixed interest rate and with fixed conversion rates and therefore do not expose us to the risk of earnings or cash flow loss due to change in market interest rates. The table below presents notional amounts and related weighted-average interest rates by year of maturity for our investment portfolio and long-term debt obligations at March 31, 2001:
2001 2002 2003 2004 2005 Thereafter Total Fair Value -------- -------- ------- ------ ------- ---------- ---------- ---------- Cash equivalents Fixed rate............. $129,947 -- -- -- -- -- $ 129,947 $ 129,805 Average rate........... 5.11% -- -- -- -- -- 5.11% Variable rate.......... $200,428 -- -- -- -- -- $ 200,428 $ 200,428 Average rate........... 4.98% -- -- -- -- -- 4.98% Short-term investments Fixed rate............. $205,976 $319,208 $57,610 $6,032 -- -- $ 588,826 $ 594,873 Average rate........... 6.32% 6.24% 5.35% 5.31% -- -- 6.17% Auction rate preferred Fixed rate............. $ 82,231 -- -- -- -- -- $ 82,231 $ 82,231 Average rate........... 5.35% -- -- -- -- -- 5.35% -------- -------- ------- ------ ------- -------- ---------- ---------- Total investments Securities............. $618,582 $319,208 $57,610 $6,032 -- -- $1,001,432 $1,007,337 ======== ======== ======= ====== ======= ======== ========== ========== Average rate........... 5.50% 6.24% 5.35% 5.31% -- -- 5.71% ======== ======== ======= ====== ======= ======== ========== Long-term debt Fixed rate............. -- -- -- -- -- $500,000 $ 500,000 $ 416,900 ======== ======== ======= ====== ======= ======== ========== ========== Average rate........... -- -- -- -- -- 5.00% 5.00% ======== ======== ======= ====== ======= ======== ==========
34 ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders Rational Software Corporation We have audited the accompanying consolidated balance sheets of Rational Software Corporation as of March 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended March 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Rational Software Corporation at March 31, 2001 and 2000, and the consolidated results of its operations, and its cash flows for each of the three years in the period ended March 31, 2001, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young llp Palo Alto, California April 16, 2001 35 RATIONAL SOFTWARE CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)
March 31, ---------------------- 2001 2000 ---------- ---------- Assets Current assets: Cash and cash equivalents............................ $ 363,717 $ 413,230 Short-term investments............................... 677,104 493,081 Accounts receivable, net of allowance for doubtful accounts of $3,317 and $3,259 in 2001 and 2000, respectively........................................ 206,099 148,818 Deferred tax assets.................................. 16,727 9,384 Prepaid expenses and other assets.................... 21,902 10,671 ---------- ---------- Total current assets............................... 1,285,549 1,075,184 Property and equipment, net............................ 103,239 52,440 Goodwill and purchased intangibles, net................ 294,824 54,064 Other assets, net...................................... 25,711 44,088 ---------- ---------- Total assets....................................... $1,709,323 $1,225,776 ========== ========== Liabilities and stockholders' equity Current liabilities: Accounts payable..................................... $ 23,909 $ 8,496 Accrued employee benefits............................ 68,624 49,290 Income taxes payable................................. 30,788 24,323 Other accrued expenses............................... 49,753 33,257 Current portion of accrued merger and integration costs............................................... 19,970 5,147 Deferred revenues.................................... 166,531 122,813 ---------- ---------- Total current liabilities.......................... 359,575 243,326 Long-term deferred tax liabilities..................... 57,900 -- Convertible subordinated notes......................... 500,000 500,000 Long-term portion of accrued merger and integration costs................................................. 25,284 700 Other accrued liabilities.............................. 310 968 ---------- ---------- Total liabilities.................................. 943,069 744,994 ---------- ---------- Minority interest...................................... -- 24,475 ---------- ---------- Stockholders' equity: Common Stock, $0.01 par value, 500,000 shares authorized, 217,501 and 199,244 shares issued in 2001 and 2000, respectively......................... 2,175 1,992 Additional paid-in capital........................... 1,236,517 708,492 Receivable from stockholders......................... (645) -- Deferred stock compensation.......................... (272,256) (2,763) Treasury stock, 15,541 and 18,758 shares in 2001 and 2000, respectively.................................. (192,417) (180,851) Retained earnings (Accumulated deficit).............. 11,445 (60,699) Accumulated other comprehensive loss................. (18,565) (9,864) ---------- ---------- Total stockholders' equity......................... 766,254 456,307 ---------- ---------- Total liabilities and stockholders' equity......... $1,709,323 $1,225,776 ========== ==========
See Notes to Consolidated Financial Statements 36 RATIONAL SOFTWARE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
Year Ended March 31, ---------------------------- 2001 2000 1999 -------- -------- -------- Net product revenues............................. $477,726 $354,497 $259,335 Consulting and support revenues.................. 337,209 217,693 152,481 -------- -------- -------- Total revenues................................. 814,935 572,190 411,816 -------- -------- -------- Cost of product revenues......................... 32,817 27,297 22,020 Cost of consulting and support revenues.......... 89,227 59,607 40,848 -------- -------- -------- Total cost of revenues......................... 122,044 86,904 62,868 -------- -------- -------- Gross margin..................................... 692,891 485,286 348,948 -------- -------- -------- Operating expenses: Research and development expenses.............. 183,509 102,565 71,869 Sales and marketing expenses................... 330,128 220,529 172,448 General and administrative expenses............ 48,567 47,124 33,910 Amortization of goodwill and purchased intangibles................................... 22,370 3,120 -- Amortization of deferred stock based compensation.................................. 14,020 281 -- Charges for acquired in-process research and development................................... 15,822 3,529 -- Merger and integration costs................... -- -- (1,200) -------- -------- -------- Total operating expenses..................... 614,416 377,148 277,027 -------- -------- -------- Operating income................................. 78,475 108,138 71,921 Interest expense................................. 25,235 4,132 37 Interest income.................................. 59,944 16,989 12,758 -------- -------- -------- Income before income taxes..................... 113,184 120,995 84,642 Provision for income taxes....................... 56,363 36,765 25,393 Minority interest................................ (15,323) (1,084) -- -------- -------- -------- Net income....................................... $ 72,144 $ 85,314 $ 59,249 ======== ======== ======== Net income per share--basic...................... $ 0.38 $ 0.49 $ 0.35 ======== ======== ======== Shares used in computing net income per share-- basic........................................... 188,566 175,458 171,394 ======== ======== ======== Net income per share--diluted.................... $ 0.35 $ 0.45 $ 0.32 ======== ======== ======== Shares used in computing net income per share-- diluted......................................... 206,211 191,274 183,698 ======== ======== ========
See Notes to Consolidated Financial Statements 37 RATIONAL SOFTWARE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
Retained Accumulated Common Stock Additional Receivable Deferred Earnings Other Total -------------- Paid-In From Stock Treasury (Accumulated Comprehensive Stockholders' Shares Amount Capital Stockholders Compensation Stock Deficit) Loss Equity ------- ------ ---------- ------------ ------------ --------- ------------ ------------- ------------- Balance at March 31, 1998........... 177,950 $1,780 $ 493,828 -- -- $ (1,340) $(205,262) $ (1,830) $ 287,176 Exercise of common stock options...... 7,106 69 27,710 -- -- -- -- -- 27,779 Issuance of common stock under Employee Stock Purchase Plans..... 1,706 17 8,250 -- -- -- -- -- 8,267 Tax benefit from employee stock plans.............. -- -- 32,021 -- -- -- -- -- 32,021 Treasury stock repurchases........ -- -- -- -- -- (118,148) -- -- (118,148) Comprehensive income: Cumulative translation adjustment........ -- -- -- -- -- -- -- (1,972) (1,972) Net income........ -- -- -- -- -- -- 59,249 -- 59,249 ------- ------ ---------- ----- --------- --------- --------- -------- --------- Total comprehensive income.......... Balance at March 31, 1999........... 186,762 $1,866 $ 561,809 -- -- $(119,488) $(146,013) $ (3,802) $ 294,372 Exercise of common stock options...... 10,488 105 64,527 -- -- -- -- -- 64,632 Issuance of common stock under Employee Stock Purchase Plans..... 1,252 13 9,923 -- -- -- -- -- 9,936 Tax benefit from employee stock plans.............. -- -- 36,825 -- -- -- -- -- 36,825 Compensation expense............ -- -- 484 -- -- -- -- -- 484 Deferred stock compensation....... -- -- 3,044 -- $ (3,044) -- -- -- -- Amortization of deferred stock compensation....... -- -- -- -- 281 -- -- -- 281 Issuance of common stock in conjunction with acquisition........ 742 8 31,880 -- -- -- -- -- 31,888 Treasury stock repurchases........ -- -- -- -- -- (61,363) -- -- (61,363) Comprehensive income: Cumulative translation adjustment........ -- -- -- -- -- -- -- (6,062) (6,062) Net income........ -- -- -- -- -- -- 85,314 -- 85,314 ------- ------ ---------- ----- --------- --------- --------- -------- --------- Total comprehensive income.......... Balance at March 31, 2000........... 199,244 $1,992 $ 708,492 -- $ (2,763) $(180,851) $ (60,699) $ (9,864) $ 456,307 Exercise of common stock options, net of repurchases..... 5,293 53 36,657 -- -- 42,640 -- -- 79,350 Issuance of common stock under Employee Stock Purchase Plans..... 1,007 11 13,403 -- -- -- -- -- 13,414 Tax benefit from employee stock plans.............. -- -- 85,857 -- -- -- -- -- 85,857 Amortization of deferred stock compensation....... -- -- -- -- 14,020 -- -- -- 14,020 Issuance of common stock in conjunction with acquisitions....... 11,957 119 392,108 $(645) (283,513) -- -- -- 108,069 Treasury stock repurchases........ -- -- -- -- -- (54,206) -- -- (54,206) Comprehensive income: Cumulative translation adjustment........ -- -- -- -- -- -- -- (12,277) (12,277) Unrealized gain on investments.... -- -- -- -- -- -- -- 3,576 3,576 Net income........ -- -- -- -- -- -- 72,144 -- 72,144 ------- ------ ---------- ----- --------- --------- --------- -------- --------- Total comprehensive income.......... Balance at March 31, 2001........... 217,501 $2,175 $1,236,517 $(645) $(272,256) $(192,417) $ 11,445 $(18,565) $ 766,254 ======= ====== ========== ===== ========= ========= ========= ======== ========= Comprehensive Income ------------- Balance at March 31, 1998........... Exercise of common stock options...... Issuance of common stock under Employee Stock Purchase Plans..... Tax benefit from employee stock plans.............. Treasury stock repurchases........ Comprehensive income: Cumulative translation adjustment........ $ (1,972) Net income........ 59,249 ------------- Total comprehensive income.......... $ 57,277 ============= Balance at March 31, 1999........... Exercise of common stock options...... Issuance of common stock under Employee Stock Purchase Plans..... Tax benefit from employee stock plans.............. Compensation expense............ Deferred stock compensation....... Amortization of deferred stock compensation....... Issuance of common stock in conjunction with acquisition........ Treasury stock repurchases........ Comprehensive income: Cumulative translation adjustment........ $ (6,062) Net income........ 85,314 ------------- Total comprehensive income.......... $ 79,252 ============= Balance at March 31, 2000........... Exercise of common stock options, net of repurchases..... Issuance of common stock under Employee Stock Purchase Plans..... Tax benefit from employee stock plans.............. Amortization of deferred stock compensation....... Issuance of common stock in conjunction with acquisitions....... Treasury stock repurchases........ Comprehensive income: Cumulative translation adjustment........ $(12,277) Unrealized gain on investments.... 3,576 Net income........ 72,144 ------------- Total comprehensive income.......... $ 63,443 ============= Balance at March 31, 2001...........
See Notes to Consolidated Financial Statements 38 RATIONAL SOFTWARE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Year Ended March 31, ------------------------------- 2001 2000 1999 --------- --------- --------- Operating activities: Net income.................................... $ 72,144 $ 85,314 $ 59,249 Adjustments to reconcile net income to net cash provided by operating activities: Charges for acquired in-process research and development................................ 15,822 3,529 -- Depreciation................................ 25,374 18,860 14,285 Amortization................................ 30,617 7,570 4,480 Compensation expense related to stock options.................................... 14,020 765 -- Tax benefit from employee stock plans....... 85,857 36,825 32,021 Noncash merger and integration costs........ -- 2,338 5,699 Minority interest in loss of Catapulse Inc........................................ (15,323) (1,084) -- Changes in operating assets and liabilities: Accounts receivable........................ (55,933) (54,806) (20,988) Prepaid expenses and other, net............ (11,050) (1,040) (1,937) Deferred tax............................... (44,274) 13,497 (11,035) Other assets............................... (9,182) -- -- Accounts payable........................... 14,470 (5,641) 586 Accrued employee benefits and other accrued expenses.................................. 34,831 31,209 1,418 Income taxes payable....................... 6,017 4,671 4,393 Accrued merger and integration expenses.... (18,965) 428 (32,106) Deferred revenues.......................... 43,718 44,164 23,516 --------- --------- --------- Net cash provided by operating activities..... 188,143 186,599 79,581 --------- --------- --------- Investing activities: Purchase of short-term investments............ (914,587) (524,642) (327,012) Maturities and sales of short-term investments.................................. 736,723 231,426 290,388 Purchases of property and equipment........... (76,173) (24,474) (21,742) Net changes in other investment assets........ -- (19,738) (1,454) Business combinations, net of cash acquired... (11,478) (13,208) -- --------- --------- --------- Net cash used in investing activities......... (265,515) (350,636) (59,820) --------- --------- --------- Financing activities: Principal payments under long-term debt and capital lease obligations.................... -- -- (1,951) Net proceeds from sale of Convertible Notes... -- 484,600 -- Net proceeds from issuance of Common Stock.... 44,512 74,568 36,046 Net proceeds from reissuance of treasury stock........................................ 48,252 -- -- Purchases of treasury stock................... (54,206) (61,363) (118,148) Proceeds from minority investors in Catapulse Inc.......................................... 1,578 25,559 -- --------- --------- --------- Net cash provided by (used in) financing activities................................... 40,136 523,364 (84,053) --------- --------- --------- Effect of changes in foreign currency exchange rate on cash................................. (12,277) (6,062) (1,972) --------- --------- --------- Net increase (decrease) in cash and cash equivalents.................................. (49,513) 353,265 (66,264) Cash and cash equivalents at beginning of year......................................... 413,230 59,965 126,229 --------- --------- --------- Cash and cash equivalents at end of year...... $ 363,717 $ 413,230 $ 59,965 ========= ========= ========= Supplemental disclosure of cash flow information: Cash paid for income taxes.................... $ 9,023 $ 4,077 $ 4,100 Cash paid for interest........................ 24,842 -- -- Noncash investing and financing activities: Unrealized gains on available-for-sale securities, net of taxes..................... $ 3,576 -- -- Deferred stock compensation................... 283,513 3,044 -- Common stock issued in connection with acquisitions................................. 391,582 31,888 --
See Notes to Consolidated Financial Statements 39 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 2001 1. Organization and Significant Accounting Policies Organization and basis of presentation. Rational Software Corporation (the Company) was incorporated under the laws of Delaware on July 28, 1982. The Company develops, markets, and supports a comprehensive solution for companies that depend on their ability to develop and deploy software. The Company provides an integrated suite of software products and services designed to improve the software development process. The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions and balances have been eliminated upon consolidation. Use of estimates. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Revenue recognition. The Company recognizes revenues in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, "Software Revenue Recognition," as amended. Revenues from software license agreements are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable, and collectibility is probable. The Company uses the residual method to recognize revenues when a license agreement includes one or more elements to be delivered at a future date and evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenues. If evidence of the fair value of one or more undelivered elements does not exist, revenues are deferred and recognized when delivery of those elements occurs or when fair value can be established. If the fee due from the customer is not fixed or determinable, revenues are recognized as cash is received from the customer, assuming all other revenue recognition criteria have been met. The Company considers all arrangements with payment terms longer than normal not to be fixed or determinable. Revenue arrangements with resellers are recognized when shipped to the end users. Services revenues include consulting services, post-contract customer support and training. Consulting revenues and the related cost of services are recognized on a time and materials basis; however, revenues from certain fixed-price contracts are recognized on the percentage of completion basis in accordance with AICPA SOP 81-1, "Accounting for Performance of Construction- Type and Certain Production-Type Contracts," which involves the use of estimates. Actual results could differ from those estimates and, as a result, future gross margin on such contracts may be more or less than anticipated. The amount of consulting contracts recognized on a percentage of completion basis has not been material to date. Software maintenance agreements provide technical support and the right to unspecified upgrades on an if-and-when available basis. Post-contract customer support revenues are recognized ratably over the term of the support period (generally one year) and training and other service revenues are recognized as the related services are provided. The unrecognized portion of amounts paid in advance for licenses and services is recorded as deferred revenues. Translation of local currencies. The Company's international subsidiaries operate primarily using local functional currencies. Accordingly, all assets and liabilities of these subsidiaries are translated using exchange rates in effect at the end of the period, and revenues and costs are translated using average exchange rates for the period. The resulting cumulative translation adjustments are presented as a separate component of stockholders' equity. Realized and unrealized exchange gains or losses from transaction adjustments are reflected in operations and have not been material. 40 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 Earnings per share. Calculation of earnings per share is as follows (in thousands, except per share amounts) and reflects a two-for-one stock split in September 2000:
Year Ended March 31, ----------------------- 2001 2000 1999 ------- ------- ------- Numerator: Net income.......................................... $72,144 $85,314 $59,249 ======= ======= ======= Denominator: Denominator for basic net income per share--weighted average shares (weighted average shares outstanding during the period, excluding weighted average shares subject to repurchase)...................... 188,566 175,458 171,394 Weighted average shares subject to repurchase....... 774 -- -- Incremental common shares attributable to shares issuable under employee stock plans (Treasury Stock Method)............................................ 16,871 15,816 12,304 ------- ------- ------- Denominator for diluted net income per share-- weighted average shares and assumed conversions.... 206,211 191,274 183,698 ======= ======= ======= Net income per share--basic......................... $ 0.38 $ 0.49 $ 0.35 ======= ======= ======= Net income per share--diluted....................... $ 0.35 $ 0.45 $ 0.32 ======= ======= =======
The effect of options to purchase 6,397,529 and 302,036 shares of Common Stock was not included in the computation of the 2001 and 2000 diluted earnings per share, respectively, because the options' exercise price was greater than the average market price of common shares. The effect of converting 13,997,760 shares of Common Stock from outstanding Convertible Notes issued in 2000 was not included in diluted earnings per share because the assumed conversion would be anti-dilutive. Cash, cash equivalents, and short-term investments. Cash equivalents are highly liquid investments with original maturity dates of three months or less at the date of acquisition. Investments with maturity dates of greater than three months are considered to be short-term investments. All of the Company's short-term investments are classified as available- for-sale and are recorded at amounts that approximate fair value based on quoted market prices at March 31, 2001 and 2000. Unrealized holding gains and losses on available-for-sale securities, net of tax, are recorded in stockholders' equity. Realized gains or losses and declines in value judged to be other than temporary on available-for-sale securities are included in interest income. The cost of securities sold is based on the specific identification method. Property and equipment. The Company's property and equipment is recorded at cost and is depreciated over its useful life, which is generally three to seven years, using the straight-line method. The cost of furniture and equipment under capital leases is recorded at the lower of the present value of the minimum lease payments or the fair value of the asset and is amortized over the shorter of the term of the related lease or the estimated useful life of the asset. Leasehold improvements are depreciated over the remaining life of the lease. Long Lived Assets. In accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," the Company is required to review for impairment long-lived assets, certain identifiable intangibles, and goodwill related to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. The Company identifies and records impairment losses, as circumstances dictate, on 41 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 long-lived assets used in operations when events and circumstances indicate that the assets are impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of these assets. Such events or circumstances include, but are not limited to, a significant decrease in the fair value of the underlying business, a significant change in the benefits realized from the acquired business, or a significant change in the operations of the acquired business. If assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. The Company's long-lived assets consist primarily of purchased intangibles, goodwill and property and equipment. Changes in the economy, the business in which the Company operates, and the Company's own relative performance could change the assumptions used to evaluate the recovery of goodwill and purchased intangibles. The Company monitors the preceding factors to identify events or circumstances, which would cause the Company to test for impairment and revise its assumptions on the estimated recovery of goodwill and purchased intangibles. In management's opinion, no material impairment loss exists at March 31, 2001. Goodwill and purchased intangibles. Goodwill represents the excess purchase price of net tangible and intangible assets acquired in business combinations over their estimated fair value. Purchased intangibles primarily represent developed and core technology, and assembled workforce. Goodwill and purchased intangibles are being amortized on a straight-line basis over their estimated useful lives, which range from one to four years. The Company reviews goodwill and purchased intangibles to assess recoverability from future operations using undiscounted cash flows. In management's opinion, no material impairment exists at March 31, 2001. Accumulated amortization of goodwill and other intangibles was $96.5 million and $65.8 million as of March 31, 2001 and 2000, respectively. Stock based compensation. The Company has elected to follow Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," and related interpretations in accounting for its employee stock options, because the alternative fair value accounting provided for under SFAS 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. The Company generally grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant, and accordingly, no compensation expense is recorded. The Company recognizes compensation expense for those options granted with an exercise price less than the fair value of the underlying Common Stock at the date of grant. Fair value of financial instruments. The carrying values reported in the balance sheet for cash and cash equivalents and short-term investments approximate fair value. The fair value of short-term investments and long-term debt is based on quoted market prices. As of March 31, 2001, the quoted market value for long-term debt was approximately $416.9 million. Advertising costs. The Company expenses advertising costs as incurred. Advertising costs totaled $19.3 million, $10.1 million, and $6.6 million for the years ended March 31, 2001, 2000, and 1999, respectively. 