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Management's Discussion and Analysis of Financial Condition and Results of Operations


Overview

This Annual Report to Shareholders contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "expects," "anticipates," "intends," "plans," "estimates," or similar expressions are intended to identify these forward-looking statements. These statements are based on the Company's current plans and expectations and involve risks and uncertainties that could cause actual future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual future activities and results to differ include, among others, the need to attract and retain professional staff, the Company's ability to manage growth, possible variations in the Company's quarterly operating results, the Company's dependence on renewals of its membership-based research services and on key personnel, and risks associated with the Company's ability to anticipate market trends and offer new products and services, and competition. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. For further information, please refer to the Company's reports and filings with the Securities and Exchange Commission.

Forrester has experienced year-to-year revenue growth every year since its inception in 1983, and the Company's total revenues increased to $25.0 million in 1996 from $14.6 million in 1995. Forrester attributes its growth to the Company's continuing reputation for quality research and services, accurate analysis of technology industry developments, the introduction of new products and services, and the expansion of the Company's sales and marketing organization. In addition, the Company believes the speed of technology change and the increasingly participatory nature of technology decisions have led to a growing market need for independent research and analysis on the impact of technology on large enterprises, consumers, and society.

Revenues from core research also increased to $18.2 million in 1996 from $10.1 million in 1995 and increased as a percentage of total revenues to 73% in 1996 from 70% in 1995. Forrester attributes this growth to, in addition to the factors cited above, an increase in total Strategy Research Services offered - from six in 1995 to a total of 10 Strategy Research Services as of December 31, 1996.

Memberships to Forrester's Strategy Research Services are renewable contracts, typically annual and payable in advance. Accordingly, a substantial portion of the Company's billings are initially recorded as deferred revenue and recognized pro rata on a monthly basis over the contract period. The Company's other revenues are derived from advisory services rendered pursuant to Forrester's Partners Program and Strategy Review Program and from the Forrester Technology Management Forum (the "Forum"). The Company's advisory service clients purchase such services in conjunction with the purchase of core research memberships to Strategy Research Services, and the contracts for such purchases are also generally payable in advance. Billings attributable to advisory services are initially recorded as deferred revenues and recognized as revenue when performed. Similarly, Forum billings are initially recorded as deferred revenues and are recognized upon completion of the event.

The Company's operating expenses consist of cost of services and fulfillment, selling and marketing expenses, general and administrative expenses, and depreciation and amortization. Cost of services and fulfillment represent the costs associated with production and delivery of the Company's products and services, and include the costs of salaries, bonuses, and related benefits for research personnel, and all associated editorial, travel, and support services. Selling and marketing expenses include salaries, employee benefits, travel expenses, promotional costs, and sales commissions, which are deferred when paid and expensed as the related revenue is recognized. General and administrative expenses include the costs of the finance, operations, and corporate IT groups, and other administrative functions of the Company.

The Company has had income from operations in each of the last six years from 1991 through 1996. Income from operations rose 129% to $4.1 million in 1996 from $1.8 million in 1995.

The Company was an S corporation under section 1362 of the Internal Revenue Code of 1986, as amended, until prior to the closing of its initial public offering. As an S corporation, the taxable income of the Company was passed through to the sole stockholder and was reported on his individual federal and state income tax returns. The Company is now taxed as a C corporation and accordingly is subject to federal and state income taxes at prevailing corporate rates. The statements for each of the three years ended December 31, 1994, 1995, and 1996 include a pro forma income tax adjustment for the income taxes that would have been recorded if the Company had been a C corporation for those periods. The Company has calculated these amounts based on an estimated effective tax rate for the respective periods. Upon termination of the S corporation election, the Company recorded a net deferred income tax liability, reflecting the tax effect of cumulative differences between the financial reporting and tax bases of certain assets and liabilities, of approximately $510,000 as a one-time increase in the actual tax provision during 1996.

The Company believes that the "agreement value" of contracts to purchase core research and advisory services provides a significant measure of the Company's business volume. Forrester calculates agreement value as the annualized fees payable under all core research and advisory services contracts in effect at a given point in time, without regard to the remaining duration of such contracts. Agreement value increased 69% to $30.0 million at December 31, 1996 from $17.8 million at December 31, 1995. The Company's experience is that a substantial portion of client companies renew expiring contracts for an equal or higher level of total core research and advisory service fees each year. Approximately 74% and 71% of Forrester's client companies with memberships expiring during 1996 and 1995, respectively, renewed one or more memberships for the Company's products and services, although these renewal rates are not necessarily indicative of the rate of future retention of the Company's revenue base. The number of client companies increased to 885 at December 31, 1996 from 799 at December 31, 1995, and no single client company accounted for over 3% of the Company's revenues in 1996 or over 4% of the Company's revenues in 1995.

