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Notes to Consolidated Financial Statments


Index:


(1) Operations and Significant Accounting Policies

Forrester Research, Inc. (the Company) creates, publishes and sells technology research reports and provides advisory services and technology conferences. The Company is incorporated under the laws of the State of Delaware and grants credit to its customers with locations throughout the world.

The preparation of the accompanying consolidated financial statements required the use of certain estimates by management in determining the Company's assets, liabilities, revenues and expenses. Actual results could differ from these estimates.

The accompanying consolidated financial statements reflect the application of certain significant accounting policies as described below and elsewhere in the accompanying financial statements and notes.

Principles of Consolidation

The accompanying consolidated financial statements as of and for the year ended December 31, 1996 include the accounts of the Company and its wholly owned subsidiary, Whitcomb Investments, Inc., a Massachusetts corporation. All significant intercompany balances have been eliminated in consolidation.

Revenue Recognition

The Company invoices its core research, advisory and other services when an order is received. The gross amount is recorded as accounts receivable and deferred revenue when the client is legally obligated to pay the invoice. Core research, which represents monthly distribution of research reports, is recorded as revenue ratably over the term of the agreement as the research is delivered. Advisory and other services are recognized during the period in which the services are performed.

Deferred Commissions

Commissions incurred in acquiring new or renewal contracts are deferred and amortized as the related revenue is recognized. The Company evaluates the recoverability of deferred commissions at each balance sheet date based on the status of the related contract.

Pro Forma Net Income Per Common Share

Pro forma net income per common share is computed by dividing pro forma net income (reflecting the pro forma income tax adjustment discussed in Note 3) by the weighted average number of shares of common stock and common stock equivalents outstanding during the period, adjusted for the reincorporation discussed in Note 6. Common stock equivalents consist of common stock issuable on the exercise of outstanding options. In accordance with Securities and Exchange Commission requirements, all common stock and common stock equivalents issued during the 12 months pre-ceding an initial public offering have been included in the net income per share computation as if they were outstanding for all periods using the treasury stock method.

Depreciation

The Company provides for depreciation, computed using the straight-line method, by charges to income in amounts that allocate the costs of these assets over their estimated useful lives as follows:

  Estimated
Useful Life

Computers and equipment 3 to 5 Years
Furniture and fixtures 7 Years
Computer software 3 Years
Vehicles 5 Years
Leasehold improvements Life of lease

Product Development

All costs associated with the development of new products and services are expensed as incurred.

Concentration of Credit Risk

Statement of Financial Accounting Standards (SFAS) No. 105, Disclosure of Information About Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. Financial instruments that potentially subject the Company to concentrations of credit risk are principally cash and cash equivalents, marketable securities and accounts receivable. The Company places its investments in highly rated institutions. No single customer accounted for greater than 10% of revenues in any of the periods presented.

Financial Instruments

SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure about fair value of financial instruments. Financial instruments consist of cash equivalents, marketable securities and accounts receivable. The estimated fair value of these financial instruments approximates their carrying value and, except for accounts receivable, is based primarily on market quotes. The Company's cash equivalents and marketable securities are generally obligations of the federal government or municipal issuers.

Notes Index


(2) Cash, Cash Equivalents and Marketable Securities

The Company considers all short-term, highly liquid investments with original maturities of 90 days or less to be cash equivalents.

The Company accounts for investments in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under SFAS No. 115, securities that the Company has the positive intent and ability to hold to maturity are reported at amortized cost and are classified as held-to-maturity. At December 31, 1995 and 1996, held-to-maturity securities consisted of investments in U.S. Treasury bills, which were recorded at cost approximating their fair market value. These investments are classified as current since they mature within one year. Securities purchased in order to be held for indefinite periods of time and not intended at the time of purchase to be held until maturity are classified as available-for-sale securities. At December 31, 1995 and 1996, these securities consisted of investments in federal and state government obligations, which were recorded at fair market value, with any unrealized gains and losses reported as a separate component of stockholders' equity. These investments were classified as current at December 31, 1995 and 1996 as it is the Company's intent to hold these securities less than one year. Securities that are bought and held principally for the purpose of selling in the near term are classified as trading securities. There were no trading securities as of December 31, 1995 and 1996.

