<PAGE> 1
This filing is made pursuant
to Rule 424(b)(1) under the
Securities Act of 1933 in
connection with Registration
No. 333-06349
LOGO
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2,300,000 SHARES
COMMON STOCK
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Of the 2,300,000 shares of Common Stock being offered hereby, 1,837,500
shares are being sold by Document Sciences Corporation ("Document Sciences"
or the "Company") and 462,500 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders." The Company will not
receive any of the proceeds from the sale of shares by the Selling
Stockholders.
Prior to this offering, there has been no public market for the Common Stock
of the Company. See "Underwriting" for a discussion of the factors considered
in determining the initial public offering price. The Company's Common Stock
has been approved for listing on The Nasdaq National Market under the symbol
DOCX.
FOR INFORMATION CONCERNING CERTAIN FACTORS WHICH SHOULD BE CONSIDERED BY
PROSPECTIVE INVESTORS, SEE "RISK FACTORS" COMMENCING ON PAGE 5.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
<TABLE>
<CAPTION>
PROCEEDS TO
PRICE UNDERWRITING PROCEEDS TO SELLING
TO PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS
<S> <C> <C> <C> <C>
Per share $12.00 $.84 $11.16 $11.16
Total(3) $27,600,000 $1,932,000 $20,506,500 $5,161,500
</TABLE>
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $600,000.
(3) The Company has granted the several Underwriters an option to purchase up
to an additional 345,000 shares of Common Stock to cover over-allotments.
If all such shares are purchased, the total Price to Public, Underwriting
Discount and Proceeds to Company will be $31,740,000, $2,221,800 and
$24,356,700, respectively. See "Underwriting."
The shares of Common Stock are offered by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by them, and subject to the
approval of certain legal matters by counsel and certain other conditions.
The Underwriters reserve the right to withdraw, cancel or modify such offer
and to reject orders in whole or in part. It is expected that delivery of the
shares of Common Stock will be made in New York, New York against payment
therefor on or about September 25, 1996.
DEUTSCHE MORGAN GRENFELL SOUNDVIEW FINANCIAL GROUP, INC.
The date of this Prospectus is September 20, 1996
<PAGE> 2
LOGO
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
------------------------
The Company intends to furnish its stockholders with annual reports
containing consolidated financial statements audited by an independent public
accounting firm, and make available to its stockholders quarterly reports for
the first three quarters of each year containing interim unaudited financial
information.
Autograph, CompuBuild, CompuSet, CompuMerge, CompuPrep, CompuSeries,
CompuView Navigator, DVS and View on Demand are trademarks of the Company. All
other brand names or trademarks appearing in this Prospectus are the property of
their respective holders.
This Prospectus contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. The Company's
actual results or experience could differ significantly from those discussed in
the forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in "Risk Factors,"
as well as those discussed elsewhere in this Prospectus.
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more
detailed information and consolidated financial statements and notes
thereto appearing elsewhere in this Prospectus. The Common Stock offered
hereby involves a high degree of risk. See "Risk Factors."
THE COMPANY
Document Sciences Corporation develops, markets and supports a family
of document automation software products and services used in high volume
electronic publishing applications. Document automation has become
increasingly important as more companies realize the benefits of
automating the high volume production of individually customized documents
that require the precise layout of information such as financial data,
marketing text and graphs. Autograph, the Company's document automation
software architecture, enables personalized and customized publishing
solutions for many industries including insurance, managed healthcare,
financial services, telecommunications, manufacturing/distribution,
government agencies and commercial print service bureaus. The Company's
products enable an important form of communication between organizations
and customers by employing enterprise database assets to produce
high-quality documents that are ready to print on demand and distribute in
high volume. Additionally, the Company's core technology can be extended
to provide electronic document automation solutions for the Internet,
intranets and commercial on-line services. CompuSet, Autograph's flagship
product, is licensed by approximately 400 customers worldwide who
collectively produce an estimated one billion customized pages per month.
The fully portable Autograph platform enables cost-effective,
just-in-time, on-demand, high volume publishing that is fully automated,
capable of quality document composition, and flexible for end-user
customization. The Company's products are used in a wide array of
computing environments from client/server to large computer systems.
Document Sciences' objective is to be the leading worldwide supplier
of document automation software and services. The Company sells its
products domestically principally through a direct sales force, and
internationally principally through distributors and value added resellers
and, to a lesser extent, through its direct sales force. The Company
expects to invest significantly in sales, marketing, professional services
and development infrastructure. The Company's end user customers include
Aetna Life Insurance Co., The Prudential Life Insurance Company of
America, Foundation Health, Compaq Computer Corporation, Bell Atlantic
Services, Inc., Morgan Grenfell Asset Management, Ace Hardware Corporation
and CAM-NET Communications Network Inc. The Company was incorporated in
Delaware in October 1991 as a wholly-owned subsidiary of Xerox Corporation
("Xerox"), which currently owns approximately 84% of the Company's
outstanding Common Stock. Upon completion of this offering, Xerox will
continue to own approximately 65% of the Company's outstanding Common
Stock.
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered............................. 2,300,000 shares, including
1,837,500 shares by the Company and
462,500 shares by the Selling Stockholders
Common Stock outstanding after the offering...... 10,374,657 shares(1)
Use of proceeds.................................. For general corporate purposes, including working capital. See "Use of
Proceeds."
Nasdaq National Market symbol.................... DOCX
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
-------------------------------------- -------------------
1992(2) 1993 1994 1995 1995 1996
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<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:(3)
Total revenues................................................. $1,567 $3,491 $7,171 $10,512 $4,164 $6,350
Gross profit................................................... 1,331 3,052 6,439 9,368 3,708 5,470
Income (loss) from operations.................................. (268 ) 720 1,354 1,685 290 400
Net income (loss).............................................. (174 ) 413 712 1,052 188 246
Pro forma net income (loss) per share(4)....................... $ (.02 ) $ .06 $ .09 $ .13 $ .02 $ .03
Shares used to compute pro forma net income (loss) per share... 7,378 7,378 8,344 8,380 8,344 8,979
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1996
DECEMBER 31, ------------------------------------------------
1995 ACTUAL PRO FORMA(5) AS ADJUSTED(6)
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<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:(3)
Cash and cash equivalents................................ $1,271 $1,466 $1,466 $ 21,372
Working capital.......................................... 1,353 1,040 1,040 20,946
Total assets............................................. 6,289 7,102 7,102 27,008
Obligations under capital leases, less current portion... 99 145 145 145
Series A Redeemable Preferred Stock...................... 1,251 1,417 -- --
Total stockholders' equity............................... 856 976 2,393 22,299
</TABLE>
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(1) Based on shares outstanding as of June 30, 1996. Excludes 373,368
shares of Common Stock issuable upon exercise of options outstanding.
See "Management -- Employee Benefit Plans," "Description of Capital
Stock," and Note 7 of Notes to Consolidated Financial Statements.
(2) The Company was incorporated on October 18, 1991, and had
insignificant activities from inception through December 31, 1991.
(3) See Note 9 of Notes to Consolidated Financial Statements for
information concerning transactions with affiliates.
(4) Assumes the repayment of the current income tax payable to Xerox out
of the proceeds of this offering, and assumes as outstanding the pro
forma shares outstanding plus 115,175 shares of the shares being
offered by the Company hereby which represent the shares deemed to be
sold to fund such repayment. See "Use of Proceeds" and Note 1 of Notes
to Consolidated Financial Statements.
(5) Reflects the conversion of all outstanding shares of Series A
Redeemable Preferred Stock into Common Stock at a conversion ratio of
1.19 to 1, before giving effect to adjustment for the 3-for-1 stock
split. See "Management -- Certain Transactions."
(6) Adjusted to give effect to the sale of 1,837,500 shares of Common
Stock by the Company at an initial public offering price of $12.00 per
share and the application of the net proceeds therefrom. See "Use of
Proceeds" and "Capitalization."