Results of Operations The following table sets forth certain financial data as a percentage of total revenues for the periods indicated:

Year Ended December 31, 1994 1995 1996

Core research 66% 70% 73%
Advisory services and other 34 30 27

Total revenues 100 100 100
 
Cost of services and fulfillment 35 37 35
Selling and marketing 37 39 36
General and administrative 10 9 10
Depreciation and amortization 2 2 3

Income from operations 16 13 16
Interest income 1 2 3

Income before state income tax provision 17 15 19
Provision for income taxes 1 1 3

Net income 16% 14% 16%

Pro forma income tax adjustment 6 5 5

Pro forma net income 10% 9% 11%


Years Ended December 31, 1996 and December 31, 1995

Revenues. Total revenues increased 71% to $25.0 million in the year ended December 31, 1996 from $14.6 million in the year ended December 31, 1995. Revenues from core research increased 79% to $18.2 million in the year ended December 31, 1996 from $10.1 million in the year ended December 31, 1995. Increases in total revenues and revenues from core research were primarily attributable to an increase in the number of clients, the introduction of four new Strategy Research Services, and continued expansion and increased productivity of the Company's sales force.

Advisory services and other revenues increased 52% to $6.8 million in the year ended December 31, 1996 from $4.4 million in the year ended December 31, 1995. This increase was primarily attributable to demand for the Partners and Strategy Review Programs.

Revenues attributable to customers outside the United States increased 106% to $5.3 million in the year ended December 31, 1996 from $2.6 million in the year ended December 31, 1995, and also increased as a percentage of total revenues to 21% for the year ended December 31, 1996 from 18% for the year ended December 31, 1995. The increase was due primarily to the addition of direct international sales personnel. The Company invoices its international clients in U.S. dollars.

Agreement value grew to $30.0 million at December 31, 1996 from $17.8 million at December 31, 1995. No single client company accounted for more than 2% of agreement value at December 31, 1996 or 3% of revenues for the year ended December 31, 1996.

Cost of Services and Fulfillment. Cost of services and fulfillment decreased as a percentage of total revenues to 35% in the year ended December 31, 1996 from 37% in the year ended December 31, 1995. These expenses increased 60% to $8.8 million in the year ended December 31, 1996 from $5.5 million in the year ended December 31, 1995. The expense increase in this period was principally due to increased analyst staffing for Strategy Research Services and related compensation expense. The decrease as a percentage of total revenues was principally due to the Company's increased leverage of its core research services.

Selling and Marketing. Selling and marketing expenses decreased as a percentage of total revenues to 36% in the year ended December 31, 1996 from 39% in the year ended December 31, 1995. These expenses increased 59% to $9.0 million in the year ended December 31, 1996 from $5.6 million in the year ended December 31, 1995. The increase in expenses was principally due to the addition of direct salespersons and increased sales commission expense associated with increased revenues. The decrease as a percentage of total revenues was principally due to increased productivity of the Company's direct sales force.

General and Administrative. General and administrative expenses increased as a percentage of total revenues to 10% in the year ended December 31, 1996 from 9% in the year ended December 31, 1995. These expenses increased 81% to $2.5 million in the year ended December 31, 1996 from $1.4 million in the year ended December 31, 1995. The increase in expenses was principally due to staffing increases in operations and IT and higher costs associated with the expansion of the Company's Cambridge headquarters.

Depreciation and Amortization. Depreciation and amortization expense increased 115% to $618,000 in the year ended December 31, 1996 from $287,000 in the year ended December 31, 1995. The increase in this expense was principally due to purchases of computer equipment, software, and office furnishings to support business growth, and the expansion of the Company's Cambridge headquarters.

Interest Income. Interest income increased to $634,000 in the year ended December 31, 1996 from $340,000 in the year ended December 31, 1995 due to an increase in the Company's cash balances resulting from positive cash flows from operations and net proceeds from the Company's initial public offering.


Years Ended December 31, 1995 and 1994

Revenues. Total revenues increased 50% to $14.6 million in 1995 from $9.7 million in 1994. Revenues from core research increased 59% to $10.1 million in 1995 from $6.4 million in 1994. The increases in total revenues and revenues from core research were primarily attributable to an increase in the number of clients, the introduction of new Strategy Research Services, continued expansion and increased productivity of the Company's sales force, and growing market acceptance of the Company's products. The Company introduced two new Strategy Research Services in 1995 and one new Strategy Research Service in 1994.