401(k) plan. The Company has a 401(k) Retirement Plan (the "Plan") that allows eligible employees to contribute up to 15% of their annual compensation to the Plan, subject to certain limitations. Starting July 1, 2000, the Company has matched employee contributions at a rate of 3% of salary, up to a maximum of $2,000. Employee contributions vest immediately, whereas the Company's matching contributions vest at a rate of 0% after the employee's first year of service, 50% after the second year of service and 100% after the third year of service. The Company recognized matching contribution expense of $2.5 million, $0, and $0 in fiscal 2001, 2000 and 1999, respectively. 42 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 Reclassifications. Certain prior-year amounts have been reclassified to conform to current-year presentation. Derivatives. The Company uses short-term forward foreign exchange contracts to hedge a portion, but not all, of its firm commitments denominated in foreign currencies. The terms of currency instruments used for hedging purposes are generally consistent with the timing of the committed transactions being hedged. The purpose of the Company's foreign currency management is to mitigate the impact of foreign currency exchange rate fluctuations on balance sheet exposures denominated in currencies other than the " functional" currency. The total amount of these contracts is approximately offset by the underlying assets and liabilities denominated in nonfunctional currencies. Forward contracts are accounted for on a mark-to- market basis and are included in prepaid expenses and other assets on the Company's Consolidated Balance Sheets. Gains and losses on forward exchange contracts are recognized in the Company's Consolidated Statements of Operations when the related transactions being hedged are recognized or the contracts mature. As the Company finds it impractical to hedge all foreign currency exposures, the Company will continue to experience foreign currency gains and losses. The Company does not use derivative financial instruments for speculative trading purposes, nor does it hold or issue leveraged derivative financial instruments. Recent pronouncements. In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in either current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. For fair value hedge transactions in which the Company is hedging changes in fair value of an asset, liability, or firm commitment, changes in the fair value of the derivative instrument will generally be offset in the income statement by changes in the fair value of the hedged item. For cash flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges will be recognized in current earnings. The Company will adopt SFAS 133 in fiscal 2002. Adoption of SFAS 133 is not expected to have a material impact on the Company's consolidated financial statements. In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44, (FIN 44), "Accounting for Certain Transactions Involving Stock Compensation--an Interpretation of APB 25." This Interpretation clarifies (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a non compensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. This Interpretation became effective July 1, 2000, but certain conclusions in this Interpretation cover specific events that occurred after either December 15, 1998 or January 12, 2000. To the extent that this Interpretation covers events occurring during the period after December 15, 1998 or January 12, 2000, but before the effective date of July 1, 2000, the effects of applying this Interpretation are recognized on a prospective basis from July 1, 2000. As a result of the Company's adoption of this guidance in July 2000, the Company recorded approximately $295.0 million of deferred stock-based compensation in conjunction with the acquisitions of Catapulse Inc. and Attol Testware, of which $14.0 million was expensed in the current year. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements," referred to as SAB 101. SAB 101 summarizes certain 43 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 of the SEC staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. In June 2000, the SEC issued SAB 101B, "Second Amendment: Revenue Recognition in Financial Statements," to defer the effective date of the implementation of SAB 101 until the fourth quarter of fiscal 2001. The adoption of SAB 101 did not have a significant impact on earnings or the financial position of the Company. On February 14, 2001, the Financial Accounting Standards Board (FASB) issued a limited revision of its September 7, 1999 Exposure Draft, "Business Combinations and Intangible Assets," that proposes to significantly change the accounting for goodwill acquired in a purchase business combination. Under the revised proposal, goodwill would not be amortized but would be reviewed for impairment, using a complex methodology different from the original proposal, when an event occurs indicating the potential for impairment. Goodwill impairment charges would be presented as a separate line item with the operating section of the income statements. The nonamortization approach would apply to previously recorded goodwill as well as goodwill arising from acquisitions completed after the application of the new standard. Amortization of the remaining book value of goodwill would cease and the new impairment- only approach would apply. FASB expects to release the final Statement in July 2001. 2. Risks Due to Concentrations Concentrations of credit risk. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments, and accounts receivable. The Company's investment policy limits its exposure to concentrations of credit risk for cash equivalents and short-term investments. The Company sells its products primarily to major corporations that develop software, and systems integrators that serve a wide variety of international markets. Collateral or deposits generally are not required from customers who demonstrate a positive credit record and sound financial condition. The Company maintains reserves for potential credit losses, and such losses have been within management's expectations. No single customer accounted for 10% or more of total revenues for all periods presented. International sales. International sales account for approximately 41%, 41% and 40% of the Company's revenues in fiscal 2001, 2000 and 1999, respectively, and the Company expects that international sales will continue to account for a significant portion of the Company's revenues in future periods. Any material adverse effect on the Company's international business would have a material adverse effect on the Company's financial statements. Also, the Company's international sales are generally denominated in foreign currencies. Losses on the conversion of foreign-denominated receivables into U.S. dollars may have a material adverse effect on the Company's financial statements. A portion of the Company's business is conducted in currencies other than the U.S. dollar. Changes in the value of major foreign currencies relative to the local, or "functional" currency of the Company or its subsidiaries may adversely affect operating results. The Company enters into short-term forward foreign exchange contracts designed to mitigate the impact of foreign currency exchange rate fluctuations on balance sheet exposures denominated in currencies other than the "functional" currency. The total amount of these contracts is approximately offset by the underlying assets and liabilities denominated in nonfunctional currencies. Forward contracts are accounted for on a mark-to-market basis. Gains and losses on forward contracts are recognized in the Company's Consolidated Statements of Operations when the related transactions being hedged are recognized or the contracts mature. Such contracts meet the criteria established in SFAS 52, "Foreign Currency Translation for Hedge Accounting Treatment." As the Company finds it impractical to hedge all foreign currency exposures, the Company will continue to experience foreign currency gains and losses. The Company does not use derivative financial instruments for speculative trading purposes, nor does it hold or issue leveraged derivative financial instruments. 44 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 At March 31, 2001 and 2000, the Company had outstanding forward exchange contracts, all having maturities of less than 90 days, to exchange various nonfunctional currencies for U.S. dollars or Euros in the aggregate contracted amounts (U.S. dollar equivalent) of $51.3 million and $47.1 million, respectively. Three major U.S. multinational banks are counterparty to all these contracts. The gains and losses associated with all forward exchange contracts when combined with the gains and losses on the underlying exposures hedged in fiscal 2001, 2000, and 1999 were not material to the Company's results of operations. 3. Acquisitions Purchase of Catapulse Inc. On February 5, 2001, the Company completed the acquisition of the remaining outstanding shares of Catapulse Inc. (Catapulse) not already owned by Rational. Catapulse was a development stage company, which was developing a hosted development service to be delivered to users over the Internet. Under the terms of the definitive agreement, Rational issued 0.0825 shares of Rational Common Stock for each outstanding share of Catapulse capital stock at the time the acquisition was consummated. In addition, each outstanding convertible security of Catapulse, including options and other rights to purchase Catapulse Common Stock was assumed by Rational in the acquisition of the remaining shares and became exercisable for a number of shares of Rational Common Stock based on the fixed exchange ratio. In connection with this acquisition of the remaining shares, the Company acquired all of the outstanding shares of capital stock of Catapulse not already owned by Rational in exchange for 11,444,956 shares of the Company's Common Stock. In addition, options of Catapulse were converted into options to purchase approximately 1,018,740 shares of the Company's Common Stock. In December 1999, Rational invested $50.0 million in Catapulse, and Rational's investment represented approximately 37% of the voting power of the outstanding capital stock of Catapulse. In addition, two of Rational's officers represented an approximate additional 29% of the voting power of the outstanding capital stock of Catapulse. Catapulse's Board of Directors comprised five directors, four of whom served on Rational's Board of Directors. Also, in July 2000, Catapulse entered into agreements with Rational whereby Rational would develop and license technology, under Rational's intellectual property rights, to Catapulse for the products and services, which were to be provided to Catapulse's customers on an exclusive basis. Because of these factors, Rational exercised significant influence over Catapulse and as a result Catapulse has been consolidated into Rational for financial reporting purposes since December 1999, with outside ownership of Catapulse reflected as minority interest through February 5, 2001. The total purchase price of Catapulse, including acquisition-related costs of approximately $55.3 million, was approximately $445.2 million. The acquisition was accounted for under the purchase method of accounting and the total purchase price was allocated based on an independent appraisal as follows (in thousands): Acquired developed and core technology.......................... $ 25,952 Acquired contract............................................... 9,299 Acquired in-process research and development (IPR&D)............ 14,167 Acquired assembled workforce.................................... 5,822 Acquired goodwill............................................... 201,480 Deferred stock based compensation on unvested stock and stock options........................................................ 288,762 Net deferred tax liability...................................... (114,220) Net book value of acquired assets and liabilities which approximate fair value......................................... 13,931 --------- Total purchase price.......................................... $ 445,193 =========
45 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 The purchase price allocation resulted in a $14.2 million charge related to the value of acquired IPR&D in the fourth quarter of fiscal 2001. The value of acquired IPR&D represents the appraised value of technology in the development stage that had not yet reached economic and technological feasibility. In reaching this determination, the Company used a present value net income approach, which computed the fair value of the subject asset based on a discounted cash flow analysis rate on the anticipated income stream of the related product revenues and considered, among other factors, the stage of development of each product and service offering, the time and resources needed to complete each product and service offering, and expected income and associated risks. The Company also used the present value net income method to allocate values to developed or core technology as well as an acquired contract. The rates utilized to discount the cash flows to their present value were based on an estimated cost of capital calculation. Due to the nature of the forecast and the risks associated with the projected growth and profitability of the developmental projects, the discount rates of 25%, 20%, and 15% were considered appropriate for IPR&D, developed or core technology and an acquired contract, respectively. The deferred stock based compensation, which relates to the intrinsic value of unvested stock options and restricted stock assumed in the acquisition, is presented as a reduction of stockholders' equity and is being amortized over the vesting period of the applicable options or restricted stock using the straight-line method. The acquired developed technology, acquired contract, assembled workforce and goodwill are being amortized on a straight-line basis over periods from two to four years, which are the estimated useful lives of these acquired assets. At March 31, 2001, cumulative amortization of goodwill, purchased intangibles and deferred stock based compensation associated with this acquisition totaled $22.9 million. The Company has formulated an exit plan effective at the date of the acquisition with respect to duplicate facilities, assets with no future economic benefit, relocation of key Catapulse employees to better align and integrate their responsibilities, as well as involuntary termination of certain Catapulse employees whose responsibilities were redundant or not deemed necessary. The exit plan has been initiated as of March 31, 2001, and is expected to be completed in fiscal 2002. Total severance pay, relocation costs, asset write-off, and lease cancellation costs of the plan, expected to be approximately $37.0 million, have been included in the purchase price allocation. Purchase of Attol Testware. On March 27, 2001, the Company completed the acquisition of Attol Testware (Attol). Attol was a France-based company that focused on testing of embedded software systems. Under the terms of the share purchase agreement, the Company acquired all of the outstanding shares of capital stock of Attol in exchange for approximately $12.3 million of cash and 466,006 shares of Rational Common Stock. The total purchase price of Attol, including acquisition-related costs of approximately $7.9 million, was approximately $30.3 million. The acquisition was accounted for under the purchase method of accounting and the total purchase price was allocated based on an independent appraisal as follows (in thousands): Acquired developed and core technology............................ $ 3,665 Acquired IPR&D.................................................... 1,655 Acquired assembled workforce...................................... 576 Acquired customer base and trade name............................. 917 Acquired goodwill................................................. 18,919 Deferred stock based compensation on unvested stock and stock options.......................................................... 6,276 Net deferred tax liability........................................ (4,573) Net book value of acquired assets and liabilities which approximate fair value........................................... 2,820 ------- Total purchase price............................................ $30,255 =======
46 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 The purchase price allocation resulted in a $1.7 million charge related to the value of acquired IPR&D in the fourth quarter of fiscal 2001. The value of acquired IPR&D represents the appraised value of technology in the development stage that had not yet reached economic and technological feasibility. In reaching this determination, the Company used a present value net income approach and considered, among other factors, the stage of development of each product, the time and resources needed to complete each product, and expected income and associated risks. The Company also used the present value net income method to allocate values to developed technology and core technology. The rates utilized to discount the cash flows to their present value were based on an estimated cost of capital calculation. Due to the nature of the forecast and the risks associated with the projected growth and profitability of the developmental projects, the discount rates of 25%, 20%, and 15% were considered appropriate for IPR&D, core technology and developed technology, respectively. The deferred stock based compensation, which relates to the intrinsic value of unvested stock options and restricted stock assumed in the acquisition is presented as a reduction of stockholders' equity and is being amortized over the vesting period of the applicable options or restricted stock using the straight-line method. The developed technology, core technology, customer base, trade name and goodwill are being amortized on a straight-line basis over periods from two to four years, the estimated useful lives of these acquired assets. The amortization of deferred stock based compensation, goodwill and intangible assets associated with this acquisition will result in an aggregate quarterly charge of approximately $2.4 million in fiscal 2002. The results of Attol are included in consolidated results of operation from March 27, 2001. The Company has formulated an exit plan effective at the date of the acquisition with respect to assets with no future economic benefit and involuntary termination of certain Attol employees whose responsibilities were redundant or not deemed necessary. The exit plan has been initiated as of March 31, 2001, and will be completed in fiscal 2002. Total severance pay and asset write-off costs of the plan, expected to be approximately $405,000, have been included in the purchase price allocation. The following table presents unaudited pro forma consolidated results for the Company assuming the acquisitions of Catapulse and Attol were consummated as of the beginning of each period. The pro forma results have been adjusted to exclude the charges of IPR&D recorded in fiscal 2001 and include amortization of deferred stock based compensation and amortization of goodwill and purchased intangibles. This information may not necessarily be indicative of the future combined results of operations of the Company (in thousands, except per share amounts).
Year Ended March 31, ------------------ 2001 2000 -------- -------- (Unaudited) Revenues................................................ $818,515 $575,096 Net loss................................................ (20,788) (25,704) Basic and diluted net loss per share.................... $ (0.10) $ (0.14)
Purchase of ObjecTime Limited. On January 13, 2000, the Company completed the acquisition of ObjecTime Limited (OTL). OTL was a developer of visual design and code generation software tools used for development of embedded software. The Company acquired all outstanding shares of OTL capital stock in exchange for approximately $9.0 million in cash and 371,400 shares of the Company's Common Stock. The Company also assumed all outstanding options to purchase OTL Common Stock in exchange for options to purchase 358,546 shares of the Company's Common Stock. Prior to the consummation of this deal, the Company held a 19.9% ownership in OTL from an initial investment of approximately $9.0 million made in December 1997. 47 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 The total purchase price of OTL, including the prior investment and acquisition-related costs of approximately $6.0 million, was approximately $58.8 million. The acquisition was accounted for under the purchase method of accounting and the total purchase price was allocated based on an independent appraisal as follows (in thousands): Acquired developed technology...................................... $ 1,610 Acquired core technology........................................... 4,250 Acquired IPR&D..................................................... 3,529 Acquired workforce................................................. 1,427 Acquired goodwill and other intangibles............................ 45,151 Net book value of acquired assets and liabilities which approximate fair value........................................................ 2,865 ------- Total purchase price............................................. $58,832 =======
The purchase price allocation resulted in a $3.5 million charge related to the value of acquired IPR&D in the fourth quarter of fiscal 2000. The value of acquired IPR&D represents the appraised value of technology in the development stage that had not yet reached economic and technological feasibility. In reaching this determination, the Company used a present value net income approach and considered, among other factors, the stage of development of each product, the time and resources needed to complete each product, and expected income and associated risks. The Company also used the present value net income method to allocate values to developed technology and core technology. The rates utilized to discount the cash flows to their present value were based on an estimated cost of capital calculation. Due to the nature of the forecast and the risks associated with the projected growth and profitability of the developmental projects, the discount rates of 25%, 20%, and 15% were considered appropriate for IPR&D, core technology and developed technology, respectively. The developed technology, core technology, goodwill, and other intangibles are being amortized on a straight-line basis over periods from one to four years, which are the estimated useful lives of these acquired assets. The results of OTL are included in consolidated results of operation from January 13, 2000. The Company formulated an exit plan effective at the date of the acquisition with respect to duplicate facilities, assets with no future economic benefit, relocation of key OTL employees to better align and integrate their responsibilities, and involuntary termination of certain OTL employees whose responsibilities were redundant or not deemed necessary. The exit plan was initiated in fiscal 2000, and was completed in fiscal 2001. The unaudited pro forma consolidated results for the Company had the acquisition been consummated at the beginning of each period, excluding the charge for acquired IPR&D recorded in fiscal 2000, are as follows (in thousands, except per share amounts):
Year Ended March 31, ----------------- 2000 1999 -------- -------- (Unaudited) Revenues.................................................. $581,701 $422,681 Net income................................................ 87,476 56,056 Diluted net income per share.............................. $ 0.91 $ 0.61
48 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 4. Short-Term Investments The Company's short-term investments are as follows (in thousands):
March 31, 2001 ---------------------------------------- Estimated Unrealized Unrealized Fair Cost Gains Losses Value -------- ---------- ---------- --------- Bank certificates of deposit...... $ 2,097 $ 5 $ -- $ 2,102 U.S. treasury and agency obligations...................... 158,794 1,899 -- 160,693 Municipal obligations............. 117,682 108 (10) 117,780 Corporate securities.............. 392,484 4,114 (69) 396,529 -------- ------ ---- -------- Total........................... $671,057 $6,126 $(79) $677,104 ======== ====== ==== ========
March 31, 2000 ---------------------------------------- Estimated Unrealized Unrealized Fair Cost Gains Losses Value -------- ---------- ---------- --------- Bank certificates of deposit...... $ 50,077 $ -- $ -- $ 50,077 U.S. treasury and agency obligations...................... 169,755 -- -- 169,755 Municipal obligations............. 126,376 -- -- 126,376 Corporate securities.............. 146,873 -- -- 146,873 -------- ---- ---- -------- Total........................... $493,081 $ -- $ -- $493,081 ======== ==== ==== ========
Realized gains and losses on sales of available-for-sale securities were immaterial for the years ended March 31, 2001 and 2000. Unrealized holding gains or losses, net of taxes, were included in accumulated other comprehensive loss, which is a separate component of stockholders' equity, and totaled approximately $3.6 million as of March 31, 2001. There were no significant unrealized holding gains or losses on such securities at March 31, 2000. Debt securities at March 31, 2001 and 2000, by contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because issuers of the securities may have the right to prepay obligations.