Except as set forth in the Consolidated Financial Statements or as
otherwise indicated, all information in this Prospectus (i) reflects the
3-for-1 split of the Company's Common Stock, (ii) reflects the conversion,
at a ratio of 1.19 to 1 before giving effect to adjustment for the 3-for-1
stock split, of all of the Company's outstanding shares of Series A
Redeemable Preferred Stock into shares of Common Stock, and (iii) assumes
that the Underwriters' over-allotment option is not exercised. See
"Description of Capital Stock," "Underwriting" and Note 7 of Notes to
Consolidated Financial Statements.
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3
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THE COMPANY
Document Sciences Corporation ("Document Sciences" or the "Company")
develops, markets and supports a family of document automation software products
and services used in high volume electronic publishing applications. Document
automation has become increasingly important as more companies realize the
benefits of automating the high volume production of individually customized
documents that require the precise layout of information such as financial data,
marketing text and graphs. Autograph, the Company's document automation software
architecture, enables personalized and customized publishing solutions for many
industries including insurance, managed healthcare, financial services,
telecommunications, manufacturing/distribution, government agencies and
commercial print service bureaus. The Company's products enable an important
form of communication between organizations and customers by employing
enterprise database assets to produce high-quality documents that are ready to
print on demand and distribute in high volume. Additionally, the Company's core
technology can be extended to provide electronic document automation solutions
for the Internet, intranets and commercial on-line services. CompuSet,
Autograph's flagship product, is licensed by approximately 400 customers
worldwide who collectively produce an estimated one billion customized pages per
month. The fully portable Autograph platform enables cost-effective,
just-in-time, on-demand, high volume publishing that is fully automated, capable
of quality document composition, and flexible for end-user customization. The
Company's products are used in a wide array of computing environments from
client/server to large computer systems.
The market for document automation software is growing rapidly as companies
recognize the need to increase document effectiveness through high quality
composition and assembly. Document automation capitalizes on the investments
corporations have made in traditional mainframe and newer client/server
computing platforms. Growth in the paper-based portion of the market is also
fueled by the increasing popularity of lower-cost midrange electronic printers
and the continuing cost/performance improvements in computing and communications
technologies. Organizations are producing increasing amounts of data and
information and consequently are demanding more effective documents and
delivery. The effectiveness includes customized and personalized content, more
robust documents, and improved forms of document delivery. In addition, in many
current and future applications, the fundamental nature of the document is
shifting from static paper-based documents to more robust interactive electronic
documents published on the Internet, intranets and commercial on-line services.
The Company's objective is to be the leading worldwide supplier of document
automation software and services. The Company's strategy includes extending its
technology leadership, leveraging its installed base of customers, expanding its
distribution channels, expanding professional services, and expanding into
electronic documents including the Internet, intranets and commercial on-line
services. The Company expects to continue to invest significantly in sales,
marketing, professional services, and development infrastructure. The Company
sells its products domestically principally through a direct sales force, and
internationally principally through distributors and value added resellers
("VARs") and, to a lesser extent, through its direct sales force. The Company
derived approximately 14%, 26%, 42% and 30% of its total revenues from export
sales, including sales through its foreign subsidiary, in 1993, 1994, 1995 and
the first half of 1996, respectively. The Company's sales and marketing
organization targets vertical industry segments that require document automation
and high volume document personalization and customization. The Company's end
user customers include Aetna Life Insurance Co., The Prudential Life Insurance
Company of America, Foundation Health, Compaq Computer Corporation, Bell
Atlantic Services, Inc., Morgan Grenfell Asset Management, Ace Hardware
Corporation and CAM-NET Communications Network Inc.
The Company was incorporated in Delaware in October 1991 as a wholly-owned
subsidiary of Xerox Corporation ("Xerox"), which currently owns approximately
84% of the Company's outstanding Common Stock. Upon completion of this offering,
Xerox will continue to own approximately 65% of the Company's outstanding Common
Stock (63% if the Underwriters' over-allotment option is exercised in full). The
Company acquired certain technology from Xerox pursuant to a Transfer and
License Agreement in July 1992. See "Certain Transactions." All references in
this Prospectus to "Document Sciences" or the "Company" refer to Document
Sciences Corporation and its consolidated subsidiary. The Company's executive
offices are located at 6333 Greenwich Drive, Suite 100, San Diego, California
92122, and its telephone number is (619) 625-2000.
4
<PAGE> 5
RISK FACTORS
The following risk factors should be considered carefully in addition to
the other information contained in this Prospectus before purchasing the Common
Stock offered hereby. This Prospectus contains forward-looking statements, and
actual results could differ materially from those projected in the
forward-looking statements as a result of numerous factors, including the
factors set forth below and elsewhere in this Prospectus.
Limited Operating History. The Company was incorporated in October 1991 as
a wholly-owned subsidiary of Xerox, and Xerox currently owns approximately 84%
of the Company's outstanding shares of Common Stock. The Company's limited
operating history makes the prediction of future operating results difficult,
and the Company's operating history during prior periods cannot necessarily be
regarded as indicative of the Company's prospects as an independent company,
especially in light of the Company's investments in sales, marketing,
professional services and development infrastructure. Accordingly, although the
Company has experienced revenue growth in recent years, there can be no
assurance that the Company will sustain such growth in revenues, if any, or that
the Company will remain profitable on a quarterly or annual basis.
Uncertainty of Future Operating Results; Fluctuations in Quarterly
Operating Results. The Company's total revenues and operating results can vary,
sometimes substantially, from quarter to quarter and are expected to vary
significantly in the future. The Company's revenues and operating results are
difficult to forecast. Future results will depend upon many factors, including
the demand for the Company's products, the level of product and price
competition, the length of the Company's sales cycle, the size and timing of
individual license transactions, the delay or deferral of customer
implementations, the budget cycles of the Company's customers, the level of
commissions on the sale of Xerox printers under the strategic marketing alliance
between the Company and Xerox, the Company's success in expanding its direct
sales force and indirect distribution channels, the timing of new product
introductions and product enhancements by the Company and its competitors, the
mix of products and services sold, levels of international sales, activities of
and acquisitions by competitors, the timing of new hires, changes in foreign
currency exchange rates, the ability of the Company to develop and market new
products and control costs and general domestic and international economic
conditions. In addition, the Company's sales generally reflect a relatively high
amount of revenues per order, and the loss or delay of individual orders,
therefore, could have a significant impact on the revenues and quarterly
operating results of the Company. Moreover, the timing of license revenue is
difficult to predict because of the length of the Company's sales cycle, which
is typically three to twelve months from the initial customer contact.
The Company's initial software license products generally are shipped as
orders are received. As a result, initial license fee revenues are substantially
dependent on orders booked and shipped in that quarter. Because the Company's
operating expenses are based on anticipated revenue levels and because a high
percentage of the Company's expenses are relatively fixed, a delay in the
recognition of revenue from a limited number of license transactions could cause
significant variations in operating results from quarter to quarter and could
result in losses. To the extent such expenses precede increased revenues, the
Company's operating results would be materially adversely affected.
The Company's business has experienced and is expected to continue to
experience seasonality, in part due to customer purchasing patterns and the
Company's expense patterns. The Company believes that fourth quarter revenues
are positively impacted by year-end capital purchases by large corporate
customers and strong fourth quarter sales of printers by Xerox (which may
generate sales of the Company's products), as well as the Company's sales
compensation plans. As reflected in the fourth quarter of 1995, these seasonal
factors have historically resulted in fourth quarter revenues being
substantially higher than revenues in the preceding three quarters, as well as
being higher than revenues in each of the first two quarters of the next year.
In addition, a significant amount of the Company's revenues occur predominantly
in the third month of each fiscal quarter and tend to be concentrated in the
latter half of the third month.
5
<PAGE> 6
As a result of these factors, revenues for any quarter are subject to
significant variation, and the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Furthermore, due
to all of the foregoing factors, it is likely that in some future quarter the
Company's operating results will be below the expectations of public market
analysts and investors. In such event, the price of the Company's Common Stock
would likely be materially adversely affected. See "Risk Factors -- Expansion of
Sales and Distribution Channels," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business -- Sales and
Marketing."