At December 31, 1995 and 1996 marketable securities consisted of the following:
  1995 1996

U.S. Treasury bills $3,876,100 $03,473,694
U.S. Treasury notes 613,456 2,510,155
Federal agency obligations 309,255 854,214
State and municipal bonds 1,721,670 3,419,654

  $6,520,481 $10,257,717
 

The following table summarizes the maturity periods of marketable securities as of December 31, 1996:
  Less than
1 Year
1 to 5
Years
5 to 10
Years
Total

U.S. Treasury bills $3,473,694 $       - $        - $03,473,694
U.S. Treasury notes - 2,006,875 503,280 2,510,155
Federal agency obligations - 445,601 408,613 854,214
State and municipal bonds - 1,887,497 1,532,157 3,419,654

  $3,473,694 $4,339,973 $2,444,050 $10,257,717
 
Gross realized gains and losses on sales of marketable securities for the years ended December 31, 1995 and 1996, which were calculated based on specific identification, were not material.

Notes Index


(3) Income Taxes

The Company accounts for income taxes, including pro forma computations, in accordance with SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 prescribes an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities.

The Company was an S corporation under Section 1362 of the Internal Revenue Code of 1986, as amended, (the Code) until prior to the closing of its public offering. As an S corporation, the taxable income of the Company was passed through the sole stockholder and was reported on his individual federal and state income tax returns. Payments to the stockholder to cover the tax liabilities as a result of the Company's taxable income are recorded as distributions in the accompanying statements of stockholders' equity. In December 1996, a distribution was recorded to distribute the cumulative S corporation earnings taxed or taxable to the original stockholder net of amounts previously distributed. This distribution totaled approximately $5,231,000, of which approximately $5,164,000 was paid in cash and $67,000 was accrued as of December 31, 1996.

As discussed above, the Company terminated its S corporation election and became subject to federal and state income taxes at prevailing corporate rates prior to the closing of its initial public offering of common stock. Accordingly, the accompanying statements of income 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 the period presented.

The components of the historical and pro forma income tax provision are as follows:
  1994 1995 1996

Current-
Federal $ - $ - $0,067,000
State 73,000 96,000 208,000

  73,000 96,000 275,000

Deferred-
Federal - - 354,000
State - - 83,000

  - - 437,000

Actual provision for income taxes 73,000 96,000 712,000

Pro forma income tax provision 656,000 835,000 1,910,000
Pro forma income tax adjustment $583,000 $739,000 $1,198,000


The Company's income tax provision for the years ended December 31, 1994 and 1995 consisted of corporate-level state income taxes that were levied against the Company as an S corporation. The pro forma tax provisions do not materially differ from the Company's combined federal and state statutory rate of 40%.

Upon termination of the S corporation election, deferred income taxes were recorded for the tax effect of cumulative temporary differences between the financial reporting and tax bases of certain assets and liabilities, primarily deferred commissions, accrued expenses and cumulative tax depreciation in excess of financial reporting allowances. These temporary differences resulted in a net deferred income tax liability of approximately $510,000. The Company recorded this tax liability as a one-time increase in the actual tax provision during 1996.

Deferred income taxes as of December 31, 1996 related to the following temporary differences:
Nondeductible reserves and accruals $ 147,000
Depreciation and amortization (47,000)
Deferred commissions (537,000)

  $(437,000)
 
The Company and George F. Colony, who was the sole stockholder of the Company prior to its initial public offering, have entered into an indemnification agreement relating to their respective income tax liabilities. Mr. Colony will continue to be liable for personal income taxes on the Company's income for all periods prior to the time the Company ceased to be an S corporation, while the Company will be liable for all income taxes subsequent to the time it ceased to be an S corporation. The agreement generally provides that the Company will indemnify Mr. Colony for any increase in his taxes (including interest and penalties) resulting from adjustments initiated by taxing authorities and from payments to him under the agreement, and Mr. Colony will pay to the Company an amount equal to any decrease in his tax liability resulting from adjustments initiated by taxing authorities. The agreement also provides that, if the Company is determined to have been a C corporation for tax purposes at any time it reported its income as an S corporation, Mr. Colony will make a capital contribution to the Company in an amount necessary to hold the Company harmless from any taxes and interest arising from such determination up to the amount of distributions made by the Company to Mr. Colony prior to the termination of the Company's S corporation election less any taxes and interest attributable to such distributions.

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(4) Commitments

The Company leases office space under an operating lease. The Company will also make lease payments on its previous facility through January 1997. The excess of the payments on its old facility over anticipated sublease income has been accrued as of December 31, 1995 and 1996.