March 31, ----------------- 2001 2000 -------- -------- Short-term investments: Due in one year or less................................. $394,588 $243,357 Due in one to five years................................ 282,516 249,724 -------- -------- Total................................................. $677,104 $493,081 ======== ========
49 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 5. Property and Equipment Property and equipment is as follows (in thousands):
March 31, ------------------ 2001 2000 -------- -------- Computer and office equipment............................ $112,957 $ 82,838 Office furniture......................................... 21,413 13,957 Leasehold improvements................................... 22,427 13,850 Construction in progress................................. 21,088 5,687 -------- -------- 177,885 116,332 Accumulated depreciation and amortization................ (74,646) (63,892) -------- -------- Net property and equipment............................... $103,239 $ 52,440 ======== ========
6. Accrued Merger and Integration Expenses Merger expenses consist principally of transaction fees for investment bankers, attorneys, accountants, financial printing, and other related charges. Integration costs include severance and other employee-related charges, elimination of redundant facilities, write-off of excess property and equipment and certain intangible assets, and other professional fees. Details of the merger and integration provisions recorded over the past three years are as follows (in thousands):
Severance and Other Asset Employee- Write-Offs Transaction Related and Lease Costs Charges Cancellations Other Total ----------- --------- ------------- ------- -------- Accrued as of March 31, 1998................... $ 1,207 $ 8,344 $13,898 $ 4,445 $ 27,894 Change in estimate...... (1,078) (668) (4,585) 5,131 (1,200) Noncash charges......... -- -- (2,927) (2,772) (5,699) Cash payments........... (129) (7,043) (1,600) (6,804) (15,576) -------- ------- ------- ------- -------- Accrued as of March 31, 1999................... $ -- $ 633 $ 4,786 $ -- $ 5,419 Provision recorded at acquisition of OTL..... 1,124 1,311 1,510 2,083 6,028 Noncash charges......... -- -- (1,464) (874) (2,338) Cash payments........... (458) (1,539) (180) (1,085) (3,262) -------- ------- ------- ------- -------- Accrued as of March 31, 2000................... $ 666 $ 405 $ 4,652 $ 124 $ 5,847 Provision recorded at acquisition of Catapulse and Attol.... 15,290 5,987 31,430 10,450 63,157 Noncash charges......... -- (4,784) (1,342) (1,027) (7,153) Cash payments........... (13,873) (651) (1,859) (214) (16,597) -------- ------- ------- ------- -------- Accrued as of March 31, 2001................... $ 2,083 $ 957 $32,881 $ 9,333 $ 45,254 ======== ======= ======= ======= ========
Severance and other employee-related charges. As a result of the mergers, certain technical support, customer service, distribution, sales, marketing, and administrative functions were combined and reduced. Approximately 15, 29, and 26 employees were terminated in fiscal 2001, 2000, and 1999, respectively, as a result of this activity. The Company also committed to pay noncontingent retention bonuses, commissions, and relocation costs to other employees of the acquired companies, and these costs have been included in the accrual. 50 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 Asset write-offs and lease cancellations. In connection with acquisitions, the Company has consolidated duplicate offices and written off certain assets with no future economic benefit. The accrual in merger and integration expenses includes lease payments resulting from the planned closure of these facilities, which are expected to continue through the lease term, or penalties associated with early termination of the leases. Certain intangibles that will have no benefit to the combined operations were written off. Redundant property and equipment were either disposed of or written down to their estimated net realizable value. Other. Other expenses specific to the Catapulse, Attol, and OTL acquisitions included costs associated with communication of the merger to employees, existing offices, and costs accrued to provide future support and maintenance for former Catapulse, Attol, and OTL customers. 7. Convertible Subordinated Notes During February 2000, Rational completed an offering of $500.0 million of Convertible Subordinated Notes (the "Notes"), to qualified institutional buyers in reliance on Rule 144A under the Securities Act of 1933, as amended. Interest on the 5% Notes, which mature on February 1, 2007, is payable on February 1 and August 1 of each year, commencing August 1, 2000. The Notes are convertible into shares of Rational Common Stock at any time prior to the close of business on the maturity date, unless previously redeemed, at a conversion price of $35.72 per share, subject to anti-dilution adjustments. This is equivalent to a conversion rate of 27.9966 shares of Common Stock per $1,000 of principal amount due at maturity. The Notes are redeemable, in whole or in part, at the option of the Company on or after February 5, 2003, and upon at least 30 days', but no more than 60 days', notice. The redemption price, expressed as a percentage of principal plus accrued interest through the date of the redemption, is as follows for the 12-month periods beginning in February of the following years:
Redemption Year Price ---- ---------- 2003............................................................ 102.857% 2004............................................................ 102.143% 2005............................................................ 101.429% 2006............................................................ 100.714%
In the event of a change of control, as defined with respect to the Notes, each holder of the Notes may require the Company to repurchase its Notes, in whole or in part, for cash or, at the Company's option, for Common Stock (valued at 95% of the average last reported sale prices for the five trading days immediately preceding the repurchase date) at a repurchase price of 100% of the principal amount of the Notes to be repurchased, plus accrued interest to the repurchase date. The Notes are unsecured and subordinated in right of payment in full to all existing and future Senior Indebtedness of the Company. Expenses associated with the offering of approximately $15.4 million were deferred in other assets and are being amortized over the term of the Notes. The Company has reserved 13,997,760 shares of Common Stock for conversion of the Notes. 51 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 8. Commitments and Contingencies The Company leases its primary office space under operating leases. Rental expense for facilities was approximately $24.6 million, $15.1 million, and $12.3 million for the fiscal years ended March 31, 2001, 2000, and 1999, respectively. Estimated future rents from sublease agreements are $106,000 annually in both fiscal 2002 and 2003. Future minimum rental payments, net of sublease income, are as follows for the fiscal years indicated as of March 31 (in thousands): 2002.............................................................. $ 36,470 2003.............................................................. 34,979 2004.............................................................. 32,047 2005.............................................................. 25,004 2006.............................................................. 16,294 Thereafter........................................................ 31,105 -------- $175,899 ========
As of March 31, 2001, the Company had letters of credit outstanding in the amount of $62,500, $4,161,447, and $256,784 guaranteeing certain rental payments at its office locations in Lexington, Massachusetts; Cupertino, California; and New York City, New York, respectively. In addition, the Company assumed a letter of credit with International Business Machines Corporation ("IBM") totaling $1,985,823 in connection with the Catapulse acquisition. As part of a strategic business alliance between Catapulse and IBM, IBM agreed to provide services to Catapulse in exchange for an upfront payment of $1,237,477 related to development work expected to occur through December 31, 2001, and monthly recurring fees of $661,941 commencing upon IBM's completion of the development work and continuing for 37 months. The monthly recurring fees are related to ongoing services to be provided by IBM. Catapulse may terminate the arrangement by paying a termination fee of up to $1,985,823. Catapulse was required under the arrangement to obtain a letter of credit in the amount of a minimum termination charge. Legal matters. The Company is not a party to any material legal proceedings. From time to time, the Company is subject to legal claims. Historically, the cost of resolution of the claims has not been significant. However, any adverse outcome to future lawsuits against the Company may result in a material adverse effect on the Company's financial condition. 9. Stockholders' Equity Stock split. The Company's Board of Directors authorized a two for one stock split of the Company's Common Stock for stockholders of record on August 17, 2000. The transfer agent distributed shares resulting from the stock split on September 5, 2000. All share and per-share numbers contained herein reflect this stock split. The Company Board also approved an increase in the Company's authorized shares of Common Stock to 500 million shares. Stock repurchase program. In April 1998, the Company's Board of Directors authorized the purchase of up to 12 million shares of the Company's Common Stock from time to time in the open market. The Company completed the repurchase of these 12 million shares by August 1998 for an aggregate cost of approximately $98.4 million. In October 1998, the Company's Board of Directors authorized the purchase of an additional 12 million shares. As of March 31, 2001, the Company had repurchased approximately 8.2 million shares of its Common Stock under this program for an aggregate cost of approximately $135.3 million. 52 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 The stock repurchase program is intended to help offset the dilution resulting from shares issued under the Company's employee stock plans. The timing and size of any future stock repurchases are subject to market conditions, stock prices, and the Company's cash position and other cash requirements in the future. Stock options. The Company provides equity incentives to employees and directors by means of incentive stock options and nonstatutory options, which historically have been provided under various stock option plans. The Company now issues options from the 2000 Director Option Plan, the 1997 Stock Option Plan, and the 1997 Supplemental Plan. Stock options generally vest over a period of four years. Under these plans, the Company may grant either nonstatutory or incentive stock options, and the option price per share cannot be less than 85% of fair value in the case of nonstatutory options, or 100% of fair value in the case of incentive stock options, determined on the date that the option is granted. Under these plans, the Company has reserved 58,341,254 shares for issuance at March 31, 2001. Options generally expire 10 years from the date of grant. Activity under the plans including options assumed by the Company in mergers (adjusted for exchange ratios) is summarized as follows:
Options Outstanding --------------------------- Shares Weighted Available Average for Grant Options Exercise Price ----------- ----------- -------------- Balance at March 31, 1998........ 1,428,328 35,134,852 $ 6.29 Additional shares authorized... 8,900,000 -- -- Granted........................ (12,277,874) 12,277,874 7.66 Exercised...................... -- (7,105,694) 3.98 Canceled....................... 7,966,482 (7,966,482) 10.20 Expired or retired............. (2,642,086) -- -- ----------- ----------- ------ Balance at March 31, 1999........ 3,374,850 32,340,550 $ 6.32 Additional shares authorized... 36,728,264 -- -- Granted........................ (17,613,354) 17,613,354 20.26 Exercised...................... -- (10,496,602) 6.21 Canceled....................... 2,159,546 (2,159,546) 9.46 Expired or retired............. (808,178) -- -- ----------- ----------- ------ Balance at March 31, 2000........ 23,841,128 37,297,756 $12.55 Additional shares authorized... 8,360,713 -- -- Granted and assumed............ (20,202,592) 20,202,592 42.46 Exercised...................... -- (10,634,530) 6.71 Canceled....................... 1,675,644 (1,675,644) 22.08 Expired or retired............. (523,813) -- -- ----------- ----------- ------ Balance at March 31, 2001........ 13,151,080 45,190,174 $26.96 =========== =========== ======
In April 1998, the Company entered into agreements with certain executive officers to reprice (at the closing price for the Company's Common Stock on April 2, 1998, of $6.69) employee stock options for an aggregate of approximately 3.4 million shares of Common Stock. All employees participating in the repricing agreed to certain limitations on the disposition of repriced options. In connection with the acquisitions of Catapulse and Attol in fiscal 2001, and pursuant to FIN 44, the Company recorded approximately $295.0 million of deferred compensation relating to the unvested stock options 53 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 and restricted stock assumed in the acquisitions (see Note 3). Deferred compensation recorded in connection with the Catapulse acquisition was reversed for options canceled or forfeited. The amortization of deferred stock based compensation in connection with Catapulse and Attol was approximately $14.0 million during fiscal 2001. In fiscal 2000 the Company recorded deferred stock compensation of approximately $3.0 million representing the difference between the exercise price and the deemed fair value of Catapulse, the results of which were consolidated with Rational's results, Common Stock on the date such stock options were granted. The Company also recorded amortization of deferred stock based compensation of approximately $0.3 million in fiscal 2000. Amortization of deferred stock based compensation is allocable as follows (in thousands):
Year Ended March 31, ----------------- 2001 2000 1999 ------- ---- ---- Research and development................................ $ 3,645 $281 $ -- Sales and marketing..................................... 5,608 -- -- General and administrative.............................. 4,767 -- -- ------- ---- ---- Total................................................. $14,020 $281 $ -- ======= ==== ====
At March 31, 2000, the Company had approximately $2.8 million of remaining unamortized deferred compensation. Additionally, as a result of accelerating the vesting period on certain stock options, the Company recorded compensation expense of $484,000, which was included in general and administrative expenses. At March 31, 2001, options to purchase 12,698,627 shares of Common Stock were exercisable and unrestricted at a weighted average exercise price of $14.75. At March 31, 2001, the range of options outstanding and exercisable was as follows:
Options Exercisable Options Outstanding and Unrestricted ------------------------------------- -------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Shares Contractual Exercise Number Exercise Exercise Prices Outstanding Life (years) Price Exercisable Price --------------- ----------- ---------------- -------- ----------- -------- $0.0009-$5.56 6,921,473 6.36 $ 4.75 4,671,997 $ 4.48 $5.59-$11.97 4,936,983 7.11 8.54 2,564,896 8.03 $12.00-$15.38 5,022,682 8.33 14.88 1,663,063 14.73 $15.56-$25.78 2,900,622 8.60 21.57 789,073 21.75 $26.16-$26.16 6,028,273 8.84 26.16 1,233,373 26.16 $27.00-$33.88 4,520,230 9.52 28.80 807,537 30.99 $34.81-$47.41 3,414,423 9.35 39.87 96,630 38.06 $48.92-$48.92 5,591,648 9.54 48.92 532,431 48.92 $49.21-$54.63 4,992,340 9.56 50.73 335,888 50.12 $57.22-$67.75 861,500 9.48 64.03 3,739 60.24 ---------- ---- ------ ---------- ------ 45,190,174 8.48 $26.96 12,698,627 $14.75 ========== ==== ====== ========== ======
At March 31, 2000, options to purchase 11,009,876 shares of Common Stock were exercisable and unrestricted at a weighted average exercise price of $6.63. At March 31, 1999, options to purchase 9,744,994 shares of Common Stock were exercisable and unrestricted at a weighted average exercise price of $5.83. Employee Stock Purchase Plans. During fiscal 1999, all remaining shares previously approved by the stockholders for the "1994 Employee Stock Purchase Plan" were issued. In July 1998, shareholders approved 54 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 the "1998 Employee Stock Purchase Plan" with an initial 4 million shares reserved. Under both plans, substantially all employees may purchase Common Stock through payroll deductions at a price equal to 85% of the lower of fair values as of the date of the employee's entrance into the plan or the end of each six-month purchase period. Employees may elect to have up to 10% of their compensation withheld to purchase company stock, with a value not to exceed $25,000 in any calendar year. During fiscal 2001, approximately 1,006,906 shares were issued under the plans. Stock based compensation. Pro forma information regarding net income (loss) and earnings (loss) per share is required by SFAS 123 for awards granted or modified after December 31, 1994, as if the Company had accounted for its stock-based awards to employees under the fair value method of SFAS 123. The fair value of the Company's stock-based awards to employees was estimated using a Black-Scholes option-pricing model. The Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's stock-based awards to employees have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock- based awards to employees. The fair value of the Company's stock-based awards to employees was estimated assuming no expected dividends and the following weighted average assumptions:
Year Ended March 31, ----------------------------- Stock Options ESPP -------------- -------------- 2001 2000 1999 2001 2000 1999 ---- ---- ---- ---- ---- ---- Expected life (in years)..................... 3.27 3.60 3.35 0.49 0.62 0.60 Expected volatility.......................... 0.98 0.76 0.72 0.91 0.74 0.67 Risk-free interest rate...................... 5.63 6.10 5.21 5.51 5.61 5.15
For pro forma purposes, the estimated fair value of the Company's stock- based awards to employees is amortized over the options' vesting period (for options) and the six-month purchase period (for stock purchases under the ESPP). The Company's pro forma information is as follows (in thousands, except for per share amounts):
Year Ended March 31, -------------------------- 2001 2000 1999 --------- ------- ------- Net income (loss): As reported.................................. $ 72,144 $85,314 $59,249 Pro forma.................................... (147,460) 20,089 13,635 Basic net income (loss) per share: As reported.................................. $ 0.38 $ 0.49 $ 0.35 Pro forma.................................... (0.78) 0.11 0.08 Diluted net income (loss) per share: As reported.................................. $ 0.35 $ 0.45 $ 0.32 Pro forma.................................... (0.78) 0.11 0.07
The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. SFAS 123 does not apply to awards made prior to 1995. Additional awards in future years are anticipated. The weighted average fair value of options granted at market value during fiscal 2001, 2000, and 1999 was $28.25, $12.02, and $3.88 per share, respectively. The weighted average fair value of employee stock purchase rights during fiscal 2001, 2000, and 1999 was $18.49, $5.20, and $2.41 per share, respectively. 55 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 10. Income Taxes Income before income taxes and the provision for income taxes consist of the following (in thousands):
March 31, ---------------------------- 2001 2000 1999 -------- -------- -------- Income before income taxes: United States............................. $ 29,572 $ 68,072 $ 51,372 Foreign................................... 83,612 52,923 33,270 -------- -------- -------- Total................................. $113,184 $120,995 $ 84,642 -------- -------- -------- Provision for income taxes: Current: Federal................................. $ 184 $ -- $ 1,469 State................................... 52 56 3,120 Foreign................................. 14,346 8,656 3,904 -------- -------- -------- Total................................. $ 14,582 $ 8,712 $ 8,493 -------- -------- -------- Deferred: Federal................................. $(34,552) $ (8,498) $(13,858) State................................... (9,524) (274) (1,263) -------- -------- -------- Total................................. $(44,076) $ (8,772) $(15,121) -------- -------- -------- Income tax benefits attributable to employee stock plan activity allocated to stockholders' equity....................... $ 85,857 $ 36,825 $ 32,021 -------- -------- -------- Total..................................... $ 56,363 $ 36,765 $ 25,393 ======== ======== ========
The provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate as a result of the following differences (in thousands):
Year Ended March 31, -------------------------- 2001 2000 1999 -------- ------- ------- Income tax provision at the federal statutory rate........................................ $ 39,614 $42,348 $29,625 State income taxes, net of federal benefit... 6,343 4,781 5,502 Tax benefit of net operating loss carryforwards............................... -- -- (7,027) Tax benefit of research credit carryforwards............................... (9,108) (6,336) (3,000) Nondeductible charges for acquired in-process research and development, and goodwill...... 7,897 2,285 -- Foreign taxes in excess of U.S. statutory rates....................................... 4,600 603 1,333 Foreign earnings permanently reinvested in foreign operations.......................... (16,100) (8,400) -- Nondeductible losses attributable to Catapulse Inc............................... 14,836 1,047 -- Foreign losses not resulting in a U.S. tax benefit..................................... 4,121 1,077 -- Change in valuation allowance................ 3,245 -- (1,474) Other........................................ 915 (640) 434 -------- ------- ------- Total...................................... $ 56,363 $36,765 $25,393 ======== ======= =======
56 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 Significant components of the Company's deferred tax assets are as follows (in thousands):
March 31, ------------------- 2001 2000 --------- -------- Deferred tax assets: Net operating loss carryforwards.................... $ 24,593 $ 31,939 Tax credit carryforwards............................ 20,352 10,052 Allowances, reserves, and accrued expenses.......... 18,645 10,943 Property and equipment.............................. 2,331 -- Intangibles and capitalized expenses................ 76,280 6,699 Other............................................... 2,365 1,466 --------- -------- Gross deferred tax assets......................... 144,566 61,099 Less valuation allowance.......................... (27,009) (8,517) --------- -------- Total deferred tax assets......................... 117,557 52,582 --------- -------- Deferred tax liabilities: Unrealized investment gains......................... (2,330) -- Unremitted earnings of foreign subsidiaries......... (17,485) (12,848) Acquired intangibles................................ (135,788) (2,651) Property and equipment.............................. -- (1,408) Other............................................... (3,127) -- --------- -------- Total deferred tax liabilities.................... (158,730) (16,907) --------- -------- Net deferred tax assets (liabilities)................. $ (41,173) $ 35,675 ========= ========
The valuation allowance increased by $18.5 million and decreased by $2.6 million in 2001 and 2000, respectively. In 2001, the $18.5 million increase was primarily attributable to capitalized research and development expenses. In 2000, the $2.6 million decrease was primarily attributable to previously unbenefited research and development tax credits. Net undistributed earnings of the foreign subsidiaries considered permanently reinvested amounted to approximately $70.0 million at March 31, 2001. Accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. SFAS No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based on the weight of available evidence, the Company has provided a valuation allowance against the future amortization of certain intangible assets. The Company will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. At March 31, 2001, the Company had net operating loss carryforwards for federal income tax purposes of approximately $74.0 million that expire in 2002 through 2021. The Company also had tax credit carryforwards for federal and state purposes of approximately $15.0 million and $5.0 million, respectively, that expire in 2002 through 2021, if not utilized. As a result of various public offerings and business combinations, the Company and some of its acquired entities experienced an ownership change as defined in Section 382 of the Internal Revenue Code. Due to the passing of time, the Company's net operating loss carryforwards and tax credit carryforwards are no longer subject to limitation. 57 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 11. Segment Information The Company adopted SFAS 131 for the fiscal year ended March 31, 1999. The Company's software products and related services are developed and marketed to support heterogeneous environments in a broad customer base. Management uses one measurement of profitability for its business within a single operating segment. The Company markets its software products and related services in the United States, Europe, and other parts of the world. Geographic revenues and long-lived asset information are as follows (in thousands):
Year Ended March 31, -------------------------- 2001 2000 1999 -------- -------- -------- Revenues: United States................................. $479,923 $339,116 $246,650 Europe........................................ 221,341 167,507 121,848 Asia/Pacific.................................. 79,110 45,906 26,207 Other......................................... 34,561 19,661 17,111 -------- -------- -------- Consolidated.................................. $814,935 $572,190 $411,816 ======== ======== ======== Long-lived assets: United States................................. $255,800 $ 87,272 $ 60,178 Europe........................................ 123,781 6,816 6,117 Asia/Pacific.................................. 5,128 3,273 3,102 Other......................................... 39,065 53,231 305 -------- -------- -------- Consolidated.................................. $423,774 $150,592 $ 69,702 ======== ======== ========
"Other" represents Canada and Latin America regions. Export sales out of the U.S. have been made primarily to customers in Europe, Australia, and Canada and represent less than 10% of U.S. revenues in all periods. 12. Subsequent Events Stock repurchase program. In April 2001, the Company's Board of Directors authorized the purchase of an additional 20 million shares of the Company's Common Stock from time to time in the open market. Stock options. In April 2001, the Company's Board of Directors approved an increase of the aggregate number of shares of Common Stock available for issuance under the 1997 Supplemental Plan from 700,000 shares to 15.7 million shares. Workforce reduction. In April 2001, the Company announced that it would reduce its workforce by approximately 10 percent, or a total of approximately 400 positions affecting all parts of the organization. These actions will result in an estimated charge to the quarter ended June 2001 of approximately $15 million to $20 million, which includes severance and other employee- related charges and write-offs of excess property and equipment. 58 RATIONAL SOFTWARE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) March 31, 2001 13. Quarterly Information (Unaudited) The following table presents unaudited quarterly operating results for each of the Company's eight quarters in the two-year period ended March 31, 2001 (in thousands, except per share amounts):
Quarter Ended ------------------------------------------ June 30 September 30 December 31 March 31 -------- ------------ ----------- -------- Fiscal 2001: Total revenues.............. $170,297 $187,501 $215,457 $241,680 Gross margin................ 145,633 158,625 182,698 205,935 Operating income............ 22,584 19,251 28,671 7,699 Net income.................. 19,361 19,689 26,533 6,561 Net income per share-- basic...................... 0.11 0.11 0.14 0.03 Net income per share-- diluted.................... 0.10 0.10 0.13 0.03 Fiscal 2000: Total revenues.............. $117,423 $128,161 $146,187 $180,419 Gross margin................ 99,800 109,165 124,218 152,103 Operating income............ 17,823 24,396 31,855 34,064 Net income.................. 14,693 19,325 25,380 25,916 Net income per share-- basic...................... 0.08 0.11 0.14 0.14 Net income per share-- diluted.................... 0.08 0.10 0.13 0.13
59 ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 of Form 10-K with respect to our directors is incorporated by reference from the information contained in the section entitled "Election of Directors" in our proxy statement for the 2001 annual meeting of stockholders, a copy of which will be filed with the Securities and Exchange Commission before the meeting date. The information required by Item 10 with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference from the information contained in the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" in our proxy statement for the 2001 annual meeting of stockholders. For information with respect to our executive officers, see the section entitled "Executive Officers" located in Part I of this report. ITEM 11--EXECUTIVE COMPENSATION The information required by Item 11 of Form 10-K is incorporated by reference from the information contained in the sections entitled "Executive Compensation," "Board Member Compensation," "Compensation Committee Interlocks and Insider Participation," "Compensation Committee Report," and "Performance Graph" in our proxy statement for the 2001 annual meeting of stockholders. ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 of Form 10-K is incorporated by reference from the information contained in the section entitled "Beneficial Ownership of Common Stock" in our proxy statement for the 2001 annual meeting of stockholders. ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 of Form 10-K is incorporated by reference from the information contained in the section entitled "Certain Relationships and Related Transactions" in our proxy statement for the 2001 annual meeting of stockholders. PART IV ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. FINANCIAL STATEMENTS See Item 8 of this report. 2. FINANCIAL STATEMENT SCHEDULES See Item 14(d) of this report. 60 3. EXHIBITS
Exhibit No. Description of Exhibits --------- ----------------------- 2.1(1) Amended and Restated Agreement and Plan of Reorganization dated as of November 27, 2000, by and among the Registrant, Catapulse Inc., and certain other parties. 3.1(2) Certificate of Incorporation of the Registrant, as amended. 3.2(3) Amendment to Certificate of Incorporation of the Registrant. 3.3(4) Bylaws of the Registrant, as amended. 4.1 Reference is made to Exhibits 3.1, 3.2, and 3.3. 4.2(5) Specimen Common Stock Certificate. 4.3(4) Indenture by and between Registrant and State Street Bank and Trust Company of California, N.A., dated as of February 2, 2000, with respect to 5% Convertible Subordinated Notes due February 1, 2007. 4.4(4) Registration Rights Agreement of the Registrant, dated as of February 2, 2000, with respect to 5% Convertible Subordinated Notes due February 1, 2007. 4.5(6) Registration Rights Agreement by and among the Registrant and selling stockholders of Attol Testware. 10.1(2) *Relocation Agreement with David H. Bernstein. 10.2(7) *Form of Employment Agreement. 10.3(7) *Form of Employment Agreement with Registrant's Chief Executive Officer. 10.4(7) *Form of Stock Option Repricing Agreement. 10.5(8) *Form of Director and Officer Indemnification Agreement. 10.6(9) *Rational Software Corporation Stock Option Plan for Directors. 10.7(10) *Form of Stock Option Agreements for the Rational Software Corporation Stock Option Plan for Directors. 10.8(11) Agreement and Plan of Acquisition and Arrangement by and among the Registrant, Rational International, 3037936 Nova Scotia Company, 1386501 Ontario Limited, 1386503 Ontario Limited, and ObjecTime Limited. 10.9(12) *1997 Stock Plan. 10.10(13) *1998 Employee Stock Purchase Plan. 10.11 *1998 Indian Stock Option Plan. 10.12(14) *2000 Director Option Plan. 10.13(15) *1997 Supplemental Stock Plan. 10.14(1) *Form of Restricted Stock and Lock-up Agreement by and between the Registrant and certain executive officers of the Registrant. 10.15(16) *Bonus Agreement between the Registrant and Kevin J. Haar. 10.16(16) *Relocation Loan Agreement between the Registrant and Kevin J. Haar. 10.17(16) *Pledge Agreement between the Registrant and Kevin J. Haar.
61
Exhibit No. Description of Exhibits ------- ----------------------- 10.18 *Relocation Agreement between the Registrant and David H. Bernstein. 10.19 *Promissory Note between the Registrant and David H. Bernstein. 10.20 *Stand-Alone Stock Option Agreement between the Registrant and Michael T. Devlin. 10.21 *Security Agreement between the Registrant and Allison R. Schleicher. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young LLP, independent auditors. 24.1 Power of Attorney (contained on signature page of this report).
- -------- (1) Incorporated by reference to the Registrant's registration statement on Form S-4 (File No. 333-51940) filed with the SEC on December 15, 2000, as amended on January 2, 2001. (2) Incorporated by reference to the Registrant's quarterly report on Form 10-Q filed with the SEC on November 14, 1997. (3) Incorporated by reference to the Registrant's quarterly report on Form 10-Q filed with the SEC on November 13, 2000. (4) Incorporated by reference to the Registrant's annual report on Form 10-K filed with the SEC on May 1, 2000. (5) Incorporated by reference to the Registrant's Amendment No. 1 to its Form S-3 registration statement (File No. 33-91740) filed with the SEC on May 31, 1995. (6) Incorporated by reference to the Registrant's registration statement on Form S-3 filed with the SEC on April 10, 2001. (7) Incorporated by reference to the Registrant's annual report on Form 10-K filed with the SEC on June 1, 1998. (8) Incorporated by reference to the Registrant's registration statement on Form S-4 (File No. 333-19669) filed with the SEC on January 13, 1997, as amended on January 17, 1997. (9) Incorporated by reference to the Registrant's current report on Form 8-K filed with the SEC on October 2, 1996. (10) Incorporated by reference to the Registrant's registration statement on Form S-8 (File No. 33-97042) filed with the SEC on September 18, 1995. (11) Incorporated by reference to the Registrant's current report on Form 8-K filed with the SEC on January 21, 2000. (12) Incorporated by reference to the Registrant's registration statement on Form S-8 filed with the SEC on October 15, 1999. (13) Incorporated by reference to the Registrant's registration statement on Form S-8 filed with the SEC on January 22, 1999. (14) Incorporated by reference to the Registrant's registration statement on Form S-8 filed with the SEC on November 13, 2000. (15) Incorporated by reference to the Registrant's registration statement on Form S-8 filed with the SEC on May 14, 2001. (16) Incorporated by reference to the Registrant's current report on Form 10- Q filed with the SEC on January 30, 2001. * Indicates those exhibits that are management contracts or compensatory plans or arrangements required to be filed as an exhibit to this form. 62 (b) REPORTS ON FORM 8-K On February 9, 2001, the Company filed Form 8-K, reporting under Item 2, regarding the closing of the acquisition of all of the remaining outstanding shares of Catapulse Inc. not already owned by Rational. (c) EXHIBITS See Item 14(a)(3) of this report. (d) FINANCIAL STATEMENT SCHEDULES The following financial statement schedule of the Company for each of the years ended March 31, 2001, 2000, and 1999, is filed as part of this Form 10-K and should be read in conjunction with the consolidated financial statements and related notes thereto of the Company. RATIONAL SOFTWARE CORPORATION SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS Years Ended March 31, 2001, 2000, and 1999 (in thousands)
Balance at Balance Beginning at End of Period Additions Deductions of Period ---------- --------- ---------- --------- March 31, 2001 Allowance for doubtful accounts..... $3,259 $589 $(531) $3,317 March 31, 2000 Allowance for doubtful accounts..... $3,226 $287 $(254) $3,259 March 31, 1999 Allowance for doubtful accounts..... $3,638 $ -- $(412) $3,226
Schedules other than those listed above have been omitted because they are either not required or not applicable or because the information is otherwise included. 63 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. Rational Software Corporation Date: June 18, 2001 /s/ Timothy A. Brennan ---------------------------------------- Timothy A. Brennan, Senior Vice President, Chief Financial Officer, and Secretary
POWER OF ATTORNEY KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Thomas F. Bogan and Timothy A. Brennan, jointly and severally, as such person's true and lawful attorneys-in-fact and agents, each with full power of substitution, for such person, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this report on Form 10-K, and to file with same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as full to all intents and purposes as such person might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitutes, may do or be done by virtue hereof. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature Title Date --------- ----- ---- /s/ Paul D. Levy Founder and Chairman of the June 18, 2001 ____________________________________ Board Paul D. Levy /s/ Michael T. Devlin Founder, Chief Executive June 18, 2001 ____________________________________ Officer, and Director Michael T. Devlin /s/ Thomas F. Bogan President and Chief June 18, 2001 ____________________________________ Operating Officer Thomas F. Bogan /s/ Timothy A. Brennan Senior Vice President, Chief June 18, 2001 ____________________________________ Financial Officer, and Timothy A. Brennan Secretary (principal financial officer and principal accounting officer) /s/ Leslie G. Denend Director June 18, 2001 ____________________________________ Leslie G. Denend /s/ John E. Montague Director June 18, 2001 ____________________________________ John E. Montague /s/ Allison R. Schleicher Director June 18, 2001 ____________________________________ Allison R. Schleicher
64 EXHIBIT INDEX
Exhibit No. Description of Exhibits --------- ----------------------- 2.1(1) Amended and Restated Agreement and Plan of Reorganization dated as of November 27, 2000, by and among the Registrant, Catapulse Inc., and certain other parties. 3.1(2) Certificate of Incorporation of the Registrant, as amended. 3.2(3) Amendment to Certificate of Incorporation of the Registrant. 3.3(4) Bylaws of the Registrant, as amended. 4.1 Reference is made to Exhibits 3.1, 3.2, and 3.3. 4.2(5) Specimen Common Stock Certificate. 4.3(4) Indenture by and between Registrant and State Street Bank and Trust Company of California, N.A., dated as of February 2, 2000, with respect to 5% Convertible Subordinated Notes due February 1, 2007. 4.4(4) Registration Rights Agreement of the Registrant, dated as of February 2, 2000, with respect to 5% Convertible Subordinated Notes due February 1, 2007. 4.5(6) Registration Rights Agreement by and among the Registrant and selling stockholders of Attol Testware. 10.1(2) *Relocation Agreement with David H. Bernstein. 10.2(7) *Form of Employment Agreement. 10.3(7) *Form of Employment Agreement with Registrant's Chief Executive Officer. 10.4(7) *Form of Stock Option Repricing Agreement. 10.5(8) *Form of Director and Officer Indemnification Agreement. 10.6(9) *Rational Software Corporation Stock Option Plan for Directors. 10.7(10) *Form of Stock Option Agreements for the Rational Software Corporation Stock Option Plan for Directors. 10.8(11) Agreement and Plan of Acquisition and Arrangement by and among the Registrant, Rational International, 3037936 Nova Scotia Company, 1386501 Ontario Limited, 1386503 Ontario Limited, and ObjecTime Limited. 10.9(12) *1997 Stock Plan. 10.10(13) *1998 Employee Stock Purchase Plan. 10.11 *1998 Indian Stock Option Plan. 10.12(14) *2000 Director Option Plan. 10.13(15) *1997 Supplemental Stock Plan. 10.14(1) *Form of Restricted Stock and Lock-up Agreement by and between the Registrant and certain executive officers of the Registrant. 10.15(16) *Bonus Agreement between the Registrant and Kevin J. Haar. 10.16(16) *Relocation Loan Agreement between the Registrant and Kevin J. Haar. 10.17(16) *Pledge Agreement between the Registrant and Kevin J. Haar.
65
Exhibit No. Description of Exhibits ------- ----------------------- 10.18 *Relocation Agreement between the Registrant and David H. Bernstein. 10.19 *Promissory Note between the Registrant and David H. Bernstein. 10.20 *Stand-Alone Stock Option Agreement between the Registrant and Michael T. Devlin. 10.21 *Security Agreement between the Registrant and Allison R. Schleicher. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young LLP, independent auditors. 24.1 Power of Attorney (contained on signature page of this report).