Control by Xerox. Upon completion of this offering, Xerox will own
approximately 65% of the outstanding shares of Common Stock of the Company (63%
if the Underwriters' over-allotment option is exercised in full). Xerox has not
expressed to the Company any present intention to sell additional shares of the
Company's Common Stock following completion of the offering. Consequently, Xerox
will control the Company, be able to elect the entire Board of Directors of the
Company and continue to have significant input into the Company's operations. In
addition, Xerox will be able to determine the outcome of all corporate actions
requiring stockholder approval, including potential mergers, acquisitions,
consolidations and sales of all or substantially all of the assets of the
Company. The voting power of Xerox could have the effect of delaying or
preventing a change in control of the Company, and may prevent or discourage
tender offers for the Company's Common Stock at a premium price by another
person or entity. At present, Xerox affiliates hold three of the six seats on
the Company's Board of Directors. See "Risk Factors -- Reliance on Relationships
with Xerox; Lack of Independent Sales and Marketing Channels," "Principal and
Selling Stockholders" and "Certain Transactions."
Reliance on Relationships with Xerox; Lack of Independent Sales and
Marketing Channels. The Company currently has, and will continue to have after
this offering, a variety of contractual and informal relationships with Xerox
and affiliates of Xerox, including a Strategic Marketing Alliance Agreement, a
Transfer and License Agreement and various distribution agreements. The Company
relies on these relationships and agreements for a significant portion of its
total revenues. In 1994, 1995 and the first half of 1996, total revenues derived
from relationships with Xerox and affiliates of Xerox accounted for
approximately $1.9 million, $3.9 million and $1.3 million, representing 27%, 37%
and 20% of the Company's total revenues, respectively. In addition, through
December 31, 1995 substantially all of the Company's domestic license revenues
were dependent on sales leads generated as a result of the Company's
relationship with Xerox and a substantial portion of the Company's international
revenues were made through distributors and distribution channels affiliated
with Xerox. Further, the commissions received by the Company from sales of Xerox
printers under the strategic marketing alliance, which were $490,400, $752,000
and $586,600 in 1994, 1995 and the first half of 1996, respectively, have little
or no associated costs, have contributed a substantial portion of the Company's
income from operations and net income for certain prior operating periods, have
had a high degree of inconsistency from quarter to quarter and are difficult to
estimate. Failure to continue to receive such commissions would have a material
adverse effect on the Company's business, operating results and financial
condition. Although neither Xerox nor its affiliated entities has expressed to
the Company any intention to terminate their respective agreements with the
Company, these agreements generally may be terminated on no more than 90 days'
notice. Accordingly, there can be no assurance that Xerox or its affiliates will
continue these relationships or, if they do, that they will be on terms
favorable to the Company. Furthermore, there can be no assurance that existing
and potential customers will not be deterred by the existence of these
relationships or by the historical ties between the Company and Xerox and its
affiliates. Following consummation of this offering, though it intends to
continue its existing relationships with Xerox, the Company's strategy is to
lessen its dependence on Xerox. However, there can be no assurance that the
Company will be able to do so and, because of the Company's current level of
dependence on Xerox there can be no assurance that the Company's transition to a
more independent company will not adversely affect its business, financial
condition or results of operations. The failure by the Company to maintain these
relationships, particularly with Xerox and
6
<PAGE> 7
its affiliates, or to establish new relationships in the future, could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Risk Factors -- Expansion of Sales and
Distribution Channels" and "Certain Transactions."
Xerox has strategic alliances and other business relationships with other
companies who supply software and services used in high volume electronic
publishing applications and who now or in the future may be a competitor of the
Company. Xerox could in the future expand these relationships or enter into
additional ones, and as a result the Company's business could be materially
adversely affected. There can be no assurance that Xerox or one of its
affiliated companies will not engage in business directly competitive with the
Company. Xerox owns approximately 34% of Image Sciences, a direct competitor of
the Company. In addition, Xerox has on-going internal development activities
which could in the future lead to products that compete with the Company. See
"Business -- Competition" and "Certain Transactions."
Expansion of Sales and Distribution Channels. The Company has
substantially increased expenditures in support of its strategy to expand its
global marketing, sales and customer support infrastructure in order to expand
the market for the Company's products by providing direct sales and support
services and increased channel distribution throughout the major markets of the
world. Through this expansion, the Company hopes to lessen its dependence on
Xerox and certain Xerox affiliates. In addition, the Company intends to increase
both its product offerings and markets through marketing, sales and distribution
and development relationships with other companies. The Company intends to
increase the number of these strategic relationships as well as form alliances
with system integrators and consultants. Whether the Company can successfully
generate its own sales leads, introduce new products and enter into new markets
will depend on its ability to expand its direct sales and support services,
expand its indirect channel distribution, and increase its relationships and
alliances with other companies. As a result of its planned expansion, the
Company has and will continue to incur significant costs to build such corporate
infrastructure ahead of anticipated revenues, and any failure to achieve growth
in revenues in excess of increased expenses would have a material adverse affect
on the Company's business, operating results and financial condition. There can
be no assurance that the Company will be able to successfully expand its direct
sales and support services force, expand its indirect channel distribution, or
establish or maintain successful third party relationships. Any failure to do so
will have a material adverse effect on the Company's business, operating results
and financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business -- Sales and Marketing."
Dependence on Success of New Products and Expansion of Professional
Services. The Company's Autograph architecture has been applied mainly to
document automation applications producing paper based documents. The Company
believes its core technology can be extended to address applications requiring
the delivery of customized and personalized electronic documents over electronic
networks such as the Internet, intranets or commercial on-line services.
The Company has recently introduced Document Viewing Service (DVS), an
optional on-line viewer for electronic documents produced by document automation
applications, and Document Library Services (DLS), an optional document
management tool. The Company began shipping DVS in October 1995, and DLS is
currently in limited release, with certain configurations still in beta testing.
Prior to the quarter ended June 30, 1996, revenues derived from license fees of
DVS and DLS have not been material as a percentage of revenues. In addition, the
Company is increasing its focus on the consulting services component of its
Professional Services to assist customers in the planning and implementation of
enterprise-wide, mission critical document automation applications. The Company
has directed a significant amount of its product development expenditures to the
on-going development of DVS and DLS and plans to devote a significant amount of
future sales and marketing resources to the full commercial introduction of DVS
and DLS.
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<PAGE> 8
The Company believes that the long-term growth of license and service
revenue will be dependent, in part upon the success of DVS, DLS and the
expansion of Professional Services. The Company has limited experience in
developing new products, and DVS and DLS have not been widely deployed. Because
of such limited experience, there can be no assurance that DVS and DLS will not
require substantial software enhancements or modifications to satisfy
performance requirements of clients or to correct design defects. Further, there
can be no assurance that the Company will be successful in expanding its
consulting services as part of its Professional Services. If the Company fails
to fully deploy its DVS and DLS products, or if clients experience significant
problems with implementation of the software or are otherwise dissatisfied with
the functionality or performance of DVS and DLS, or if DVS or DLS fails to
achieve market acceptance for any reason, or if the Company fails to
successfully expand its Professional Services, the Company's business, operating
results and financial condition will be materially adversely affected. See
"Business -- Products."
Lengthy Sales and Implementation Cycles. The license of the Company's
software products is often an enterprise-wide decision by prospective customers
and generally requires the Company to engage in a lengthy sales cycle, typically
between three and twelve months, to provide a significant level of education to
prospective customers regarding the use and benefits of the Company's products.
In addition, the implementation of the Company's products by customers involves
a significant commitment of resources by such customers over an extended period
of time, and is commonly associated with substantial customer business process
reengineering efforts. For these and other reasons, the sales and customer
implementation cycles are subject to a number of significant delays over which
the Company has little or no control. Delay in the sale or customer
implementation of a limited number of license transactions could have a material
adverse effect on the Company's business and results of operations and cause the
Company's operating results to vary significantly from quarter to quarter. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business -- Sales and Marketing."
Product Concentration. The Company currently derives substantially all of
its license revenues from licenses of CompuSet and related CompuSet option
products and from fees for services related to the CompuSet software. As a
result, factors adversely affecting the pricing of or demand for CompuSet and
related products, such as competition from other products, negative publicity or
obsolesce of the hardware or software environments in which the Company's
products run, could have a material adverse effect on the Company's business,
operating results and financial condition. The Company's financial performance
will continue to depend, in significant part, on the successful development,
introduction and customer acceptance of new and enhanced versions of the
CompuSet software and related products. There can be no assurance that the
Company will continue to be successful in developing and marketing CompuSet
products and related services. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and "Business -- Products" and
"-- Research and Development."