Advisory services and other revenues increased 33% to $4.4 million in 1995 from $3.3 million in 1994. The increase in advisory services and other revenues was primarily attributable to demand for the Company's advisory services. The decrease of these revenues as a percentage of total revenues to 30% in 1995 from 34% in 1994 reflects the results of the Company's strategy to expand sales of its core research.

Revenues attributable to sales to customers outside the United States increased 61% to $2.6 million in 1995 from $1.6 million in 1994. International sales represented 18% and 16% of total revenue for 1995 and 1994, respectively. The increase was due primarily to the Company's expansion of its direct international sales force during 1995.

Agreement value grew 74% to $17.8 million at December 31, 1995 from $10.2 million at December 31, 1994.

Cost of Services and Fulfillment. Cost of services and fulfillment increased as a percentage of total revenues to 37% in 1995 from 35% in 1994. These costs increased 60% to $5.5 million in 1995 from $3.4 million in 1994. The increase was principally due to investment in new Strategy Research Services and resultant increased analyst staffing and related compensation expense.

Selling and Marketing. Selling and marketing expenses increased as a percentage of total revenues to 39% in 1995 from 37% in 1994. These expenses increased 57% to $5.6 million in 1995 from $3.6 million in 1994. The increase in expenses was principally due to the addition of direct salespersons and marketing personnel and increased sales commissions resulting from increased revenues.

General and Administrative. General and administrative expenses decreased as a percentage of total revenues to 9% in 1995 from 10% in 1994. These expenses increased 33% to $1.4 million in 1995 from $1.0 million in 1994. The increase in expenses was principally due to staffing increases in operations and IT, higher costs associated with the Company's new Cambridge headquarters, and investment in the Company's internal IT systems.

Depreciation and Amortization. Depreciation and amortization expense increased 91% to $287,000 in 1995 from $150,000 in 1994. The increase in this expense was principally due to purchases of computer equipment, software, and office furnishings to support business growth and the Company's move to its new Cambridge headquarters and expansion thereof.

Interest Income. Interest income increased 171% to $340,000 in 1995 from $125,000 in 1994. This increase resulted primarily from an increase in the Company's cash balances resulting from positive cash flows from operations.


Liquidity and Capital Resources

The Company has financed its operations to date through funds generated from operations. Memberships for core research, which constituted approximately 73% of the Company's revenues for the year ended December 31, 1996, are annually renewable and are generally payable in advance. These up-front payment terms together with historical year-to-year revenue growth have allowed the Company to generate positive cash flows each year since 1984, one year after its inception in 1983. The Company generated $11.3 million in cash from operating activities during 1996 compared with $4.5 million of cash from operating activities during 1995.

The Company's revenues, earnings, and cash flows may fluctuate from quarter to quarter based on a variety of factors including the timing and size of new and renewal memberships from clients, the timing of revenue-generating events sponsored by the Company, the utilization of its advisory services, the hiring and training of new analysts and sales personnel, changes in demand for the Company's research, and general economic conditions. As a result, the Company's operating results in future quarters may be below the expectations of securities analysts and investors which could have a material adverse effect on the market price for the Company's common stock.

In 1996, the Company used $5.5 million of cash in investing activities, consisting of $2.0 million for the purchase of property and equipment and $3.5 million for net purchases of marketable securities. The Company regularly invests excess funds in short -- and intermediate-term interest-bearing obligations of investment grade.

In 1996, the Company generated a net $27.7 million in cash from financing activities. This includes net proceeds of $33.2 million (net of underwriting discount and offering expenses) to the Company from the sale of 2,300,000 shares of common stock in its initial public offering at a price of $16.00 per share, and less a $5.6 million distribution to its sole stockholder prior to the offering, for undistributed S corporation earnings. The Company expects to use the net proceeds of the initial offering for working capital and general corporate purposes, including possible acquisitions. The Company currently has no commitments or agreements with respect to any specific acquisition. Pending such uses, the Company intends to invest the net proceeds primarily in short- and intermediate-term interest-bearing obligations of investment grade.

As of December 31, 1996, the Company had cash and cash equivalents of $34.4 million and $10.3 million in marketable securities. The Company does not have a line of credit and does not anticipate the need for one in the foreseeable future. The Company currently has no material capital commitments and does not foresee that capital expenditures will increase substantially during the next two years. The Company believes that its current cash balance, marketable securities, and cash flows from operations will satisfy working capital, financing activities, and capital expenditure requirements for at least the next two years.