- -------- (1) Incorporated by reference to the Registrant's registration statement on Form S-4 (File No. 333-51940) filed with the SEC on December 15, 2000, as amended on January 2, 2001. (2) Incorporated by reference to the Registrant's quarterly report on Form 10-Q filed with the SEC on November 14, 1997. (3) Incorporated by reference to the Registrant's quarterly report on Form 10-Q filed with the SEC on November 13, 2000. (4) Incorporated by reference to the Registrant's annual report on Form 10-K filed with the SEC on May 1, 2000. (5) Incorporated by reference to the Registrant's Amendment No. 1 to its Form S-3 registration statement (File No. 33-91740) filed with the SEC on May 31, 1995. (6) Incorporated by reference to the Registrant's registration statement on Form S-3 filed with the SEC on April 10, 2001. (7) Incorporated by reference to the Registrant's annual report on Form 10-K filed with the SEC on June 1, 1998. (8) Incorporated by reference to the Registrant's registration statement on Form S-4 (File No. 333-19669) filed with the SEC on January 13, 1997, as amended on January 17, 1997. (9) Incorporated by reference to the Registrant's current report on Form 8-K filed with the SEC on October 2, 1996. (10) Incorporated by reference to the Registrant's registration statement on Form S-8 (File No. 33-97042) filed with the SEC on September 18, 1995. (11) Incorporated by reference to the Registrant's current report on Form 8-K filed with the SEC on January 21, 2000. (12) Incorporated by reference to the Registrant's registration statement on Form S-8 filed with the SEC on October 15, 1999. (13) Incorporated by reference to the Registrant's registration statement on Form S-8 filed with the SEC on January 22, 1999. (14) Incorporated by reference to the Registrant's registration statement on Form S-8 filed with the SEC on November 13, 2000. (15) Incorporated by reference to the Registrant's registration statement on Form S-8 filed with the SEC on May 14, 2001. (16) Incorporated by reference to the Registrant's current report on Form 10-Q filed with the SEC on January 30, 2001. * Indicates those exhibits that are management contracts or compensatory plans or arrangements required to be filed as an exhibit to this form. 66 EX-10.11 2 dex1011.txt 1998 INDIAN STOCK OPTION PLAN EXHIBIT 10.11 RATIONAL SOFTWARE CORPORATION 1998 INDIAN STOCK OPTION PLAN 1. Purposes of the Plan. The purposes of this 1998 Indian Stock Option -------------------- Plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to Service Providers, to allow Service Providers to benefit from appreciation in the Common Stock without having to actually purchase Common Stock and to promote the success of the Company's and the Subsidiary's business. 2. Definitions. As used herein, the following definitions shall apply: ----------- (a) "Administrator" means the Board or any of its Committees as shall ------------- be administering the Plan, in accordance with Section 4 hereof. (b) "Applicable Laws" means the requirements relating to the --------------- administration of stock option plans under the applicable laws, rules and regulations of India, U.S. state corporate laws, U.S. federal and state securities laws, the Code and any stock exchange or quotation system on which the Common Stock is listed or quoted. (c) "Board" means the Board of Directors of the Company. ----- (d) "Code" means the Internal Revenue Code of 1986, as amended. ---- (e) "Committee" means a committee of Directors appointed by the Board --------- in accordance with Section 4 hereof. (f) "Common Stock" means the Common Stock of the Company. ------------ (g) "Company" means Rational Software Corporation, a Delaware ------- corporation. (h) "Consultant" means any person who is engaged by the Subsidiary to ---------- render consulting or advisory services. (i) "Director" means a member of the Board of Directors of the -------- Subsidiary. (j) Employee" means any person, including Officers and Directors, -------- employed by the Subsidiary. A Service Provider shall not cease to be an Employee in the case of (i) any leave of absence approved by the Subsidiary or (ii) transfers between locations of the Subsidiary or between the Company, any parent or subsidiary corporation, or any successor thereto. Neither service as a Director nor payment of a director's fee by the Company or any Parent or Subsidiary shall be sufficient to constitute "employment" by 1 the Subsidiary. (k) "Fair Market Value" means, as of any date, the value of Common ----------------- Stock determined as follows: (i) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation the Nasdaq National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its Fair Market Value shall be the closing sales price or such stock (or the closing bid, if no sales were reported) as quoted on such exchange for system for the last market trading day prior to the time of determination, as reported in The Wall Street Journal or such other source as the Administrator deems reliable, (ii) If the Common Stock is regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean between the high bid and low asked prices for the Common Stock on the last market trading day prior to the day of determination, or; (iii) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Administrator. (i) "Option" means a stock option covering Common Stock granted ------ to a Service Provider pursuant to the Plan. (m) "Option Agreement" means a written or electronic agreement between ---------------- the Company and an Optionee evidencing the terms and conditions of an individual Option grant. The Option Agreement is subject to the terms and conditions of the Plan. (n) "Option Exchange Program" means a program whereby outstanding ----------------------- Options are exchanged for Options with a lower exercise price. (o) "Optioned Stock" means the Common Stock subject to an Option. -------------- (p) "Optionee" means the holder of an outstanding Option granted under -------- the Plan. (q) "Plan" means this 1998 Indian Stock Option Plan. ---- (r) "Service Provider" means an Employee, Director or Consultant. ---------------- (s) "Share" means a share of Common Stock, as adjusted in accordance ----- with Section 11 below. (t) "Subsidiary" means Rational Software India Pvt. Ltd., a ---------- subsidiary corporation of the Company, and any successor thereto. 2 3. Stock Subject to the Plan. Subject to the provisions of Section 11 of ------------------------- the Plan, the maximum aggregate number of Shares which may be subject to option and sold under the Plan is 600,000 Shares. The Shares may be authorized, but unissued, or reacquired Common Stock. If an Option expires or becomes unexercisable without having been exercised in full, or is surrendered pursuant to an Option Exchange Program, the unpurchased Shares which were subject thereto shall become available for future grant or sale under the Plan (unless the Plan has terminated); provided, --------- however, that Shares that have actually been issued under the Plan shall not be returned to the Plan and shall not become available for future distribution under the Plan. 4. Administration of the Plan. --------------------------- (a) Procedure. The Plan shall be administered by the Board or a --------- Committee appointed by the Board, which Committee shall be constituted to comply with Applicable Laws. (b) Powers of the Administrator. Subject to the provisions of the --------------------------- Plan and, in the case of a Committee, the specific duties delegated by the Board to such Committee, and subject to the approval of any relevant authorities, the Administrator shall have the authority, in its discretion: (i) to determine the Fair Market Value; (ii) to select the Service Providers to whom Options may from time to time be granted hereunder; (iii) to determine the number of Shares to be covered by each such award granted hereunder; (iv) to approve forms of agreement for use under the Plan; (v) to determine the terms and conditions of any Option granted hereunder; (vi) to determine whether and under what circumstances an Option may be settled in cash under subsection 9(e) instead of Common Stock; (vii) to reduce the exercise price of any Option to the then current Fair Market Value, if the Fair Market Value has declined since the date the Option was granted; (viii) to institute an Option Exchange Program 3 (ix) to prescribe, amend and rescind rules and regulations relating to the Plan, including rules and regulations relating to sub-plans established for the purpose of qualifying for preferred tax treatment under foreign tax laws; and (x) to construe and interpret the terms of the Plan and awards granted pursuant to the Plan. (c) Effect of Administrator's Decision. All decisions,determinations ---------------------------------- and interpretations of the Administrator shall be final and binding on all Optionees. 5. Eligibility ----------- (a) Options may be granted to Service Providers. (b) The Plan shall not confer upon any Optionee any right with respect to continuing the Optionee's relationship as a Service Provider with the Subsidiary, nor shall it interfere in any way with his or her right or the Subsidiary's right to terminate such relationship at any time, with or without cause. 6. Term of the Plan. The Plan shall become effective upon the later to ---------------- occur of (i) its adoption by the Board, or (ii) its approval by the Reserve Bank of India. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section 13 of the Plan. 7. Term of Option. The term of each Option shall be stated in the Option ---------------- Agreement. 8. Option Exercise Price and Consideration. --------------------------------------- (a) The per share exercise price for the Shares to be issued pursuant to exercise of an Option shall be such price as is determined by the Administrator at the time the Option is granted. (b) The consideration for the Shares to be issued upon exercise of an Option shall be consideration received by the Company under a cashless exercise program implemented by the Company in connection with the Plan. The cashless exercise program may be implemented in the manner and example described in Exhibit A hereto. 9. Exercise of Option. ------------------ (a) Procedure for Exercise; Rights as a Stockholder. Any Option ----------------------------------------------- granted hereunder shall be exercisable according to the terms of the Plan and at such times and under such conditions as determined by the Administrator and set forth in the Option Agreement. An Option may not be exercised for a fraction of a Share. An Option shall be deemed exercised when the Company receives 4 written or electronic notice of exercise (in accordance with the Option Agreement) from the person entitled to exercise the Option. Shares issued upon exercise of an Option shall be issued in the name of the Optionee or, if requested by the Optionee, in the name of the Optionee and his or her spouse. Until the Shares are issued (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company), no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the Shares, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such Shares promptly after the Option is exercised. No adjustment will be made for a dividend or other right for which the record date is prior to the date the Shares are issued, except as provided in Section 11 of the Plan. Exercise of an Option in any manner shall result in a decrease in the number of Shares thereafter available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. (b) Termination of Relationship as a Service Provider. If an Optionee ------------------------------------------------- ceases to be a Service Provider, other than upon the Optionee's death or Disability, the Optionee may exercise his or her Option within such period of time (of at least thirty (30) days) as is specified in the Option Agreement to the extent that the Option is vested on the date of termination (but in no event later than the expiration of the term of such Option as set forth in the option Agreement). In the absence of a specified time in the Option Agreement, the Option shall remain exercisable for three (3) months following the Optionee's termination. If, on the date if termination, the Optionee is not vested as to his or her entire option, the Shared covered by the unvested portion of the Option shall revert to the Plan. (c) Disability of Optionee. If an Optionee ceases to be a Service ---------------------- Provider as a result of the Optionee's disability, the Optionee may exercise his or her Option within such period of time as specified in the Option Agreement (of at least six (6) months) to the extent the Option is vested on the date of termination, but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement. In the absence of a specified time in the Option Agreement, the Option shall remain exercisable for twelve (12) months following the Optionee's termination. If, on the date of termination, the Optionee is not vested as to the entire Option, the Shares covered by the unvested portion of the Option shall revert to the Plan. If, after termination, the Option is not exercised within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan. (d) Death of Optionee. If an Optionee dies while a Service Provider, ----------------- the Option may be exercised within such period of time as is specified in the Option Agreement (of at least six (6) months) to the extent that the Option is vested on the date of death (but in no event later than the expiration of the term of such Option as set forth in the Option Agreement) by the Optionee's estate or by a person who acquires the right to exercise the Option by bequest or inheritance. In the absence of a specified time in the Option Agreement, the Option shall remain exercisable for twelve (12) months following the Optionee's termination. It at the time of death, the Optionee is not vested as to the entire 5 Option, the Shares covered by the unvested portion of the Option shall revert to the Plan. If the Option is not so exercised within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan. (e) Buyout Provisions. The Administrator may at any time offer to buy ----------------- out for a payment in cash or Shares, an Option previously granted, based on such terms and conditions as the Administrator shall establish and communicate to the Optionee at the time that such offer is made. 10. Non-Transferability of Options. Options may not be sold, pledged, ------------------------------ assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the Optionee, only by the Optionee. 11. Adjustments Upon Changes in Capitalization or Merger. ---------------------------------------------------- (a) Changes in Capitalization. Subject to any required action by the -------------------------- stockholders of the Company, the number of shares of Common Stock covered by each outstanding Option, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, as well as the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Administrator, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. (b) Dissolution or Liquidation. In the event of the proposed -------------------------- dissolution or liquidation of the Company, the Administrator shall notify each Optionee as soon as practicable prior to the effective date of such proposed transaction. The Administrator in its discretion may provide for an Optionee to have the right to exercise his or her Option until fifteen (15) days prior to such transaction as to all of the Optioned Stock covered thereby, including Shares as to which the Option would not otherwise be exercisable. To the extent it has not been previously exercised, an Option will terminate immediately prior to the consummation of such proposed action. (c) Merger or Asset Sale. In the event of a merger of the Company -------------------- with or into another corporation, or the sale of substantially all of the assets of the Company, 6 each outstanding Option shall be assumed or an equivalent option substituted by the successor corporation or a Parent or Subsidiary of the successor corporation. In the event that the successor corporation refuses to assume or substitute for the Option, the Optionee shall fully vest in and have the right to exercise the Option as to all of the Optioned Stock, including Shares as to which it would not otherwise be vested or exercisable. If an Option becomes fully vested and exercisable in lieu of assumption or substitution in the event of a merger or sale of assets, the Administrator shall notify the Optionee in writing or electronically that the Option shall be fully exercisable for a period of fifteen (15) days from the date of such notice, and the Option shall terminate upon the expiration of such period. For the purposes of this paragraph, the Option shall be considered assumed if, following the merger or sale of assets, the option confers the right to purchase or receive, for each Share of Optioned Stock subject to the Option immediately prior to the merger or sale of assets, the consideration (whether stock, cash, or other securities or property) received in the merger or sale of assets by holders of Common Stock for each Share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares); provided, however, that if such consideration received in the merger or sale of assets is not solely common stock of the successor corporation or its Parent, the Administrator may, with the consent of the successor corporation, provide for the consideration to be received upon the exercise of the Option, for each Share of Optioned Stock subject to the Option, to be solely common stock of the successor corporation or its Parent equal in fair market value to the per share consideration received by holders of Common Stock in the merger or sale of assets. 12. Date of Grant. The date of grant of an Option shall, for all purposes, ------------- be the date on which the Administrator makes the determination granting such Option, or such other date as is determined by the Board. Notice of the determination shall be given to each Service Provider to whom an Option is so granted within a reasonable time after the date of such grant. 13. Amendment and Termination of the Plan. ------------------------------------- (a) Amendment and Termination. The Board may at any time amend, ------------------------- alter, suspend or terminate the Plan. (b) Stockholder Approval. The Board shall obtain stockholder approval -------------------- of any Plan amendment to the extent necessary and desirable to comply with Applicable Laws. (c) Effect of Amendment or Termination. No amendment, alteration, ---------------------------------- suspension or termination of the Plan shall impair the rights of any Optionee, unless mutually agreed otherwise between the Optionee and the Administrator, which agreement must be in writing and signed by the Optionee and the Company. Termination of the Plan shall not affect the Administrator's ability to exercise the powers granted to it hereunder with respect to Options granted under the Plan prior to the date of such termination. 7 14. Conditions upon Issuance of Shares. ---------------------------------- (a) Legal Compliance. Shares shall not be issued pursuant to the ---------------- exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares shall comply with Applicable Laws and shall be further subject to the approval of counsel for the Company with respect to such compliance. (b) Investment Representations. As a condition to the exercise of an -------------------------- Option, the Administrator may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required. 15. Inability to Obtain Authority. The inability of the Company to obtain ----------------------------- authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 16. Reservation of Shares. The Company, during the term of this Plan, --------------------- shall at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. 17. Tax Consequences. Each Optionee is advised that he or she may suffer ---------------- adverse tax consequences as a result of the purchase or disposition of Common Stock hereunder. Accordingly, each Optionee shall be liable for his or her taxes and other liabilities under the Plan in accordance with the laws applicable thereto Optionee is further advised to consult with any tax consultants. Optionee deems advisable in connection with the purchase or disposition of Common Stock hereunder, as neither the Company nor the Subsidiary can provide any Optionee with tax advice. Neither the Company nor the Subsidiary shall be responsible or liable for any tax liabilities for and on behalf of any Optionee under the Plan, except as required by Applicable Laws. 8 EXHIBTT A - CASHLESS EXERCISE PROGRAM: - -------------------------------------- The Cashless Exercise Program (referenced in Clause 8 (b) of the Plan) provides that the employee, upon exercise of an Option, will receive cash or Common Stock, or a combination thereof, equal to the difference between the Option exercise price and the Fair Market Value of the Common Stock on the exercise day. The transaction will be consummated through a broker, who will sell all or a portion of the Optioned Stock on the open market. A portion of the proceeds from such sale will be transferred to the Company in satisfaction of the Optionee's exercise price. Any remaining Common Stock or cash will be remitted to the Optionee. No cash or other property will be transferred out of India. Example: - -------- Assume a 5,000 share option grant, a Fair Market Value and exercise price of $10 per share at the time of grant, and a Fair Market Value on the date of exercise of $15 per share. The employee may receive the following: -total market value = $75,000 -total exercise price $50,000 -profit = $25,000 cash = $25,000 or == shares - $25,000/15 = 1,666 So the employee receives $25,000 (in Indian Rupees) or 1,666 shares without any cash expenditures, but still needs to pay taxes on the entire profit amount of $25,000. The employee is free to choose any combination of cash and Common Stock. 9 EX-10.18 3 dex1018.txt RELOCATION AGREEMENT EXHIBIT 10.18 RATIONAL SOFTWARE CORPORATION ----------------------------- RELOCATION AGREEMENT -------------------- This Relocation Agreement (the "Agreement") is entered into effective as of April 12, 2001 (the "Effective Date"), by and between Rational Software Corporation, a Delaware corporation (the "Company"), and David H. Bernstein (the "Employee"). 1. Nature of Employment. The Company agrees to employ Employee as Senior -------------------- Vice President, Products. The Company and Employee agree that Employee's employment with the Company is and shall continue to be "at-will" and may be terminated at any time with or without cause or notice by either the Company or Employee. Not withstanding this fact, this agreement shall bind the Company for reimbursement of all of Employee's expenses as itemized in paragraphs 3-6 inclusive of this Agreement for a period not to exceed two (2) years from the effective date of this agreement. 