Industry Concentration. Licenses to end users in the insurance and
commercial print services industries for 1994, 1995 and the first half of 1996
accounted for 65%, 61% and 55%, respectively, of total revenues. The future
success of the Company will depend on its ability to continue to successfully
market its products in such industries, and to successfully market its products
in other industries. The failure of the Company to do so would have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Dependence on New Products and Product Enhancements. The Company's future
business, operating results and financial condition will continue to depend upon
its ability to develop new products that address the future needs of its target
markets and to respond to emerging industry standards and practices. The Company
believes that its core technology can be extended to the Internet, intranets and
commercial on-line services, and has only recently begun initial development
activity in this area. There can be no assurance that the Company will be
successful in developing, introducing and marketing new products or product
enhancements, including new products or the
8
<PAGE> 9
extension of existing products for the Internet, intranets and commercial
on-line services, on a timely and cost effective basis, if at all, or that its
new products and product enhancements will adequately meet the requirements of
the marketplace or achieve market acceptance. Delays in the commencement of
commercial shipments of new products or enhancements, including DVS and DLS, may
result in client dissatisfaction and delay or loss of product revenues. If the
Company is unable, for technological or other reasons, to develop and introduce
new products or enhancements of existing products in a timely manner in response
to changing market conditions or client requirements, or if new products or new
versions of existing products do not achieve market acceptance, the Company's
business, operating results and financial condition will be materially adversely
affected. In order to provide its customers with integrated product solutions,
the Company's future success will also depend in part upon its ability to
maintain and enhance relationships with its technology partners, such as
Computer Associates and Data Retrieval. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and
"Business -- Products" and "-- Research and Development."
International Operations. Revenues from export sales, including sales
through its foreign subsidiary accounted for 26%, 42% and 30% of the Company's
total revenues in 1994, 1995 and the first half of 1996, respectively. The
Company's wholly owned subsidiary, Document Sciences Europe, markets and
supports the Company's products in Europe. The Company licenses its products in
Europe through value added resellers and to a lesser extent, direct sales. The
value added resellers are principally Xerox affiliates who re-market the
Company's products. In Australia and Canada, the Company distributes its
products through Fuji Xerox Co., Ltd. and Xerox Canada, Limited, respectively.
Revenues generated by these Xerox affiliates were $1.3 million, $3.1 million and
$675,900 in 1994, 1995 and the first half of 1996, respectively. In 1994 and
1995, a substantial portion of the Company's revenues from export sales were
generated through entities affiliated with Xerox. In order to successfully
expand export sales, the Company must establish additional foreign operations,
hire additional personnel and develop relationships with additional
international resellers. To the extent that the Company is unable to do so in a
timely manner, the Company's growth, if any, in international export sales will
be limited, and the Company's business, operating results and financial
condition could be materially adversely affected. In addition, there can be no
assurance that the Company will be able to maintain or increase international
market demand for its products. Additional risks inherent in the Company's
international business activities generally include currency fluctuations,
unexpected changes in regulatory requirements, tariffs and other trade barriers,
costs of and the Company's limited experience in localizing products for foreign
countries, lack of acceptance of localized products in foreign countries, longer
accounts receivable payment cycles, difficulties in managing international
operations, potentially adverse tax consequences including restrictions on the
repatriation of earnings, and the burdens of complying with a wide variety of
foreign laws. A portion of the Company's business is conducted in currencies
other than the U.S. dollar, primarily the French franc. Although to date
exchange rate fluctuations have not had a significant impact on the Company,
fluctuations in the value of the currencies in which the Company conducts its
business relative to the U.S. dollar could cause currency transaction gains and
losses in future periods. The Company does not currently engage in currency
hedging transactions, and there can be no assurance that fluctuations in the
currency exchange rates in the future will not have a material adverse impact on
international revenues and thus the Company's business, operating results or
financial condition. There can be no assurance that such factors will not have a
material adverse effect on the Company's future international operations and,
consequently, the Company's results of operations. See "Risk Factors -- Control
by Xerox," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business -- Sales and Marketing," "Certain
Transactions" and Notes 3 and 9 of Notes to Consolidated Financial Statements.
Dependence on Emerging Markets for Document Automation Software. The
market for document automation software is relatively new, intensely
competitive, highly fragmented, underdeveloped and subject to rapid change.
Marketing and sales techniques in the document automation
9
<PAGE> 10
software marketplace, as well as the bases for competition, are not well
established. There can be no assurance that the market for document automation
software will develop or that, if it does develop, organizations will adopt the
Company's products. The Company has spent, and intends to continue to spend,
significant resources educating potential customers about the benefits of its
products. However, there can be no assurance that such expenditures will enable
the Company's products to achieve further market acceptance, and if the document
automation software market fails to develop or develops more slowly than the
Company currently anticipates, the Company's business, operating results and
financial condition would be materially adversely affected. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business -- The Document Sciences Strategy."
In addition, the commercial market for document automation of electronic
documents designed for use with the Internet, intranets and commercial on-line
services has only recently begun to develop, and the success of the Company's
products designed for this market will depend, in part, on their compatibility
with such services. It is difficult to predict with any assurance whether the
Internet, intranets and commercial on-line services will prove to be a viable
commercial marketplace or whether the demand for related products and services
will increase or decrease in the future. Since the increased commercial use of
the Internet, intranets and commercial on-line services could require
substantial modification and customization of certain of the Company's products
and services and the introduction of new products and services, there can be no
assurance that the Company will be able to effectively or successfully compete
in this emerging market.
Intense Competition. The market for the Company's document automation
products is intensely competitive, subject to rapid change and significantly
affected by new product introductions and other market activities of industry
participants. The Company's software products are targeted at document intensive
organizations that require the ability to produce large quantities of customized
and personalized documents in paper or electronic form. The Company faces direct
and indirect competition from a broad range of competitors who offer a variety
of products and solutions to the Company's current and potential customers. The
Company's principal competition currently comes from (i) systems developed
in-house by the internal MIS departments of large organizations, (ii) direct
competition in a number of its vertical markets, including Image Sciences, which
is partially owned by Xerox, and FormMaker Software, Inc. in the insurance
industry, M&I DataServices, Inc. in banking and financial services and Group 1
Software, Inc. in commercial direct mailing, and (iii) direct competitors such
as IBM's Direct Composition Facility (DCF) and Group 1 Software's recently
introduced DOC1 product. The Company faces market resistance from the large
installed base of systems because of the reluctance of these customers to commit
the time and effort necessary to convert their document automation processes to
the Company's document automation software. Several of the Company's competitors
have longer operating histories, significant greater financial, technical,
marketing and other resources than the Company, greater name recognition and a
larger installed base of customers.
It is also possible that the Company will face competition from new
competitors. These include large independent software companies offering
personal computer-based application software solutions, such as Microsoft
Corporation and Adobe Corporation, and from large corporations providing
database management software solutions, such as Oracle Corporation. In addition,
Xerox, either directly or through affiliated entities, could compete with the
Company. Moreover, as the market for document automation software develops, a
number of these or other companies with significantly greater resources than the
Company could attempt to enter or increase their presence in the Company's
market either independently or by acquiring or forming strategic alliances with
competitors of the Company or to otherwise increase their focus on the industry.
In addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the
ability of their products to address the needs of the Company's current and
prospective customers, and it is possible that new competitors or alliances
among competitors may emerge and rapidly acquire significant market share.
Increased competition
10
<PAGE> 11
may result in price reductions, reduced gross margins and loss of market share,
any of which could have a material adverse effect on the Company's business,
operating results and financial condition. There can be no assurance that the
Company will be able to compete successfully against current or future
competitors or that competitive pressures faced by the Company will not
materially adversely affect its business, operating results and financial
condition. See "Business -- Competition."