At December 31, 1996, approximate future minimum rentals due are as follows:

1997 $1,011,000
1998 1,001,000
1999 1,007,000
2000 1,012,000
2001 262,000

  Total minimum lease payments $4,293,000
 
Rent expense was approximately $369,000, $663,000 and $664,000 for the years ended December 31, 1994, 1995 and 1996, respectively.

In connection with its facility leases, the Company has outstanding letters of credit of approximately $73,000.

Notes Index | Back to previous page


(5) 401(k) Plan

The Company has a 401(k) savings plan covering substantially all eligible employees. The Plan is a qualified defined contribution plan in accordance with Section 401(k) of the Code and is funded entirely through employee contributions.

Notes Index


(6) Stockholders' Equity

(a) Initial Public Offering In December 1996, the Company sold through an underwritten public offering 2,300,000 shares of its common stock at $16 per share. The proceeds to the Company from the Company's initial public offering, net of underwriting discounts and expenses, were $33,234,053.

(b) Reincorporation In February 1996, in connection with the Company's reincorporation in Delaware, the Company increased the number of authorized shares of common stock to 7,000,000, and each outstanding share of common stock was exchanged for 6,000 shares of common stock in the reincorporated entity. The accompanying financial statements and notes have been retroactively adjusted to reflect this transaction. Immediately prior to the Company's initial public offering, the Company's Certificate of Incorporation was amended to increase the number of authorized shares of common stock to 25,000,000.

(c) Preferred Stock Prior to its initial public offering, the Company amended its Certificate of Incorporation to authorize 500,000 shares of $.01 par value preferred stock. The Board of Directors has full authority to issue this stock and to fix the voting powers, preferences, rights, qualifications, limitations or restrictions thereof, including dividend rights, conversion rights, redemption privileges and liquidation preferences and the number of shares constituting any series or designation of such series.

Notes Index


(7) Stock Option Plans

In February 1996, the Company adopted the Forrester Research, Inc. 1996 Equity Incentive Plan, which was amended in September 1996 (the Plan). The Plan provides for the issuance of incentive stock options (ISOs) and nonqualified stock options (NSOs) to purchase up to 2,750,000 shares of common stock. Under the terms of the Plan, ISOs may not be granted at less than fair market value on the date of grant (and in no event less than par value). ISO grants to holders of 10% of the combined voting power of all classes of Company stock must be granted at an exercise price of not less than 110% of the fair market value at the date of grant. The fair market value of $5.50 per share for the options granted in February 1996 was based on an independent appraisal. Options vest ratably over three years and expire after 10 years. Options granted under the Plan immediately vest upon certain events, as defined.

Stock option activity since the Plan's inception to December 31, 1996 was as follows:
  Number
of Shares
Exercise
Price
pre Share
Weighted
Average
Exercise
Price
per Share

Granted 790,046 $5.50-$13.00 $8.16
Canceled (31,355) 5.50 5.50

Outstanding at December 31, 1996 758,691 $5.50-$13.00 $8.28

Exercisable at December 31, 1996 149,376 $5.50 $5.50

The weighted average remaining contractual life of options outstanding at December 31, 1996 is 9.4 years. As of December 31, 1996, options available for future grant under the Plan were 1,991,309.

In September 1996, the Company adopted the 1996 Stock Option Plan for Non-Employee Directors (the Directors' Plan), which provides for the issuance of options to purchase up to 150,000 shares of common stock. Under the Directors' Plan the Company's four non-employee directors each received, on the date that the Company first filed a registration statement under the Securities Act of 1933 covering its common stock, an option to purchase 6,000 shares of the Company's common stock at an exercise price of $13.00 per share. Such options vest in three equal installments commencing on the date that the Company completed its initial public offering of the common stock and on the first and second anniversaries of such date. Each non-employee director elected thereafter shall be awarded options to purchase 6,000 shares of common stock at an exercise price equal to the fair market value of the common stock upon his or her election as a director, which will vest in three equal installments commencing on the date of grant and on the first and second anniversaries of the date of grant. Each non-employee director will also receive an option to purchase 4,000 shares of common stock, at an exercise price equal to the fair market value of the common stock each year immediately following the Company's annual stockholders meeting, which will vest in three equal installments on the first, second and third anniversaries of the date of grant. The Compensation Committee (the Committee) of the Board of Directors also has the authority under the Directors' Plan to grant options to non-employee directors in such amounts and on such terms as set forth in the Directors' Plan as it shall determine at the time of grant.