2. Terms of Relocation Loan. In connection with the transfer of ------------------------ Employee's principal place of employment from Massachusetts to California, the Company will provide Employee with a non-interest bearing loan in the amount of $2.5 million (the "Loan") for purposes of Employee's acquisition of a new principal residence located at 27240 Natoma Road, Los Altos Hills, California (the "California Residence"). The Loan shall be subject to, and governed by, the terms and conditions of a Promissory Note and mortgage between the Employee and the Company, the form of which shall be provided to Employee by the Company (the "Promissory Note"). Company and Employee shall promptly execute such Promissory Note, and all other documents necessary to effect such Promissory Note, after execution of this Agreement. The Promissory Note shall state that the Employee shall grant Company a mortgage security interest in the California Residence (as more particularly described in the Promissory Note) for the term of the Loan and that the loan proceeds be used only to purchase the California Residence. The Promissory Note shall also state that the Loan shall be due and payable upon the occurrence of a Maturity event as defined in the Promissory Note The Loan is intended to satisfy the Requirements of Temporary Treasury Regulation Section 1.7872-5T(c)(1)(i) and the Employee and Company agree to execute such documents as are necessary to reasonably comply therewith. 3. Reimbursement/Relocation. ------------------------ (a) Relocation Costs. Company will reimburse the Employee, under the ---------------- Company's standard relocation policy, for all of the Employee's costs reasonably incurred to relocate from Massachusetts to California. These costs shall include: 1. The cost of selling Employee's home at 25 Glezen Lane, Wayland, Massachusetts (the "Massachusetts Residence"), including standard, market-rate brokerage commission. 2. The cost of relocating the Employee's family and possessions located in the Massachusetts Residence to California. (b) Loss on Sale (Massachusetts Residence). The Company -------------------------------------- will reimburse Employee for any loss (net of sales costs) that the Employee sustains as a result of the sale of the Massachusetts Residence ; provided, however, that Employee shall use reasonable efforts to obtain the maximum market value for the Massachusetts Residence at any such sale. Company will reimburse the difference between the Employee's initial purchase price of One Million Eight Hundred Thousand Dollars ($1,800,000) and the sales price of said property realized at such sale, less selling costs. (c) Loss on Sale (California Residence). The Company will ----------------------------------- reimburse Employee for any loss (net of sales costs) that the Employee sustains as a result of the sale of the California Residence so long as Employee is employed by the Company on the date of such sale ; provided, however, that Employee shall use reasonable efforts to obtain the maximum market value for the California Residence at any such sale. The purchase price of the California Residence is Five Million Two Hundred Thousand Dollars ($5,200,000). 4. Reimbursement/Transition. The Company and Employee anticipate that ------------------------ employee will spend a significant amount of time in both the Massachusetts location and the California location during a period of approximately two years from the Effective Date (the "Transition Period"). During the Transition Period, Company will reimburse Employee for costs reasonably incurred by the Employee to maintain two residences, up to $100,000 per year. This amount will be reviewed one year after the Effective date, and may be adjusted at that time by mutual consent of the parties. 5. Tax Reimbursement. The Company will make a "gross-up" payment with ----------------- respect to all taxable payments made under this Agreement at the Employee's tax rate to compensate the Employee for any incremental federal or state tax liability that may be incurred by the Employee as a result of payments received by the Employee from the Employer pursuant to this agreement. 6. Arbitration and Equitable Relief. -------------------------------- (a) Except as provided in Section 6(c) below, the Company and Employee agree that any dispute or controversy arising out of, relating to, or in connection with this Agreement, or the interpretation, validity, construction, performance, breach, or termination thereof shall be settled by arbitration to be held in Santa Clara County, California in accordance with the National Rules for the Resolution of Employment Disputes then in effect of the American Arbitration Association (the "Rules"). The arbitrator may grant injunctions or other relief in such dispute or controversy. The decision of the arbitrator shall be final, conclusive and binding on the parties to the arbitration. Judgment may be entered on the arbitrator's decision in any court having jurisdiction. (b) The Company shall pay all costs and expenses of such arbitration. (c) The parties may apply to any court of competent jurisdiction for a temporary restraining order, preliminary injunction or other interim or conservatory relief as 2 necessary, without breach of this arbitration agreement and without abridgment of the powers of the arbitrator. (d) EMPLOYEE HAS READ AND UNDERSTANDS THIS SECTION 6, WHICH DISCUSSES ARBITRATION. EMPLOYEE UNDERSTANDS THAT BY SIGNING THIS AGREEMENT, EMPLOYEE AGREES, EXCEPT AS PROVIDED IN SECTION 6(c), TO SUBMIT ANY FUTURE CLAIMS ARISING OUT OF, RELATING TO, OR IN CONNECTION WITH THIS AGREEMENT, OR THE INTERPRETATION, VALIDITY, CONSTRUCTION, PERFORMANCE, BREACH, OR TERMINATION THEREOF TO BINDING ARBITRATION, AND THAT THIS ARBITRATION CLAUSE CONSTITUTES A WAIVER OF EMPLOYEE'S RIGHT TO A JURY TRAIL AND RELATES TO THE RESOLUTION OF ALL DISPUTES RELATING TO ALL ASPECTS OF THE EMPLOYER/EMPLOYEE RELATIONSHIP THAT ARE THE SUBJECT OF THIS AGREEMENT. Executed as a sealed instrument as of the effective Date of this Agreement. RATIONAL SOFTWARE CORPORATION (Company) BY: /s/ Timothy A. Brennan, Senior VP, CFO and Secretary ---------------------------------------------------- /s/ David H. Bernstein ---------------------------------------------------- DAVID H. BERNSTEIN (Employee) 3 EX-10.19 4 dex1019.txt PROMISSORY NOTE EXHIBIT 10.19 PROMISSORY NOTE SECURED BY DEED OF TRUST $2,500,000 June 1, 2001 Palo Alto, California FOR VALUE RECEIVED, the undersigned, DAVID H. BERNSTEIN (referred to herein as "Employee" or "Borrower"), promises to pay to the order of RATIONAL SOFTWARE CORPORATION, a Delaware corporation ("Lender" or the "Company"), at 18880 Homestead Road, Cupertino, CA 95014 (or at such other place as Lender may from time to time designate by written notice to Borrower), or order, in lawful money of the United States, the principal sum of Two Million Five Hundred Thousand Dollars ($2,500,000), together with interest thereon at the rate of zero percent (0%) per annum. RECITALS -------- A. Employee is employed by the Company as its Senior Vice President, Products. B. Employee is in the process of relocating his residence in order for employee to perform his duties as an employee of the company. C. Borrower desires that the Company lend to Borrower the sum of Two Million Five Hundred Thousand Dollars ($2,500,000) to assist Borrower in purchasing a new principal residence. 1. Payment: The principal and interest due pursuant to this Note shall be ------- paid as follows: (a) Upon the occurrence of a Maturity Event (as defined herein), Borrower shall pay to Lender all amounts due under this Note, including all unpaid principal. (b) Subject to Section 3 below, the entire outstanding principal balance of this Note, plus any accrued, but unpaid interest thereon, and any other sum due hereunder shall be due and payable in full on or before the third (3rd) anniversary date of this Note. (c) Principal shall be payable in lawful money of the United States. Each payment shall be applied to reduce principal. (d) All payments made hereunder shall be made by Borrower free and clear of, and without deduction for, any and all present and future taxes, levies, charges, deductions and withholdings. Borrower shall pay upon demand any stamp or other taxes, levies or charges of any jurisdiction with respect to the execution, delivery, performance and enforcement of this Note. 2. Security: This Note is secured by that certain Deed of Trust (the -------- "Deed of Trust") of even date herewith made by Borrower, as trustor, to First American Title Insurance Company, as trustee, for the benefit of Lender, as beneficiary, which shall be recorded in the Official Records of the County of Santa Clara, State of California, encumbering certain real property commonly known as 27240 Natoma Road, in the City of Los Altos Hills and County of Santa Clara,State of California (the "Property"), described with particularity in the Deed of Trust, which Borrower intends to occupy as his principal place of residence. The Deed of Trust provides, among other things, as follows: "If the Trustor (herein the Borrower) shall sell, convey, encumber, grant any lien upon, or otherwise alienate the Property, or any part thereof, or any interest therein, or shall be divested of his title or any interest therein in any manner or way, whether voluntarily or involuntarily, without the written consent of the Beneficiary being first had and obtained, Beneficiary (herein the Lender) shall have the right, at its option, except as prohibited by law, to declare any indebtedness or obligations secured hereby (including, without limitation, the Note), irrespective of the maturity date specified therein, immediately due and payable." 3. Maturity Event: Upon the occurrence of a Maturity Event (as -------------- hereinafter defined), the entire unpaid principal balance, and all other sums due hereunder, shall become immediately due and payable without further demand or notice to Borrower. To the extent permitted by law, any of the following events shall be a "Maturity Event" under this Note and the Deed of Trust: (a) Borrower shall fail to pay any amount of the principal on this Note when due and shall fail to cure such non-payment within ten (10) days following written notice of such delinquency. (b) There shall occur a breach or default in the performance of any obligation of Borrower contained in this Note or the Deed of Trust or any other agreement now or hereafter entered into by Borrower, on the one hand, and the Company, on the other hand. (c) There shall occur a breach or default in the performance of any obligation of Borrower in any other deed of trust or other security instrument (whether superior or subordinate in rights to the Deed of Trust) now or hereafter encumbering the Property. (d) Borrower shall sell, convey, encumber, grant any lien upon, or otherwise alienate the Property, or any part thereof, or any interest therein, or shall be divested of his title or any interest therein in any manner or way, whether voluntarily or involuntarily, without the written consent of the Lender being first had and obtained. (e) Borrower (i) admits in writing his inability to pay debts, (ii) makes an assignment for the benefit of creditors, (iii) files a voluntary petition in bankruptcy, effects a plan or other arrangement with creditors, liquidates his assets under arrangement with creditors, or liquidates his assets under court supervision, (iv) has an involuntary petition in bankruptcy filed against him that is not discharged within sixty (60) days after such petition is filed, or (v) applies for or permits the -2- appointment of a receiver or trustee or custodian for any of his property or assets which shall not have been discharged within sixty (60) days after the date of appointment. (f) The occurrence of the third (3rd) anniversary of the date of this Note. (g) The occurrence of the ninetieth (90th) day following the termination by Employee of his employment with Lender for Cause. For the purposes of this Note, "Cause" shall mean(i) Employee's conviction by, or entry of a plea of guilty or nolo contendere in, a court of competent and final, jurisdiction for any intentional crime which constitutes a felony in the jurisdiction involved; or (ii) Employee's conviction of an act of fraud or misappropriation of material property, subsequent to the date hereof, upon the Company, or any of its respective affiliates. (h) The occurrence of the one hundred eightieth (180th) day following the termination by Employee of his employment to Lender without Cause. (i) Any representation of Borrower contained herein or in any certificate or agreement entered into between Borrower for the benefit of Lender in connection herewith shall prove to be false or misleading in any material respect. (j) The Deed of Trust is not recorded against the Property within sixty (90) days after the closing of the purchase by Borrower of the Property or at any time ceases to be a valid first lien on the Property. (k) Borrower has failed to deliver to Lender, within sixty (90) days after the closing of the purchase by Borrower of the Property a copy of a U.S. FIRPTA certificate, and the state equivalent certificate, executed by seller of the Property, acceptable to Lender and providing that no withholding of any portion of the purchase prices must be withheld. (l) Any lien or other monetary encumbrance is imposed against the Property; provided, however, that in the event that a lien or monetary encumbrance is imposed against the Property without the consent of any Borrower, a Maturity Event shall not occur until the lien or other monetary encumbrance is imposed against the Property for a period of at least thirty (30) days. (m) One (1) year following the death of the Employee. (n) Borrower defaults in his obligation to pay any sum or to perform any obligation, which is secured by a deed of trust, mortgage, lien, or other encumbrance on the Property (other than the Deed of Trust). (o) Borrower shall sell, convey, encumber, grant any lien upon, or otherwise alienate the property located at, and commonly known as, 25 Glezen Lane, Wayland, Massachusetts (the "Massachusetts Property"), or any part thereof, or any interest therein, or shall be divested of his title or any interest therein in any manner or way, whether voluntarily or involuntarily, provided that the entire principal balance shall not be due if Borrower sells the Massachusetts Property with Lender's -3- consent, not to be unreasonably withheld, and one hundred percent (100%) of the net proceeds of such sale are concurrently paid to Lender to reduce the outstanding principal balance of the Note. 4. Late Charge: Because the actual damage to Lender resulting from ----------- any default by Borrower in the payment of any installment of principal when due is impractical and extremely difficult to ascertain, in addition to its other rights and remedies, Lender shall be entitled to recover six percent (1%) of the amount of any such delinquent installment as liquidated damages, if Borrower fails to pay any installment within ten (10) days after Borrower receives written notice from Lender of the amount due and owing. 5. Borrower's Representations: Borrower hereby makes the following -------------------------- representations to the Lender and acknowledges that Lender is relying on such representations in making the loan: (a) Borrower shall have good and marketable title to the Property free and clear of any security interests, liens or encumbrances other than the deed of trust in favor of Lender securing this Note; (b) The consent of no other person or entity is required to grant to Lender the security interest in the Property evidenced by the Deed of Trust. (c) There are no actions, proceedings, claims, or disputes pending or, to the Borrower's knowledge, threatened against or affecting the Borrower, the Property or the Massachusetts Property. (d) Borrower has delivered to Lender true, correct and complete copies of all Loan Documents. (e) Borrower shall use the proceeds of this indebtedness solely for the purpose of purchasing the Property (f) Borrower understands that both the proceeds of this indebtedness and this Note are not transferable by Borrower and are conditioned on the future performance of substantial services by the Employee. (g) The proceeds of this indebtedness shall be used only to purchase a principal residence of Borrower being acquired in connection with the commencement of employment at a "new principal place of work" within the meaning of Section 217 of the Internal Revenue Code of 1986. (h) The Massachusetts Property shall not be converted to business or investment use. 6. Borrower's Additional Obligations: Borrower shall take any and all --------------------------------- further actions that may from time to time be required to ensure that the Deed of Trust creates a valid first priority lien on the Property in favor of the Lender as security for the Note. Borrower shall not further encumber the Property or permit any lien to encumber the Property. Upon request by Lender, but not more frequently than once during any calendar year, Borrower shall furnish evidence reasonably satisfactory to the Lender that: (i) Borrower has good and marketable title to the Property; (ii) the -4- consent of no other person or entity is required to grant a first priority security interest in the Property to the Company; (iii) the Deed of Trust is a first priority security interest in the Property, and (iv) there are no other deeds of trust, mortgages or encumbrances against the Property. If it should be hereafter determined that there are defects against title or matters which could result in defects against title to the Property, or that the consent of another person or entity is required to grant to and perfect in the Lender a valid first-priority lien on the Property, Borrower shall promptly take all action necessary to remove such defects and to obtain such consent and grant (or cause to be granted) and perfect such lien on the Property. Failure of the Deed of Trust to be a valid first lien against the Property shall be deemed a Maturity Event as aforesaid. 7. Notice: This Note is subject to Section 2924(i) and 2966 of the ------ California Civil Code which provides that the holder of this Note shall give written notice to Borrower or his successors-in-interest, of prescribed information (as set forth in said Civil Code Sections) at least ninety (90) days and not more than one hundred and fifty (150) days before any Balloon Payment is due. 8. Attorneys' Fees: In the event of Borrower's default hereunder, --------------- Borrower shall pay all costs of collection, including reasonable attorneys' fees incurred by the holder hereof on account of such collection, whether or not suit is filed hereon. 9. Notices, Addresses and Methods: All notices and other communications ------------------------------ required or permitted hereunder shall be in writing and may be given by (a) personal delivery, (b) certified mail, postage prepaid, return-receipt requested, (c) courier service, fully prepaid for next business day delivery, or (d) facsimile. Any such notice shall be properly addressed Lender at 18880 Homestead Road, Cupertino, CA 95014 or to Borrower at 27240 Natoma, Los Altos Hills CA and shall be deemed to have been given (i) if personally delivered, when delivered, (ii) if by certified mail, return-receipt requested, when delivered or refused, (iii) if by courier service, on the next business day following deposit, cost prepaid, with Federal Express or similar private carrier, or (iv) if by facsimile, instantaneously upon confirmation of receipt of facsimile. The Company or Borrower may change its address by giving notice of the same in accordance with this paragraph. The term "business day" shall mean a day on which national banks are open for business in San Francisco, California. 10. Waiver: The waiver by Lender of any breach of or default under any ------ term, covenant or condition contained herein or in any other agreement referred to above shall not be deemed to be a waiver of any subsequent breach of or default under the same or any other such term, covenant or condition. 11. No Usury: Borrower hereby represents and warrants that at no time -------- shall the proceeds of the indebtedness evidenced hereby be used "primarily for personal, family, or household purposes" as that term is defined and used in Article XV of the California Constitution (as amended from time to time). Anything in this Note to the contrary notwithstanding, it is expressly stipulated and agreed that the intent of Borrower and Lender is to comply at all times with all usury and other laws relating to this Note. If the laws of the State of California would now or hereafter render usurious, or are revised, repealed or judicially interpreted so as to render usurious, any amount called for under this Note, or contracted for, charged or received with respect to the loan evidenced by this Note, or if any prepayment by Borrower results in Borrower having paid any interest in excess of that permitted by -5- law, then it is Borrower's and Lender's express intent that all excess amounts theretofore collected by Lender be credited to the principal balance of this Note (or, if this Note has been paid in full, refunded to Borrower), and the provisions of this Note immediately be deemed reformed and the amounts therefor collectible hereunder reduced, without the necessity of execution of any new document, so as to comply with the then applicable law, but so as to permit the recovery of the fullest amount otherwise called for hereunder. 12. Prepayment: Borrower may prepay all or any portion of this Note at any ---------- time prior to the Maturity Date, with no premium or penalty. 13. No Covenant for Employment or Advances: Employee understands and -------------------------------------- acknowledges that this Note and the underlying indebtedness do not modify Employee's at-will status at the Company and do not constitute an employment agreement or a promise by the Company to continue Employee's employment. Either the Company or Employee may terminate such employment relationship at any time, with or without Cause. 