Management of Change; Dependence Upon Key Personnel. The Company has
recently experienced a period of growth in total revenues. The Company's ability
to compete effectively and to manage future change will require the Company to
continue to improve its financial and management controls, reporting systems and
procedures on a timely basis and to expand, train and manage its employee work
force. There can be no assurance that the Company will be able to do so
successfully. The Company's failure to do so could have a material adverse
effect on the Company's business, operating results and financial condition. The
Company's future performance depends in significant part upon the continued
service of its key technical, sales and senior management personnel, none of
whom are parties to employment agreements with the Company. The loss of the
services of one or more of the Company's executive officers could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company's future success also depends on its continuing
ability to attract and retain highly-qualified product development, sales and
managerial personnel. Competition for such personnel is intense, and there can
be no assurance that the Company will be able to retain its key employees or
that it will be able to attract, assimilate or retain other highly qualified
product development, sales and managerial personnel in the future. See "Risk
Factors -- Control by Xerox," "Business -- Sales and Marketing" and
"Management."
Dependence on Proprietary Technology; Risks of Infringement. The Company's
success is dependent, in part, upon its ability to protect its proprietary
technology. The Company relies primarily on a combination of copyright and
trademark laws, trade secrets, confidentiality procedures and contractual
provisions to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials under trade secret and
copyright laws, which afford only limited protection. The Company presently has
no patents or patent applications pending. Despite the Company's efforts to
protect its proprietary rights, unauthorized parties may attempt to copy aspects
of the Company's products or to obtain and use information that the Company
regards as proprietary. Policing unauthorized use of the Company's products is
difficult, and while the Company is unable to determine the extent to which
piracy of its software products exists, software piracy can be expected to be a
persistent problem. In addition, the laws of some foreign countries do not
protect the Company's proprietary rights to as great an extent as do the laws of
the United States. There can be no assurance that the Company's means of
protecting its proprietary rights will be adequate or that the Company's
competitors will not independently develop similar technology. The Company is
not aware that any of its products infringe the proprietary rights of third
parties. There can be no assurance, however, that third parties will not claim
infringement by the Company with respect to current or future products. The
Company expects that software product developers will increasingly be subject to
infringement claims as the number of products and competitors in the Company's
industry segment grows and the functionality of products in different industry
segments overlaps. Any such claims, with or without merit, could be time-
consuming, result in costly litigation, cause product shipment delays or require
the Company to enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, may not be available on terms acceptable to
the Company or at all, which could have a material adverse effect upon the
Company's business, operating results and financial condition. In addition, the
Company also relies on software that it licenses from third parties, including
software that is integrated with internally developed software and used
primarily in the Company's DLS product, to perform key functions. There can be
no assurances that such firms will remain in business, that they will continue
to support their products or that their products will otherwise continue to be
available to the Company on commercially reasonable terms. The loss or inability
to maintain any of these software licenses could result in delays or reductions
in product shipments until equivalent software
11
<PAGE> 12
can be developed, identified, licensed and integrated, which would adversely
affect the Company's business, operating results and financial condition. See
"Business -- Intellectual Property and Other Proprietary Rights."
Product Liability. The Company's license agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential product liability claims. However, it is possible that the limitation
of liability provisions contained in the Company's license agreements may not be
effective under the laws of certain jurisdictions. Although the Company has not
experienced any product liability claims to date, the sale and support of
products by the Company may entail the risk of such claims, and there can be no
assurance that the Company will not be subject to such claims in the future. A
successful product liability claim or claim arising as a result of professional
services rendered by the Company brought against the Company could have a
material adverse effect upon the Company's business, operating results and
financial condition.
Risk of Product Defects. Software products as complex as those offered by
the Company, particularly the Company's new DVS and DLS products, may contain
undetected defects or errors when first introduced or as new versions are
released. As a result, the Company could in the future lose or delay recognition
of revenues as a result of software errors or defects. In addition, the
Company's products are typically intended for use in applications that may be
critical to a customer's business. As a result, the Company expects that its
customers and potential customers have a greater sensitivity to product defects
than the market for software products generally. Although the Company's business
has not been adversely affected by any such errors to date, there can be no
assurance that, despite testing by the Company and by current and potential
customers, errors will not be found in new products or releases after
commencement of commercial shipments, resulting in loss of revenue or delay in
market acceptance, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs, any of which would have a
material adverse effect upon the Company's business, operating results and
financial condition. See "Business -- Research and Development."
No Prior Public Market for Common Stock; Possible Volatility of Stock
Price. Prior to this offering, there has been no public market for the Common
Stock, and there can be no assurance that an active public market for the Common
Stock will develop or be sustained after the offering. The initial public
offering price will be determined by negotiations between the Company, the
Selling Stockholders and the representatives of the Underwriters. See
"Underwriting" for a discussion of the factors to be considered in determining
the initial public offering price. The trading price of the Company's Common
Stock could be subject to significant fluctuations in response to variations in
quarterly operating results, the gain or loss of significant orders, changes in
earning estimates by analysts, announcements of technological innovations or new
products by the Company or its competitors, general conditions in the software
and computer industries and other events or factors. In addition, the stock
market in general has experienced extreme price and volume fluctuations which
have affected the market price for many companies in industries similar or
related to that of the Company and which have been unrelated to the operating
performance of these companies. These market fluctuations may adversely affect
the market price of the Company's Common Stock.
Anti-takeover Effects of Certificate of Incorporation, Bylaws and Delaware
Law. Upon the closing of this offering, the Company's Board of Directors will
have the authority to issue up to 2,000,000 shares of Preferred Stock and to
determine the price, rights, preferences, privileges and restrictions, including
voting rights, of those shares without any further vote or action by the
stockholders. The Preferred Stock could be issued with voting, liquidation,
dividend and other rights superior to those of the Common Stock. The rights of
the holders of Common Stock will be subject to, and may be adversely affected
by, the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of Preferred Stock, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, could
have the effect of making it more difficult for a third party to acquire a
majority of the outstanding voting stock of the Company. The Company has no
current plans to issue any shares of Preferred Stock. Further, certain
12
<PAGE> 13
provisions of the Company's Amended and Restated Bylaws and of Delaware law
could delay or make more difficult a merger, tender offer or proxy contest
involving the Company. See "Description of Capital Stock."
Shares Eligible for Future Sale. Sales of a substantial number of shares
of Common Stock in the public market following this offering could adversely
affect the market price of the Common Stock. See "Management -- Employee Benefit
Plans," "Description of Capital Stock" and "Shares Eligible for Future Sale."
Uncertainty as to Use of Proceeds. The principal purposes of this offering
are to strengthen the Company's equity capital base, obtain additional working
capital, create a public market for the Common Stock, facilitate future access
by the Company to public capital markets and retire the Company's current income
tax liability to Xerox. The Company expects to use the net proceeds of the
offering for general corporate purposes, including working capital and expansion
of the Company's product development and sales, marketing and customer support
organizations. A portion of the net proceeds may also be used to acquire or
invest in complementary businesses, products or otherwise to obtain the right to
use complementary technologies which broaden or enhance the Company's current
product offerings. There are no current agreements or negotiations with respect
to any acquisitions, investments or other transactions. As of this date of this
Prospectus, other than as set forth above, the Company has no specific plans as
to the use of the net proceeds from this offering, and will have broad
discretion in the application of the proceeds. Pending any such uses, the net
proceeds will be invested in interest-bearing securities. See "Use of Proceeds."
Immediate and Substantial Dilution. Purchasers of the Common Stock offered
hereby will suffer immediate and substantial dilution in the net tangible book
value per share of the Common Stock from the initial public offering price. To
the extent outstanding options to purchase the Company's Common Stock are
exercised, there will be further dilution. See "Dilution."
13
<PAGE> 14
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,837,500 shares of
Common Stock offered by the Company hereby, at the initial public offering price
of $12.00 per share, are estimated to be approximately $19,906,500 ($23,756,700
if the Underwriters' over-allotment option is exercised in full), after
deducting the underwriting discount and estimated offering expenses. In
addition, the Company will retire its current tax liability to Xerox in the
amount of $1,382,100 for the period from the Company's inception through
December 31, 1995. See "Certain Transactions -- Tax Sharing Agreement." The
Company will not receive any proceeds from the sale of shares of Common Stock by
the Selling Stockholders. See "Principal and Selling Stockholders."