In October 1995, the Financial Accounting Standards Board (FASB) issued SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires the measurement of the fair value of stock options or warrants to be included in the statement of income or disclosed in the notes to financial statements. The Company has determined that it will continue to account for stock-based compensation for employees under Accounting Principles Board Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123. The Company has computed the pro forma disclosures required under SFAS No. 123 for options granted in 1996 using the Black-Scholes option pricing model prescribed by SFAS No. 123. The weighted average assumptions used for 1996 are:

Risk-free interest rate 6.21%
Expected dividend yield -
Expected lives 7.5 years
Expected volatility 0%-64%

The total value of options granted during the year ended December 31, 1996 was computed as approximately $2,705,000. Of this amount, approximately $377,000 would be charged to operations for the year ended December 31, 1996, and the remaining amount, approximately $2,328,000, would be amortized over the related remaining vesting periods. There were no options or warrants issued prior to 1996. The pro forma effect of SFAS No. 123 for the year ended December 31, 1996 is approximately as follows:

   As Reported Pro Forma

Net income $2,806,000 $2,429,000

Net income per share $0.43 $0.37

Notes Index


(8) Employee Stock Purchase Plan

In September 1996, the Company adopted the 1996 Employee Stock Purchase Plan (the Stock Purchase Plan), which provides for the issuance of up to 200,000 shares of common stock. The Stock Purchase Plan is administered by the Committee. With certain limited exceptions, all employees of the Company who have completed six months or more of continuous service in the employ of the Company and whose customary employment is more than 20 hours per week, including officers and directors who are employees, are eligible to participate in the Stock Purchase Plan. The first purchase period under the Stock Purchase Plan commenced on the first day that the Company's common stock was publicly traded on the Nasdaq National Market and will end on June 30, 1997. Each subsequent purchase period under the Stock Purchase Plan will be six months in length and will commence on each successive July 1 and January 1. During each purchase period under the Stock Purchase Plan, the maximum number of shares of common stock that may be purchased by an employee is limited to the number of shares equal to $12,500 divided by the fair market value of a share of common stock on the first day of the purchase period. An employee may elect to have up to a maximum of 10% deducted from his or her regular salary for the purpose of purchasing shares under the Stock Purchase Plan. The price at which the employee's shares are purchased is the lower of (a) 85% of the closing price of the common stock on the day that the purchase period commences, or (b) 85% of the closing price of the common stock on the day that the purchase period terminates. Because the first purchase period under the Stock Purchase Plan ends on June 30, 1997, no shares were purchased under the Stock Purchase Plan during 1996.

Notes Index


(9) Net Sales by Geographic Destination

Net sales by geographic destination and as a percentage of total sales are as follows:
  1994 1995 1996
United States $8,103,708 $12,025,529 $19,694,363
Europe 629,208 1,066,314 2,751,858
Other 965,886 1,496,969 2,516,900

  $9,698,802 $14,588,812 $24,963,121
 
United States 84% 82% 79%
Europe 6 8 11

Other 10 10 10
  100% 100% 100%

Notes Index


(10) Accrued Expenses

Accrued expenses consist of the following:
  1995 1996

Payroll and related $0,802,673 $1,446,752
OTHER 742,142 1,754,359
 
  $1,544,815 $3,201,111

Notes Index


(11) Summary Selected Quarterly Financial Data (unaudited)

The following is a summary of selected quarterly financial data for the years ended December 31, 1995 and 1996
(in thousands, except per share data):

Quarter Ended March 31,
1995
June 30,
1995
Sept. 30,
1995
Dec. 31,
1995

Revenues $4,746 $5,316 $6,312 $8,589
Income from operations $0,459 $0,566 $1,129 $1,928
Pro forma net income $0,339 $0,409 $0,716 $1,314
Pro forma net income per common share $00.05 $00.07 $00.11 $00.18
Quarter Ended March 31,
1996
June 30,
1996
Sept. 30,
1996
Dec. 31,
1996

Revenues $2,708 $2,873 $3,535 $5,473
Income from operations $0,209 $0,162 $0,370 $1,043
Pro forma net income $0,168 $0,157 $0,272 $0,691
Pro forma net income per common share $00.03 $00.03 $00.04 $00.11

Notes Index