14. General Provisions: This Note shall be governed by and construed in ------------------ accordance with the laws of the State of California. The makers of this Note hereby waive presentment for payment, protest and demand, notice of protest, demand and dishonor and nonpayment of this Note, and consent that Lender may extend the time for payment or otherwise modify the terms of payment or any part of the whole of the debt evidenced by this Note, at the request of any person liable hereon, and such consent shall not alter nor diminish the liability of any person. Borrower hereby waives the defense of the statute of limitations in any action on this Note to the extent permitted by law. Time is of the essence of this Note, the Deed of Trust and any other document executed by Borrower in connection therewith. Liability hereunder shall be joint and several both between Borrower and among all other persons and entities now or hereafter liable for all or any part of the Loan. 15. Acknowledgement by Borrower: THIS NOTE, THE LOAN AGREEMENT, THE DEED --------------------------- OF TRUST, AND ALL RELATED DOCUMENTATION ARE EXECUTED VOLUNTARILY AND WITHOUT ANY DURESS OR UNDUE INFLUENCE ON THE PART OF OR ON BEHALF OF THE PARTIES HERETO, WITH THE FULL INTENT OF CREATING THE OBLIGATIONS AND SECURITY INTERESTS DESCRIBED HEREIN AND THEREIN. THE PARTIES ACKNOWLEDGE THAT: (a) THEY HAVE READ SUCH DOCUMENTATION; (b) THEY HAVE BEEN REPRESENTED IN THE PREPARATION, NEGOTIATION AND EXECUTION OF SUCH DOCUMENTATION BY LEGAL COUNSEL OF THEIR OWN CHOICE; (c) THEY UNDERSTAND THE TERMS AND CONSEQUENCES OF THIS NOTE, THE LOAN AGREEMENT, THE DEED OF TRUST, AND ALL RELATED AGREEMENTS AND DOCUMENTATION AND THE OBLIGATIONS THEY CREATE; AND (d) THEY ARE FULLY AWARE OF THE LEGAL AND BINDING EFFECT OF THIS NOTE, THE DEED OF TRUST AND THE OTHER DOCUMENTS CONTEMPLATED BY OR ENTERED INTO IN CONNECTION WITH THIS NOTE. [Signatures on next page] -6- IN WITNESS WHEREOF, Borrower has executed this Note as of the day and year first above written. /s/ David H. Bernstein ---------------------- DAVID H. BERNSTEIN -7- EX-10.20 5 dex1020.txt STAND-ALONE STOCK OPTION AGREEMENT EXHIBIT 10.20 CataPULSE INC. STAND-ALONE STOCK OPTION AGREEMENT I. NOTICE OF STOCK OPTION GRANT ---------------------------- Michael T. Devlin Address: ___________________________ ____________________________________ You have been granted a Nonstatutory Stock Option to purchase shares (the "Shares") of Common Stock of the Company, subject to the terms and conditions of this Agreement, as follows: Date of Grant December 6, 1999 Vesting Commencement Date December 6, 1999 Exercise Price per Share $0.03 Total Number of Shares Granted 21,111,111 Total Exercise Price $633,333.33 Term/Expiration Date: December 6, 2009 Vesting Schedule: ---------------- This Option shall vest and may be exercised (in accordance with Section 3), in whole or in part, in accordance with the following schedule: 1/48/th/ of the Shares (439,814.8125 Shares) subject to the Option shall vest each month after the Vesting Commencement Date, so that the Option shall be fully vested four (4) years from the Date of Grant, subject to the Optionee continuing to be a Service Provider on such dates. All of the remaining Shares subject to the Option shall vest immediately prior to the closing of a change of control. A "change of control" shall mean a merger or consolidation of the Company with or into another corporation, entity or person (where the stockholders of the Company immediately prior to such merger or consolidation hold less than 50% of the capital stock of the surviving corporation immediately following the merger or consolidation), or the sale of all or substantially all of the Company's assets to another corporation, entity or person. In addition, all of the remaining Shares subject to the Option shall vest if Optionee is not elected as a member of the Company's Board of Directors, is removed (other than for cause) from the Board of Directors or is not reelected to the Board of Directors, unless, in either event, Optionee has voluntarily resigned as an employee of the Company; provided, however that a voluntary resignation from the Board of Directors by Optionee or Optionee's voluntary election to not stand for election to the Board of Directors shall not cause the remaining Shares subject to the Option to vest. Termination Period ------------------ This Option may be exercised, to the extent it is then vested, within three (3) months after Optionee ceases to be a Service Provider in accordance with Section 8 of this Agreement. Upon the death or Disability of the Optionee, this Option may be exercised, to the extent it is then vested, within twelve (12) months after the Optionee ceases to be a Service Provider in accordance with Sections 9 and 10 of this Agreement. In no event shall this Option be exercised later than the Term/Expiration Date provided. II. AGREEMENT --------- 1. Definitions. As used herein, the following definitions shall ----------- apply: (a) "Agreement" means this stock option agreement between the --------- Company and Optionee evidencing the terms and conditions of this Option. (b) "Applicable Laws" means the requirements relating to the --------------- administration of stock options under U.S. state corporate laws, U.S. federal and state securities laws, the Code, any stock exchange or quotation system on which the Common Stock is listed or quoted and the applicable laws of any foreign country or jurisdiction that may apply to this Option. (c) "Board" means the Board of Directors of the Company or any ----- committee of the Board that has been designated by the Board to administer this Agreement. (d) "Code" means the Internal Revenue Code of 1986, as amended. ---- (e) "Common Stock" means the common stock of the Company. ------------ (f) "Company" means CataPULSE Inc., a Delaware corporation. ------- (g) "Consultant" means any person, including an advisor, engaged ---------- by the Company or a Parent or Subsidiary to render services to such entity. (h) "Director" means a member of the Board. -------- (i) "Disability" means total and permanent disability as defined ---------- in Section 22(e)(3) of the Code. (j) "Employee" means any person, including Officers and Directors, -------- employed by the Company or any Parent or Subsidiary of the Company. A Service Provider shall not cease to be an Employee in the case of (i) any leave of absence approved by the Company or (ii) transfers -2- between locations of the Company or between the Company, its Parent, any Subsidiary, or any successor. (k) "Exchange Act" means the Securities Exchange Act of 1934, as ------------ amended. (l) "Fair Market Value" means, as of any date, the value of ----------------- Common Stock determined as follows: (i) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation The Nasdaq National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or system for the last market trading day prior to the time of determination, as reported in The Wall Street Journal or such other source as the Administrator deems reliable; (ii) If the Common Stock is regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean between the high bid and low asked prices for the Common Stock on the last market trading day prior to the day of determination; or (iii) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Board. (m) "Nonstatutory Stock Option" means an Option not intended ------------------------- to qualify as an incentive stock option within the meaning of Section 422 of the Code and the regulations promulgated thereunder. (n) "Notice of Grant" means the written notice, in Part I of --------------- this Agreement, evidencing certain the terms and conditions of this Option. The Notice of Grant is part of the Agreement. (o) "Officer" means a person who is an officer of the Company ------- within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder. (p) "Option" means this stock option. ------ (q) "Optioned Stock" means the Common Stock subject to this -------------- Option. (r) "Optionee" means the person named in the Notice of Grant -------- or such person's successor. (s) "Parent" means a "parent corporation," whether now or ------ hereafter existing, as defined in Section 424(e) of the Code. (t) "Service Provider" means an individual that serves as ---------------- either an Employee, Director or Consultant (as requested by the Company) for at least twenty-five (25) percent of such individual's time. -3- (u) "Share" means a share of the Common Stock, as adjusted in ----- accordance with Section 11 of this Agreement. (v) "Subsidiary" means a "subsidiary corporation", whether ---------- now or hereafter existing, as defined in Section 424(f) of the Code. 2. Grant of Option. The Board hereby grants to the Optionee named in --------------- the Notice of Grant, attached as Part I of this Agreement, the Option to purchase the number of Shares, as set forth in the Notice of Grant, at the exercise price per share set forth in the Notice of Grant (the "Exercise Price"), subject to the terms and conditions of this Agreement. 3. Exercise of Option. ------------------ (a) Right to Exercise. ----------------- (i) Subject to subsections 3(a)(ii) and 3(a)(iii) below, this Option shall be exercisable cumulatively according to the Vesting Schedule set forth in the Notice of Grant. Alternatively, at the election of the Optionee, this Option may be exercised in whole or in part at any time as to Shares that have not yet vested. For purposes of this Agreement, Shares subject to the Option shall vest based on continued employment of Optionee continuing to be a Service Provider with the Company. Vested Shares shall not be subject to the Company's repurchase right (as set forth in the Restricted Stock Purchase Agreement, attached hereto as Exhibit C-1). ----------- (ii) As a condition to exercising this Option for unvested Shares, the Optionee shall execute the Restricted Stock Purchase Agreement. (iii) This Option may not be exercised for a fraction of a Share. (b) Method of Exercise. This Option is exercisable by delivery of ------------------ an exercise notice, in the form attached as Exhibit A (the "Exercise Notice"), --------- which shall state the election to exercise the Option, the number of Shares in respect of which the Option is being exercised (the "Exercised Shares"), and such other representations and agreements as may be required by the Company. The Exercise Notice shall be completed by the Optionee and delivered to Secretary of the Company. The Exercise Notice shall be accompanied by payment of the aggregate Exercise Price as to all Exercised Shares. This Option shall be deemed to be exercised upon receipt by the Company of such fully executed Exercise Notice accompanied by such aggregate Exercise Price. (c) Legal Compliance. No Shares shall be issued pursuant to the ---------------- exercise of this Option unless such issuance and exercise complies with Applicable Laws. Assuming such compliance, for income tax purposes the Exercised Shares shall be considered transferred to the Optionee on the date the Option is exercised with respect to such Exercised Shares. (d) Buyout Provisions. The Board may at any time offer to buy out ----------------- for a payment in cash or Shares an Option previously granted based on such terms and conditions as the Board shall establish and communicate to the Optionee at the time that such offer is made. 4. Optionee's Representations. In the event the Shares have not been -------------------------- registered under the Securities Act of 1933, as amended, at the time this Option is exercised, the Optionee shall, if -4- required by the Company, concurrently with the exercise of all or any portion of this Option, deliver to the Company his or her Investment Representation Statement in the form attached hereto as Exhibit B. --------- 5. Method of Payment. Payment of the aggregate Exercise Price shall ----------------- be by any of the following, or a combination thereof, at the election of the Optionee: (a) cash or check; (b) consideration received by the Company under a cashless exercise program implemented by the Company; or (c) surrender of other Shares which (i) in the case of Shares acquired upon exercise of an option, have been owned by the Optionee for more than six (6) months on the date of surrender, and (ii) have a Fair Market Value on the date of surrender equal to the aggregate Exercise Price of the Exercised Shares. (d) delivery of Optionee's promissory note (the "Note") in the form attached hereto as Exhibit E, in the amount of the aggregate Exercise Price --------- of the Exercised Shares together with the execution and delivery by the Optionee of the Security Agreement attached hereto as Exhibit D. The Note shall bear --------- interest at the "applicable federal rate" prescribed under the Code and its regulations at time of purchase, and shall be secured by a pledge of the Shares purchased by the Note pursuant to the Security Agreement. 6. Non-Transferability of Option. This Option may not be transferred ----------------------------- in any manner otherwise than by will or by the laws of descent or distribution and may be exercised during the lifetime of Optionee only by the Optionee. The terms of this Agreement shall be binding upon the executors, administrators, heirs, successors and assigns of the Optionee. 7. Term of Option. This Option may be exercised only within the term -------------- set out in the Notice of Grant, and may be exercised during such term only in accordance with the terms of this Agreement. 8. Termination of Relationship as a Service Provider. If the Optionee ------------------------------------------------- ceases to be a Service Provider (other than for death or Disability), this Option may be exercised for a period of three (3) months after the date of such termination (but in no event later than the expiration date of this Option as set forth in the Notice of Grant) to the extent that the Option is vested on the date of such termination. To the extent that the Optionee does not exercise this Option within the time specified herein, the Option shall terminate. 9. Disability of Optionee. If the Optionee ceases to be a Service ---------------------- Provider as a result of the Optionee's Disability, this Option may be exercised for a period of twelve (12) months after the date of such termination (but in no event later than the expiration date of this Option as set forth in the Notice of Grant) to the extent that the Option is vested on the date of such termination. To the extent that Optionee does not exercise this Option within the time specified herein, the Option shall terminate. -5- 10. Death of Optionee. If the Optionee dies while a Service Provider, ----------------- the Option may be exercised at any time within twelve (12) months following the date of death (but in no event later than the expiration date of this Option as set forth in the Notice of Grant), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent that the Option is vested on the date of death. If, after death, the Optionee's estate or a person who acquired the right to exercise the Option by bequest or inheritance does not exercise the Option within the time specified herein, the Option shall terminate. 11. Adjustments Upon Changes in Capitalization, Dissolution, Merger or ------------------------------------------------------------------ Asset Sale. - ---------- (a) Changes in Capitalization. Subject to any required action by ------------------------- the stockholders of the Company, the number of shares of Common Stock covered by this Option, as well as the price per share of Common Stock covered by this Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to this Option. (b) Dissolution or Liquidation. In the event of the proposed -------------------------- dissolution or liquidation of the Company, the Board shall notify Optionee as soon as practicable prior to the effective date of such proposed transaction. The Board in its discretion may provide for the Optionee to have the right to exercise his or her Option until fifteen (15) days prior to such transaction as to all of the Optioned Stock covered thereby, including Shares as to which the Option would not otherwise be exercisable. The Board may permit the Option to be exercised contingent upon this transaction. To the extent it has not been previously exercised, the Option will terminate immediately prior to the consummation of such proposed action. 12. Lock-Up Period. Optionee agrees, in connection with the Company's -------------- initial public offering of the Company's securities, (i) not to sell, make short sales of, loan, grant any options for the purchase of, or otherwise dispose of any shares of Common Stock of the Company held by Optionee (other than those shares included in the registration) without the prior written consent of the Company or the underwriters managing such initial underwritten public offering of the Company's securities for up to one hundred eighty (180) days from the effective date of such registration and (ii) further agrees to execute any agreement reflecting (i) above as may be requested by the underwriters at the time of the public offering. 13. Notices. Any notice to be given to the Company hereunder shall be ------- in writing and shall be addressed to the Company at its then current principal executive office or to such other address as the Company may hereafter designate to the Optionee by notice as provided in this Section. Any notice to be given to the Optionee hereunder shall be addressed to the Optionee at the address set forth beneath his signature hereto, or at such other address as the Optionee may hereafter -6- designate to the Company by notice as provided herein. A notice shall be deemed to have been duly given when personally delivered or mailed by registered or certified mail to the party entitled to receive it. 14. Tax Consequences. Some of the federal tax consequences relating to ---------------- this Option, as of the date of this Option, are set forth below. THIS SUMMARY IS NECESSARILY INCOMPLETE, AND THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. THE OPTIONEE SHOULD CONSULT A TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE SHARES. (a) Exercising the Option. The Optionee may incur regular federal --------------------- income tax liability upon exercise of a Nonstatutory Stock Option (an "NSO"). The Optionee will be treated as having received compensation income (taxable at ordinary income tax rates) equal to the excess, if any, of the Fair Market Value of the Exercised Shares on the date of exercise over their aggregate Exercise Price. If the Optionee is an Employee or a former Employee, the Company will be required to withhold from his or her compensation or collect from Optionee and pay to the applicable taxing authorities an amount in cash equal to a percentage of this compensation income at the time of exercise, and may refuse to honor the exercise and refuse to deliver Shares if such withholding amounts are not delivered at the time of exercise. (b) Disposition of Shares. If the Optionee holds NSO Shares for at --------------------- least one year, any gain realized on disposition of the Shares will be treated as long-term capital gain for federal income tax purposes. (c) Section 83(b) Election for Unvested Shares Purchased Pursuant ------------------------------------------------------------- to Options. With respect to the exercise of this Option for unvested Shares, an - ---------- election may be filed by the Optionee with the Internal Revenue Service, within ------ 30 days of the purchase of the Shares, electing pursuant to Section 83(b) of the - ------- Code to be taxed currently on any difference between the purchase price of the Shares and their Fair Market Value on the date of purchase. This will result in a recognition of taxable income to the Optionee on the date of exercise, measured by the excess, if any, of the Fair Market Value of the Shares, at the time the Option is exercised over the purchase price for the Shares. Absent such an election, taxable income will be measured and recognized by Optionee at the time or times on which the Company's repurchase option lapses. Optionee is strongly encouraged to seek the advice of his or her own tax consultants in connection with the purchase of the Shares and the advisability of filing of the Election under Section 83(b) of the Code. A form of Election under Section 83(b) is attached hereto as Exhibit C-5 for reference. ----------- 15. Entire Agreement; Governing Law. This Agreement constitutes the ------------------------------- entire agreement of the parties with respect to the subject matter hereof and supersedes in its entirety all prior undertakings and agreements of the Company and Optionee with respect to the subject matter hereof, and may not be modified adversely to the Optionee's interest except by means of a writing signed by the Company and Optionee. This agreement is governed by the internal substantive laws, but not the choice of law rules, of California 16. NO GUARANTEE OF CONTINUED SERVICE. OPTIONEE ACKNOWLEDGES AND AGREES --------------------------------- THAT THE VESTING OF SHARES PURSUANT TO THE VESTING SCHEDULE HEREOF IS EARNED ONLY BY CONTINUING AS A SERVICE PROVIDER AT -7- THE WILL OF THE COMPANY (AND NOT THROUGH THE ACT OF BEING HIRED, BEING GRANTED AN OPTION OR PURCHASING SHARES HEREUNDER). OPTIONEE FURTHER ACKNOWLEDGES AND AGREES THAT THIS AGREEMENT, THE TRANSACTIONS CONTEMPLATED HEREUNDER AND THE VESTING SCHEDULE SET FORTH HEREIN DO NOT CONSTITUTE AN EXPRESS OR IMPLIED PROMISE OF CONTINUED ENGAGEMENT AS A SERVICE PROVIDER FOR THE VESTING PERIOD, FOR ANY PERIOD, OR AT ALL, AND SHALL NOT INTERFERE WITH OPTIONEE'S RIGHT OR THE COMPANY'S RIGHT TO TERMINATE OPTIONEE'S RELATIONSHIP AS A SERVICE PROVIDER AT ANY TIME, WITH OR WITHOUT CAUSE. By your signature and the signature of the Company's representative below, you and the Company agree that this Option is granted under and governed by the terms and conditions of this Agreement. Optionee has reviewed this Agreement in its entirety, has had an opportunity to obtain the advice of counsel prior to executing this Agreement and fully understands all provisions of this Agreement. Optionee hereby agrees to accept as binding, conclusive and final all decisions or interpretations of the Board upon any questions relating to this Agreement. Optionee further agrees to notify the Company upon any change in the residence address indicated below. OPTIONEE CATAPULSE INC. /s/ Michael T. Devlin /s/ Paul D. Levy - ----------------------------------- ----------------------------------- Signature Paul D. Levy Chief Executive Officer Michael T. Devlin - ----------------------------------- Print Name ___________________________________ Residence Address ___________________________________ ___________________________________ -8- CONSENT OF SPOUSE The undersigned spouse of Optionee has read and hereby approves the terms and conditions of this Agreement. In consideration of the Company's granting his or her spouse the right to purchase Shares as set forth in this Agreement, the undersigned hereby agrees to be irrevocably bound by the terms and conditions of this Agreement and further agrees that any community property interest shall be similarly bound. The undersigned hereby appoints the undersigned's spouse as attorney-in-fact for the undersigned with respect to any amendment or exercise of rights under this Agreement. /s/ Bobbie Devlin ------------------------------------------- Spouse of Optionee EXHIBIT D --------- SECURITY AGREEMENT This Security Agreement is made as of December 6, 1999, between CataPULSE Inc., a Delaware corporation ("Pledgee"), and Michael T. Devlin ("Pledgor"). Recitals -------- Pursuant to Pledgor's election to purchase shares of Pledgee's common stock ("Common Stock") under the Stand-Alone Stock Option Agreement dated December 6, 1999 (the "Option"), between Pledgor and Pledgee, and Pledgor's election under the terms of the Option to pay for such shares with his promissory note (the "Note"), Pledgor has purchased 21,111,111 shares of Pledgee's Common Stock (the "Shares") at a price of $0.03 per share, for a total purchase price of $633,333.33. The Note and the obligations thereunder are as set forth in Exhibit ------- E to the Option. - - NOW, THEREFORE, it is agreed as follows: 1. Creation and Description of Security Interest. In consideration of the --------------------------------------------- transfer of the Shares to Pledgor under the Option Agreement, Pledgor, pursuant to the California Commercial Code, hereby pledges all of such Shares (herein sometimes referred to as the "Collateral") represented by certificate number 3, duly endorsed in blank or with executed stock powers, and herewith delivers said certificate to the Secretary of Pledgee ("Pledgeholder"), who shall hold said certificate subject to the terms and conditions of this Security Agreement. The pledged stock (together with an executed blank stock assignment for use in transferring all or a portion of the Shares to Pledgee if, as and when required pursuant to this Security Agreement) shall be held by the Pledgeholder as security for the repayment of the Note, and any extensions or renewals thereof, to be executed by Pledgor pursuant to the terms of the Option, and the Pledgeholder shall not encumber or dispose of such Shares except in accordance with the provisions of this Security Agreement. 