The primary purposes of this offering are to strengthen the Company's
equity capital base, obtain additional working capital, create a public market
for the Common Stock, facilitate future access to public capital markets and
retire the Company's current income tax liability to Xerox.
The Company intends to use the net proceeds of this offering primarily for
general corporate purposes, including working capital and expansion of the
Company's product development and sales, marketing and customer support
organizations. The amounts actually expended by the Company for working capital
purposes may vary significantly depending upon a number of factors, including
future revenues, the amount of cash generated by the Company's operations, the
success of the Company's expansion of its sales and distribution channels and
the progress of the Company's product development efforts.
In addition the Company may from time to time consider acquisitions of
complementary technologies, products or businesses that will broaden or enhance
the Company's current product offerings. However, the Company has no specific
agreements or commitments, and is not currently engaged in any negotiations for
any such acquisition. Pending such uses, the net proceeds will be invested in
short-term, interest-bearing, investment grade securities. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operation -- Liquidity and Capital Resources."
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain any future earnings to finance
the growth and development of its business and therefore does not anticipate
paying any cash dividends in the foreseeable future. Under the terms of the
Company's bank line of credit, the Company may not pay any dividends on its
capital stock without the bank's prior written consent. See Note 4 of Notes to
Consolidated Financial Statements.
14
<PAGE> 15
CAPITALIZATION
The following table sets forth at June 30, 1996 (i) the actual
capitalization of the Company after giving effect to the 3-for-1 split of the
Company's Common Stock, (ii) the pro forma capitalization of the Company after
giving effect to the conversion, on a 1.19 to 1 basis prior to giving effect to
the stock split, of all outstanding shares of Series A Redeemable Preferred
Stock into Common Stock and the change in the authorized number of shares of
Preferred Stock and Common Stock and (iii) the pro forma capitalization of the
Company as adjusted to give effect to the sale of the Common Stock offered by
the Company hereby at the initial public offering price of $12.00 per share
(after deducting the underwriting discount and estimated offering expenses).
<TABLE>
<CAPTION>
JUNE 30, 1996
--------------------------------
ACTUAL PRO FORMA AS ADJUSTED
------ --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Obligations under capital leases, less current portion(1)..... $ 145 $ 145 $ 145
------ ------ ------
Series A Redeemable Preferred Stock, $.001 par value,
2,000,000 shares authorized, issued and outstanding actual,
no shares issued and outstanding pro forma and as
adjusted(2)................................................. 1,417 -- --
Stockholders' equity:
Preferred Stock, $.001 par value, 2,000,000 shares
authorized, no shares issued and outstanding, pro forma
and as adjusted.......................................... -- -- --
Common Stock, $.001 par value, 3,000,000 shares authorized
1,397,157 shares issued and outstanding actual;
30,000,000 shares authorized, 8,537,157 shares issued and
outstanding pro forma, and 10,374,657 shares issued and
outstanding as adjusted(3)............................... 1 8 10
Additional paid-in capital.................................. 557 1,967 21,871
Deferred compensation....................................... (406) (406) (406)
Retained earnings........................................... 824 824 824
------ ------ ------
Total stockholders' equity............................... 976 2,393 22,299
------ ------ ------
Total capitalization................................ $2,538 $ 2,538 $22,444
====== ====== ======
</TABLE>
- ---------------
(1) See Note 5 of Notes to Consolidated Financial Statements.
(2) See Note 6 of Notes to Consolidated Financial Statements.
(3) Excludes (i) 373,368 shares of Common Stock issuable upon the exercise of
options outstanding as of June 30, 1996 with a weighted average exercise
price of $.37 per share, and (ii) an aggregate of 623,475 shares of Common
Stock available as of June 30, 1996 for future grant under the Company's
equity incentive plans. See "Management -- Employee Benefit Plans" and Note
7 of Notes to Consolidated Financial Statements.
15
<PAGE> 16
DILUTION
The pro forma net tangible book value of the Company as of June 30, 1996,
was approximately $1,965,100, or $.23 per share of Common Stock. Pro forma net
tangible book value per share is determined by dividing the amount of the
Company's tangible net worth (total tangible assets less total liabilities) by
the number of shares of Common Stock outstanding, after giving effect to the
conversion of all outstanding shares of Series A Redeemable Preferred Stock into
Common Stock upon the closing of this offering. After giving effect to the sale
by the Company of 1,837,500 shares of Common Stock offered hereby at the initial
public offering price of $12.00 per share (after deducting the underwriting
discount, estimated offering expenses and payment to Xerox of the Company's
current income tax liability in the amount of $1,382,100 for the period from
inception through December 31, 1995), and the application of the estimated net
proceeds therefrom, the pro forma net tangible book value, as adjusted, of the
Company as of June 30, 1996 would have been approximately $20,489,500, or $1.97
per share based on 10,374,657 shares of Common Stock to be outstanding after the
offering. This represents an immediate increase in such pro forma net tangible
book value of $1.74 per share to existing stockholders and an immediate dilution
of $10.03 per share to new investors purchasing shares of Common Stock in this
offering. The following table illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share.......................... $12.00
Pro forma net tangible book value per share as of
June 30, 1996(1)............................................... $ .23
Increase in pro forma net tangible book value per share
attributable to new investors(1)............................... 1.74
------
Pro forma net tangible book value per share after this
offering(1).................................................... 1.97
------
Dilution per share of Common Stock to new investors(1)........... $10.03
======
</TABLE>
- ---------------
(1) Assuming the exercise of options to purchase 373,368 shares of the Company's
Common Stock outstanding at June 30, 1996, (i) pro forma net tangible book
value per share as of June 30, 1996 would equal $.22, (ii) pro forma net
tangible book value per share after the offering would equal $1.91, (iii)
the increase in pro forma net tangible book value per share attributable to
new investors would equal $1.69, and (iv) dilution per share of Common Stock
to the new investors would equal $10.09.
The following table summarizes on a pro forma basis as of June 30, 1996,
the differences between the number of shares purchased from the Company,
assuming conversion of all outstanding shares of Preferred Stock into Common
Stock, the total consideration paid and the average price paid per share by the
existing holders of Common Stock and by the new investors at the initial public
offering price of $12.00 per share (before deduction of the underwriting
discount and estimated offering expenses):
<TABLE>
<CAPTION>
TOTAL
SHARES PURCHASED(1) CONSIDERATION(1) AVERAGE
-------------------- --------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE(1)
---------- ------- ----------- ------- ------------
<S> <C> <C> <C> <C> <C>
Existing stockholders(2)....... 8,537,157 82% $ 118,462 1% $ .01
New investors(2)............... 1,837,500 18 22,050,000 99% 12.00
------- ----- -------- ---- -
Total.......................... 10,374,657 100% $22,168,462 100%
======= ===== ======== =====
</TABLE>
- ---------------
(1) Assuming the exercise of options to purchase 373,368 shares of the Company's
Common Stock outstanding at June 30, 1996, after the offering: (i) shares
purchased by existing stockholders would total 8,910,525 (approximately 83%
of total shares purchased) and shares purchased by new investors will total
1,837,500 (approximately 17% of total shares purchased); (ii) consideration
paid by existing stockholders would amount to $256,608 (approximately 2% of
total consideration paid) and consideration paid by new investors would
total $22,050,000 (approximately 99% of total consideration paid); and
(iii) average price per share
16
<PAGE> 17
paid by existing stockholders would equal $.03 and average price per share
paid by new investors will equal $12.00.
(2) Sales by the Selling Stockholders in this offering will reduce the number of
shares held by existing stockholders to 8,074,657 shares or approximately
78% of the total shares of Common Stock outstanding after this offering and
will increase the number of shares held by new investors to 2,300,000 shares
or approximately 22% of the total shares of Common Stock outstanding after
this offering. Assuming the exercise of options to purchase 373,368 shares
of the Company's Common Stock outstanding at June 30, 1996, after the
offering, sales by the Selling Stockholders in this offering would cause
such percentages to be 79% and 21%, respectively.
The foregoing tables and calculations assume no exercise of options
outstanding as of June 30, 1996. At June 30, 1996 there were 373,368 shares of
Common Stock reserved for issuance upon exercise of outstanding options at a
weighted average exercise price of approximately $.37 per share, and an
additional 623,475 shares were reserved for issuance in connection with future
grants under the 1995 Stock Incentive Plan. To the extent that outstanding
options are exercised or shares reserved for future grant of options under the
1995 Stock Incentive Plan are issued, there will be further dilution to new
investors. See "Management -- Employee Benefit Plans" and Note 7 of Notes to
Consolidated Financial Statements.
17
<PAGE> 18
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data presented below should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and notes thereto included elsewhere in this Prospectus. The consolidated
statement of income data for each of the three years in the period ended
December 31, 1995 and the consolidated balance sheet data at December 31, 1994
and 1995 are derived from the consolidated financial statements audited by Ernst
& Young LLP, independent auditors, which are included elsewhere in this
Prospectus. The consolidated statement of income data for the year ended
December 31, 1992 and the consolidated balance sheet data at December 31, 1992
and 1993 are also derived from consolidated financial statements audited by
Ernst & Young LLP which are not included in this Prospectus. The consolidated
statements of income for the six-month periods ended June 30, 1995 and 1996 and
the consolidated balance sheet data at June 30, 1996 are derived from unaudited
consolidated financial statements. In the opinion of management, the unaudited
consolidated financial statements have been prepared on the same basis as the
audited consolidated financial statement and contain all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
Company's results of operations for such periods and financial condition at such
dates. The results of operations for the six months ended June 30, 1996 are not
necessarily indicative of the results to be expected for the full year or future
periods.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
----------------------------------------- ------------------
1992(1) 1993 1994 1995 1995 1996
------- ------- ------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA(2):
Revenues:
Initial license fees......................................... $ 585 $ 1,980 $ 4,426 $ 6,299 $ 2,492 $ 3,503
Annual renewal license and support fees...................... 628 980 1,521 1,942 894 1,100
Services and other........................................... 354 531 1,224 2,271 778 1,747
------ ------ ------ ------- ------ ------
Total revenues......................................... 1,567 3,491 7,171 10,512 4,164 6,350
------ ------ ------ ------- ------ ------
Cost of revenues:
Initial license fees......................................... 24 145 273 351 98 314
Annual renewal license and support fees...................... 149 217 267 369 179 245
Services and other........................................... 63 77 192 424 179 321
------ ------ ------ ------- ------ ------
Total cost of revenues................................. 236 439 732 1,144 456 880
------ ------ ------ ------- ------ ------
Gross profit................................................... 1,331 3,052 6,439 9,368 3,708 5,470
------ ------ ------ ------- ------ ------
Operating expenses:
Research and development..................................... 408 401 1,045 1,748 819 1,085
Selling and marketing........................................ 581 935 2,765 4,415 1,866 3,249
General and administrative................................... 610 996 1,275 1,520 733 736
------ ------ ------ ------- ------ ------
Total operating expenses............................... 1,599 2,332 5,085 7,683 3,418 5,070
------ ------ ------ ------- ------ ------
Income (loss) from operations.................................. (268) 720 1,354 1,685 290 400
Interest income (expense), net................................. (1) (23) (9) 5 9 16
------ ------ ------ ------- ------ ------
Income before provision (credit) for income taxes.............. (269) 697 1,345 1,690 299 416
Provision (credit) for income taxes............................ (95) 284 633 638 111 170
------ ------ ------ ------- ------ ------
Net income (loss).............................................. $ (174) $ 413 $ 712 $ 1,052 $ 188 $ 246
====== ====== ====== ======= ====== ======
Pro forma net income (loss) per share(3)....................... $ (.02) $ .06 $ .09 $ .13 $ .02 $ .03
====== ====== ====== ======= ====== ======
Shares used to compute pro forma net income (loss) per
share(3)..................................................... 7,290 7,290 8,256 8,292 8,256 8,891
====== ====== ====== ======= ====== ======
Supplemental pro forma net income (loss) per share(4).......... $ (.02) $ .06 $ .09 $ .13 $ .02 $ .03
====== ====== ====== ======= ====== ======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------- JUNE 30,
1992 1993 1994 1995 1996
------ -------- ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA(2):
Cash and cash equivalents................................................. $ 1 $ 112 $ 584 $ 1,271 $ 1,466
Working capital (deficit) (319) 84 537 1,353 1,040
Total assets.............................................................. 744 1,805 4,209 6,289 7,102
Obligations under capital leases, less current portion.................... 10 18 20 99 145
Series A Redeemable Preferred Stock....................................... 252 585 918 1,251 1,417
Total stockholders' equity (deficit)...................................... (388) (308) 71 856 976
</TABLE>
- ---------------
(1) The Company was incorporated on October 18, 1991, and had insignificant
commercial activities from inception through December 31, 1991.
(2) See Note 9 of Notes to Consolidated Financial Statements for information
concerning transactions with affiliates.
(3) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the computation of pro forma net income per share.
(4) Assumes the repayment of the current income tax payable to affiliate out of
the proceeds of this offering, and assumes as outstanding the pro forma
shares outstanding plus 115,175 shares of the shares being offered by the
Company hereby which represent the shares deemed to be sold to fund such
repayment. See "Use of Proceeds" and Note 1 of Notes to Consolidated
Financial Statements.
18
<PAGE> 19
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's revenues and results of operations are difficult to forecast
and could differ materially from those discussed in the forward-looking
statements contained in this Prospectus as a result of a number of factors,
including, without limitation, those discussed under "Risk Factors" above.
OVERVIEW
Document Sciences develops, markets and supports a family of document
automation software and services used in high volume electronic publishing
applications. The Company's revenues are divided into three categories: initial
license fees, annual renewal license and support fees, and services and other
revenues. Initial license fees are comprised principally of license fees for the
first year of use of the Company's products by end user customers. Annual
renewal license and support fees are comprised principally of mandatory fees
paid by customers annually for continued use and support of the licensed
products. Services and other revenues are comprised principally of fees for
consulting, application development and training services performed by the
Company as well as fees received from Xerox in connection with the sale of
certain Xerox printer products. The Company recognizes revenue in accordance
with AICPA Statement of Position on Software Revenue Recognition No. 91-1.
Initial license revenue is recognized upon shipment of the product to customers
if no significant Company obligations remain and collection of the receivable is
deemed probable. The portion of the initial license revenue which represents the
software support for the first year is deferred and recognized ratably over the
contract period. Annual renewal license and support revenue is deferred and
recognized ratably over the contract period. Revenues from commissions paid by
Xerox in connection with the sale of Xerox printer products are recognized upon
installation of the printer products. Revenues generated from consulting and
training services are recognized as the related services are performed. See Note
1 of Notes to Consolidated Financial Statements.
Revenues from the Company's CompuSet software and related products
comprised approximately 100%, 100%, 97% and 85% of initial license fees for
years 1993, 1994, 1995 and the first half of 1996, respectively. The Company
expects that its CompuSet products will continue to account for a substantial
majority of initial license fee revenue for the foreseeable future.
The Company's business has experienced and is expected to continue to
experience seasonality, in part due to customer purchasing patterns and the
Company's expense patterns. The Company believes that fourth quarter revenues
are positively impacted by year-end capital purchases by large corporate
customers, and strong fourth quarter sales of printers by Xerox (which may
generate sales of the Company's products, as well as commissions to the
Company), as well as the Company's sales compensation plans. These seasonal
factors typically result in fourth quarter revenues being substantially higher
than revenues in each of the preceding three quarters, as well as being higher
than revenues in each of the first two quarters of the next year. In addition, a
significant amount of the Company's revenues occur predominantly in the third
month of each fiscal quarter and tend to be concentrated in the latter half of
that third month.
The Company has substantially increased expenditures in support of its
strategy to expand its global marketing, sales and customer support
infrastructure in order to expand the market for the Company's products by
providing direct sales and support services and increased channel distribution
throughout the major markets of the world. Through this expansion, the Company
hopes to lessen its dependence on Xerox Corporation and certain Xerox
affiliates. In addition, the Company's strategy is to increase both its product
offerings and markets through marketing, sales and distribution, and its product
development relationships with other companies. The Company intends to increase
the number of these strategic relationships as well as form alliances with
system integrators and consultants. Whether the Company can successfully
generate its own sales leads,
19
<PAGE> 20
introduce new products and enter into new markets will depend on its ability to
expand its direct sales and support services, expand its indirect channel
distribution, and increase its relationships and alliances with other companies.