2. Pledgor's Representations and Covenants. To induce Pledgee to enter --------------------------------------- into this Security Agreement, Pledgor represents and covenants to Pledgee, its successors and assigns, as follows: (a) Payment of Indebtedness. Pledgor will pay the principal sum of ----------------------- the Note secured hereby, together with interest thereon, at the time and in the manner provided in the Note. (b) Encumbrances. The Shares are free of all other encumbrances, ------------ defenses and liens, and Pledgor will not further encumber the Shares without the prior written consent of Pledgee. (c) Margin Regulations. In the event that Pledgee's Common Stock is ------------------ now or later becomes margin-listed by the Federal Reserve Board and Pledgee is classified as a "lender" within the meaning of the regulations under Part 207 of Title 12 of the Code of Federal Regulations ("Regulation G"), Pledgor agrees to cooperate with Pledgee in making any amendments to the Note or providing any additional collateral as may be necessary to comply with such regulations. 3. Voting Rights. During the term of this pledge and so long as all ------------- payments of principal and interest are made as they become due under the terms of the Note, Pledgor shall have the right to vote all of the Shares pledged hereunder. 4. Stock Adjustments. In the event that during the term of the pledge any ----------------- stock dividend, reclassification, readjustment or other changes are declared or made in the capital structure of Pledgee, all new, substituted and additional shares or other securities issued by reason of any such change shall be delivered to and held by the Pledgee under the terms of this Security Agreement in the same manner as the Shares originally pledged hereunder. In the event of substitution of such securities, Pledgor, Pledgee and Pledgeholder shall cooperate and execute such documents as are reasonable so as to provide for the substitution of such Collateral and, upon such substitution, references to "Shares" in this Security Agreement shall include the substituted shares of capital stock of Pledgor as a result thereof. 5. Options and Rights. In the event that, during the term of this pledge, ------------------ subscription Options or other rights or options shall be issued in connection with the pledged Shares, such rights, Options and options shall be the property of Pledgor and, if exercised by Pledgor, all new stock or other securities so acquired by Pledgor as it relates to the pledged Shares then held by Pledgeholder shall be immediately delivered to Pledgeholder, to be held under the terms of this Security Agreement in the same manner as the Shares pledged. 6. Default. Pledgor shall be deemed to be in default of the Note and of ------- this Security Agreement in the event: (a) Payment of principal or interest on the Note shall be delinquent for a period of 10 days or more; or (b) Pledgor fails to perform any of the covenants set forth in the Option or contained in this Security Agreement for a period of 10 days after written notice thereof from Pledgee. In the case of an event of Default, as set forth above, Pledgee shall have the right to accelerate payment of the Note upon notice to Pledgor, and Pledgee shall thereafter be entitled to pursue its remedies under the California Commercial Code. 7. Release of Collateral. Subject to any applicable contrary rules under --------------------- Regulation G, there shall be released from this pledge a portion of the pledged Shares held by Pledgeholder hereunder upon payments of the principal of the Note. The number of the pledged Shares which shall be released shall be that number of full Shares which bears the same proportion to the initial number of Shares pledged hereunder as the payment of principal bears to the initial full principal amount of the Note. 8. Withdrawal or Substitution of Collateral. Pledgor shall not sell, ---------------------------------------- withdraw, pledge, substitute or otherwise dispose of all or any part of the Collateral without the prior written consent of Pledgee. 9. Term. This pledge of Shares shall continue until the payment of all ---- indebtedness secured hereby, at which time the remaining pledged stock shall be promptly delivered to Pledgor, subject to the provisions for prior release of a portion of the Collateral as provided in paragraph 7 above. 10. Insolvency. Pledgor agrees that if a bankruptcy or insolvency ---------- proceeding is instituted by or against it, or if a receiver is appointed for the property of Pledgor, or if Pledgor makes an assignment for the benefit of creditors, the entire amount unpaid on the Note shall become immediately due and payable, and Pledgee may proceed as provided in the case of default. 11. Pledgeholder Liability. In the absence of willful or gross negligence, ---------------------- Pledgeholder shall not be liable to any party for any of his acts, or omissions to act, as Pledgeholder. 12. Invalidity of Particular Provisions. Pledgor and Pledgee agree that ----------------------------------- the enforceability or invalidity of any provision or provisions of this Security Agreement shall not render any other provision or provisions herein contained unenforceable or invalid. 13. Successors or Assigns. Pledgor and Pledgee agree that all of the terms --------------------- of this Security Agreement shall be binding on their respective successors and assigns, and that the term "Pledgor" and the term "Pledgee" as used herein shall be deemed to include, for all purposes, the respective designees, successors, assigns, heirs, executors and administrators. 14. Governing Law. This Security Agreement shall be interpreted and ------------- governed under the internal substantive laws, but not the choice of law rules, of California. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. PLEDGOR /s/ Michael T. Devlin ----------------------------------- Signature Michael T. Devlin ----------------------------------- Print Name Address: ___________________________________ ___________________________________ PLEDGEE CATAPULSE INC., a Delaware corporation /s/ Paul D. Levy ----------------------------------- Paul D. Levy Chief Executive Officer PLEDGEHOLDER /s/ Michael Charney ----------------------------------- Assistant Secretary of CataPULSE Inc. EXHIBIT E --------- NOTE $633,333.33 Cupertino, California December 6, 1999 FOR VALUE RECEIVED, Michael T. Devlin promises to pay to CataPULSE Inc., a Delaware corporation (the "Company"), or order, the principal sum of Six Hundred Thirty Three Thousand Three Hundred Thirty Three Dollars and Thirty Three Cents ($633,333.33), together with interest on the unpaid principal hereof from the date hereof at the rate of 6.11 percent (6.11%) per annum, compounded ----- semiannually. Principal and interest shall be due and payable on December 6, 2004. Payment of principal and interest shall be made in lawful money of the United States of America. The undersigned may at any time prepay all or any portion of the principal or interest owing hereunder. This Note is subject to the terms of the Stand-Alone Stock Option Agreement, dated as of December 6, 1999. This Note is secured in part by a pledge of the Company's common stock under the terms of a Security Agreement of even date herewith and is subject to all the provisions thereof. The holder of this Note shall have full recourse against the undersigned, and shall not be required to proceed against the collateral securing this Note in the event of default. In the event the undersigned shall cease to be an employee, director or consultant of the Company for any reason, this Note shall, at the option of the Company, be accelerated, and the whole unpaid balance on this Note of principal and accrued interest shall be immediately due and payable. Should any action be instituted for the collection of this Note, the reasonable costs and attorneys' fees therein of the holder shall be paid by the undersigned. /s/ Michael T. Devlin ----------------------------------- Michael T. Devlin EX-10.21 6 dex1021.txt SECURITY AGREEMENT EXHIBIT 10.21 CATAPULSE, INC. SECURITY AGREEMENT This Security Agreement is made as of March 1, 2000 between Catapulse, Inc., a Delaware corporation ("Pledgee"), and Allison R. Schleicher ("Pledgor"). Recitals -------- Pursuant to Pledgor's election to purchase Shares under the Option Agreement dated December 6, 1999 (the "Option"), between Pledgor and Pledgee under Pledgee's 1999 Stock Plan, and Pledgor's election under the terms of the Option to pay for such shares with his promissory note (the "Note"), Pledgor has purchased 400,000 shares of Pledgee's Common Stock (the "Shares") at a price of $.03 per share, for a total purchase price of $12,000.00 The Note and the obligations thereunder are as set forth in Exhibit C to the Option. NOW, THEREFORE, it is agreed as follows: 1. Creation and Description of Security Interest. In consideration --------------------------------------------- of the transfer of the Shares to Pledgor under the Option Agreement, Pledgor, pursuant to the California Commercial Code, hereby pledges all of such Shares (herein sometimes referred to as the "Collateral") represented by certificate number TBD, duly endorsed in blank or with executed stock powers, and herewith delivers said certificate to the Secretary of Pledgee ("Pledgeholder"), who shall hold said certificate subject to the terms and conditions of this Security Agreement. The pledged stock (together with an executed blank stock assignment for use in transferring all or a portion of the Shares to Pledgee if, as and when required pursuant to this Security Agreement) shall be held by the Pledgeholder as security for the repayment of the Note, and any extensions or renewals thereof, to be executed by Pledgor pursuant to the terms of the Option, and the Pledgeholder shall not encumber or dispose of such Shares except in accordance with the provisions of this Security Agreement. 2. Pledgor's Representations and Covenants. To induce Pledgee to --------------------------------------- enter into this Security Agreement, Pledgor represents and covenants to Pledgee, its successors and assigns, as follows: (a) Payment of Indebtedness. Pledgor will pay the principal sum of ----------------------- the Note secured hereby, together with interest thereon, at the time and in the manner provided in the Note. (b) Encumbrances. The Shares are free of all other encumbrances, ------------ defenses and liens, and Pledgor will not further encumber the Shares without the prior written consent of Pledgee. (c) Margin Regulations. In the event that Pledgee's Common Stock is ------------------ now or later becomes margin-listed by the Federal Reserve Board and Pledgee is classified as a "lender" within the meaning of the regulations under Part 207 of Title 12 of the Code of Federal Regulations ("Regulation G"), Pledgor agrees to cooperate with Pledgee in making any amendments to the Note or providing any additional collateral as may be necessary to comply with such regulations. 3. Voting Rights. During the term of this pledge and so long as all ------------- payments of principal and interest are made as they become due under the terms of the Note, Pledgor shall have the right to vote all of the Shares pledged hereunder. 4. Stock Adjustments. In the event that during the term of the ----------------- pledge any stock dividend, reclassification, readjustment or other changes are declared or made in the capital structure of Pledgee, all new, substituted and additional shares or other securities issued by reason of any such change shall be delivered to and held by the Pledgee under the terms of this Security Agreement in the same manner as the Shares originally pledged hereunder. In the event of substitution of such securities, Pledgor, Pledgee and Pledgeholder shall cooperate and execute such documents as are reasonable so as to provide for the substitution of such Collateral and, upon such substitution, references to "Shares" in this Security Agreement shall include the substituted shares of capital stock of Pledgor as a result thereof. 5. Options and Rights. In the event that, during the term of this ------------------ pledge, subscription Options or other rights or options shall be issued in connection with the pledged Shares, such rights, Options and options shall be the property of Pledgor and, if exercised by Pledgor, all new stock or other securities so acquired by Pledgor as it relates to the pledged Shares then held by Pledgeholder shall be immediately delivered to Pledgeholder, to be held under the terms of this Security Agreement in the same manner as the Shares pledged. 6. Default. Pledgor shall be deemed to be in default of the Note and ------- of this Security Agreement in the event: (a) Payment of principal or interest on the Note shall be delinquent for a period of 10 days or more; or (b) Pledgor fails to perform any of the covenants set forth in the Option or contained in this Security Agreement for a period of 10 days after written notice thereof from Pledgee. In the case of an event of Default, as set forth above, Pledgee shall have the right to accelerate payment of the Note upon notice to Pledgor, and Pledgee shall thereafter be entitled to pursue its remedies under the [state] Commercial Code. 7. Release of Collateral. Subject to any applicable contrary rules --------------------- under Regulation G, there shall be released from this pledge a portion of the pledged Shares held by Pledgeholder hereunder upon payments of the principal of the Note. The number of the pledged Shares which shall be released shall be that number of full Shares which bears the same proportion to the initial -2- number of Shares pledged hereunder as the payment of principal bears to the initial full principal amount of the Note. 8. Withdrawal or Substitution of Collateral. Pledgor shall not sell, ---------------------------------------- withdraw, pledge, substitute or otherwise dispose of all or any part of the Collateral without the prior written consent of Pledgee. 9. Term. The within pledge of Shares shall continue until the ---- payment of all indebtedness secured hereby, at which time the remaining pledged stock shall be promptly delivered to Pledgor, subject to the provisions for prior release of a portion of the Collateral as provided in paragraph 7 above. 10. Insolvency. Pledgor agrees that if a bankruptcy or insolvency ---------- proceeding is instituted by or against it, or if a receiver is appointed for the property of Pledgor, or if Pledgor makes an assignment for the benefit of creditors, the entire amount unpaid on the Note shall become immediately due and payable, and Pledgee may proceed as provided in the case of default. 11. Pledgeholder Liability. In the absence of willful or gross ---------------------- negligence, Pledgeholder shall not be liable to any party for any of his acts, or omissions to act, as Pledgeholder. 12. Invalidity of Particular Provisions. Pledgor and Pledgee agree ----------------------------------- that the enforceability or invalidity of any provision or provisions of this Security Agreement shall not render any other provision or provisions herein contained unenforceable or invalid. 13. Successors or Assigns. Pledgor and Pledgee agree that all of the --------------------- terms of this Security Agreement shall be binding on their respective successors and assigns, and that the term "Pledgor" and the term "Pledgee" as used herein shall be deemed to include, for all purposes, the respective designees, successors, assigns, heirs, executors and administrators. 14. Governing Law. This Security Agreement shall be interpreted and ------------- governed under the internal substantive laws, but not the choice of law rules, of California. -3- IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. "PLEDGOR" /s/ Allison R. Schleicher -------------------------------------- Signature ALLISON R. SCHLEICHER -------------------------------------- Print Name Address: 1080 STONEBRIDGE DR. --------------------------- NAPA, CA 94558 --------------------------- "PLEDGEE" CATAPULSE, INC. a Delaware corporation /s/ Paul D. Levy -------------------------------------- Signature Paul D. Levy -------------------------------------- Print Name Chief Executive Officer -------------------------------------- Title "PLEDGEHOLDER" /s/ Elizabeth Jordan -------------------------------------- Secretary of CATAPULSE, INC. -4- EXHIBIT C --------- NOTE $12,000.00 Cupertino, California March 1, 2000 FOR VALUE RECEIVED, Allison R. Schleicher promises to pay to CATAPULSE, INC., a Delaware corporation (the "Company"), or order, the principal sum of Twelve Thousand Dollars ($12,000.00), together with interest on the unpaid principal hereof from the date hereof at the rate of ____________ percent (6.11%) per annum, compounded semiannually. Principal and interest shall be due and payable on March 1, 2005. Payment ------- ----- of principal and interest shall be made in lawful money of the United States of America. The undersigned may at any time prepay all or any portion of the principal or interest owing hereunder. This Note is subject to the terms of the Option, dated as of December 6, 1999. This Note is secured in part by a pledge of the Company's Common Stock under the terms of a Security Agreement of even date herewith and is subject to all the provisions thereof. The holder of this Note shall have full recourse against the undersigned, and shall not be required to proceed against the collateral securing this Note in the event of default. In the event the undersigned shall cease to be an employee, director or consultant of the Company for any reason, this Note shall, at the option of the Company, be accelerated, and the whole unpaid balance on this Note of principal and accrued interest shall be immediately due and payable. Should any action be instituted for the collection of this Note, the reasonable costs and attorneys' fees therein of the holder shall be paid by the undersigned. /s/ Allison R. Schleicher ------------------------------------- 3/1/00 ------------------------------------- -5- EX-21.1 7 dex211.txt SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.1 LIST OF WHOLLY OWNED SUBSIDIARIES RATIONAL SOFTWARE CORPORATION
Name Jurisdiction of Incorporation - ---- ----------------------------- Rational Software Holdings LLC Delaware Rational Software Technology Corporation Delaware Rational Software SPC LLC Delaware Rational International California Rational Software Canada Co. Canada Rational Software Limited United Kingdom Rational Software SARL France Rational Software GmbH Germany Rational Software B.V. Netherlands Rational Software N.V. Belgium Rational Software Nordic AB Sweden Rational Software Finland Oy Finland Rational Software Norway AS Norway Rational Software Denmark A/S Denmark Rational Software Schweiz GmbH Switzerland Rational Software s.r.l. Italy Rational Software Austria GmbH Austria Rational Software Spain S.R.L. Spain Rational Software Ireland Limited Ireland Rational Holding SARL France Attol Testware SA France Rational Software Israel Ltd. Israel Rational Software Pty Ltd. Australia Rational Software Pte Ltd. Singapore Rational Software Korea Ltd. Korea Rational Software Corp. (India) Pvt. Ltd. India Rational Software New Zealand New Zealand Rational Software Greater China Ltd. Hong Kong Nihon Rational Software K.K. Japan Rational Software Sdn Bhd Malaysia Rational Software Do Brasil Ltda. Brazil Rational Software S.A. de C.V. Mexico
EX-23.1 8 dex231.txt CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We have audited the consolidated financial statements of Rational Software Corporation as of March 31, 2001 and 2000, and for each of the three years in the period ended March 31, 2001, and have issued our report thereon dated April 16, 2001 (included elsewhere in the Annual Report on Form 10-K). Our audits also included the financial statement schedule of Rational Software Corporation listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the registration statements (Form S-3 No. 333-36128, No. 333-37506, No. 333-58636) pertaining to the 5% Convertible Subordinated Notes due 2007, acquisition of ObjecTime Limited, acquisition of Attol Testware and in the registration statements (Form S-8 No. 33-77382, No. 33-85906, No. 33-97042, No. 33-97044, No. 333- 15015, No. 333-21563, No. 333-22687, No. 333-25815, No. 333-31505, No. 333- 32991, No. 333-39569, No. 333-45393, No. 333-52017, No. 333-60579, No. 333-70989, No. 333-84655, No. 333-89089, No. 333-94819, No. 333-37374, No. 333-43350, No. 333-49778, No. 333-55688, No. 333-60848) pertaining to the Rational 1983 Incentive Stock Option Plan, Verdix Corporation 1983 Incentive Stock Option Plan, Verdix Corporation 1986 Stock Option Plan, Rational 1993 Stock Option Plan, Rational Software Corporation 1994 Stock Option Plan, Requisite, Inc., 1994 Stock Option Plan, SQA 1995 Stock Plan, SQA 1995 Non- Employee Director Stock Option Plan, SQA 1990 Incentive and Nonqualified Stock Option Plan, Rational Software Corporation 1997 Stock Plan, Performance Awareness Corporation 1997 Stock Plan, Rational Software Corporation 1997 Supplemental Stock Plan, Pure Atria 1995 Stock Plan, Pure Software, Inc. 1992 Stock Option/Stock Issuance Plan, Atria Software, Inc. 1994 Stock Plan, Atria Software, Inc. 1990 Stock Option Plan, Integrity QA Software, Inc. 1995 Stock Option Plan, Vigor Technology, Inc. 1996 Stock Option Plan, Rational Software Corporation 1998 Indian Stock Option Plan, Rational Software Corporation 1998 Employee Stock Purchase Plan, Rational Software Corporation Directors Stock Option Plan, ObjecTime Limited U.S. Stock Option Plan (1997), ObjecTime Limited Canadian Stock Option Plan (1997), ObjecTime Limited 1998 U.S. Stock Option Plan, ObjecTime Limited 1998 Canadian Stock Option Plan, Rational Software Corporation 2000 Director Option Plan, and Catapulse Inc. 1999 Stock Plan of our report dated April 16, 2001, with respect to the consolidated financial statements included herein and our report included in the preceding paragraph with respect to the financial statement schedule included in this annual report (Form 10-K) of Rational Software Corporation. /s/ Ernst & Young LLP Palo Alto, California June 15, 2001 -----END PRIVACY-ENHANCED MESSAGE-----