As a result of its planned expansion, the Company has and will continue to incur
significant costs to build such corporate infrastructure ahead of anticipated
revenues, and any failure to achieve growth in revenues would have a material
adverse effect on the Company's business, operating results and financial
condition. See "Risk Factors -- Expansion of Sales and Distribution Channels."
The license of the Company's software products is often an enterprise-wide
decision by prospective customers and generally requires the Company to engage
in a lengthy sales cycle, typically between three and twelve months, to provide
a significant level of education to prospective customers regarding the use and
benefits of the Company's projects. In addition, the implementation by customers
of the Company's products involves a significant commitment of resources by such
customers over an extended period of time and is commonly associated with
substantial customer reengineering efforts. For these and other reasons, the
sales and customer implementation cycles are subject to a number of significant
delays over which the Company has little or no control. Delay in the sale or
customer implementation of a limited number of license transactions could have a
material adverse effect on the Company's business, operating results and
financial condition.
The Company sells its products principally through a direct sales force
domestically, and internationally principally through distributors and value
added resellers ("VARS") and, to a lesser extent, through its direct sales
force. The Company derived approximately 14%, 26%, 42% and 30% of its total
revenues from export sales, including sales through its foreign subsidiary, in
1993, 1994, 1995 and the first half of 1996, respectively. International
revenues reflect the start-up and expansion of the Company's international
operations. The Company's international business is subject to various risks
common to international activities, including currency fluctuations. Revenues
and expenses of the Company's international operations are translated at the
average exchange rate in effect during the period. Although to date exchange
rate fluctuations have not had a significant impact on the Company, fluctuations
in the value of the currencies in which the Company conducts its business
relative to the U.S. dollar could cause currency transaction gains and losses in
future periods. Such fluctuations could affect the Company's operating results
and financial condition. The Company does not currently engage in currency
hedging transactions. See Notes 3 and 9 of Notes to Consolidated Financial
Statements.
The Company and Xerox maintain a strategic marketing alliance agreement
under which the parties have agreed to pay each other fees on referrals that
lead to the successful licensing or sales of each other's products. The
Company's revenues from the strategic marketing alliance, principally
commissions from sales of Xerox printers, were $490,400, $752,000 and $586,600
in 1994, 1995 and the first half of 1996, respectively, and payments to Xerox
under this agreement were $113,500, $167,200 and $67,300 in 1994, 1995 and the
first half of 1996, respectively. The commissions received by the Company from
sales of Xerox printers under the strategic marketing alliance have little
associated costs, have had a high degree of inconsistency from quarter to
quarter and are difficult to estimate. Failure to continue to receive such
commissions would have a material adverse effect on the Company's business,
operating results and financial condition. In addition, the Company has entered
into distributorship agreements with various Xerox foreign affiliates to re-
market the Company's products internationally. The Company's revenues from such
distributorship agreements related to the licensing, maintenance and support of
the Company's products were $1.3 million, $3.1 million and $675,900 in 1994,
1995 and the first half of 1996, respectively. When initial licenses of the
Company's software products are installed with Xerox products, from time to time
Xerox bills and collects for the licensed software on behalf of the Company.
Funds collected and remitted by Xerox to the Company for these end user software
products were $835,200 in 1994, $1.2 million in 1995 and $821,600 in the first
half of 1996. See Note 9 of Notes to Consolidated Financial Statements. Although
neither Xerox nor its affiliated entities has expressed to the
20
<PAGE> 21
Company any intention to terminate their respective agreements with the Company,
these agreements generally may be terminated on no more than 90 days' notice.
Accordingly, there can be no assurance that Xerox or its affiliates will
continue these relationships or, if they do, that they will be on terms
favorable to the Company.
RESULTS FROM OPERATIONS
The following table sets forth the percentage of total revenues for certain
items in the Company's consolidated statement of income for the periods
indicated:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------ --------------
1993 1994 1995 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues:
Initial license fees.............................. 57 % 62 % 60 % 60 % 55 %
Annual renewal license and support fees........... 28 21 18 21 17
Services and other................................ 15 17 22 19 28
--- --- --- --- ---
Total revenues............................ 100 100 100 100 100
--- --- --- --- ---
Cost of revenues:
Initial license fees.............................. 4 3 3 3 5
Annual renewal license and support fees........... 6 4 4 4 4
Services and other................................ 3 3 4 4 5
--- --- --- --- ---
Total cost of revenues.................... 13 10 11 11 14
--- --- --- --- ---
Gross profit........................................ 87 90 89 89 86
--- --- --- --- ---
Operating expenses:
Research and development.......................... 11 14 17 20 17
Selling and marketing............................. 27 39 42 45 51
General and administrative........................ 28 18 14 17 12
--- --- --- --- ---
Total operating expenses.................. 66 71 73 82 80
--- --- --- --- ---
Income from operations.............................. 21 19 16 7 6
Interest income (expense), net...................... (1 ) -- -- -- --
--- --- --- --- ---
Income before provision for income taxes............ 20 19 16 7 6
Provision for income taxes.......................... 8 9 6 2 2
--- --- --- --- ---
Net income................................ 12 % 10 % 10 % 5 % 4 %
=== === === === ===
</TABLE>
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
Revenues
Total revenues were $3.5 million in 1993, $7.2 million in 1994, and $10.5
million in 1995, representing increases from the prior year of 105% in 1994 and
47% in 1995. The increases were primarily attributable to increases in revenues
from initial licenses of software and growth in services and other revenue. In
addition, the Company's revenues from export sales and sales through its foreign
subsidiary increased from 14% of total revenues in 1993 to 26% in 1994 and 42%
in 1995.
Initial license fees. Initial license revenues increased 124% from $2.0
million in 1993 to $4.4 million in 1994 and 42% to $6.3 million in 1995,
representing 57%, 62% and 60% of total revenues in the respective years. The
increase in initial licenses of software was due principally to sales to new
customers and expansion of the Company's indirect distribution channel,
especially the value added reseller channel in Europe, and to a lesser extent to
the release in October 1993 of the Windows-based CompuSeries products.
Annual renewal license and support fees. Revenues from annual renewal
license and support fees increased 55% from $980,700 in 1993 to $1.5 million in
1994, and by 28% to $1.9 million in 1995. The increase was principally due to
expansion in the installed base of the users of the Company's
21
<PAGE> 22
software products. As a percentage of total revenues, annual renewal license and
support fees have decreased from approximately 28% in 1993 to 21% in 1994 and
18% in 1995. This decrease is principally due to the strong increase in initial
license revenues in 1994 and 1995 and, to a lesser extent, to licenses of
CompuSeries products in 1994 and 1995 when such products did not carry a
follow-on annual license obligation.
Services and other. Revenues from services and other increased 131% from
$530,900 in 1993 to $1.2 million in 1994, and 86% to $2.3 million in 1995 and
have increased as a percentage of total revenues from 15% in 1993 to 17% in 1994
and 22% in 1995. The increase in revenues was the result of increasing demand
from customers for consulting services due principally to the increased number
of new customer licenses of the Company's software generating increased demand
for services, and the increase in commissions from $198,600 in 1993 to $490,400
and $752,000 in 1994 and 1995, respectively, under the strategic marketing
alliance from the sale of Xerox printers.
Cost of Revenues
Total cost of revenues have remained relatively constant at 10% to 13% of
total revenues during the last three fiscal years.
Cost of initial license fees. Cost of initial license fees of software
includes documentation, reproduction costs, product packaging, packaging design,
product media, employment costs for training, installation and distribution
personnel. The cost of initial licenses has ranged between 5% to 7% of initial
license revenues during the last three years. The cost of third party software
has been insignificant to date; however, these costs will increase in the future
to the extent that the Company integrates third party software into its Document
Library software products and to the extent that the Document Library software
products become a significant component of initial license revenue. Also
included in the cost of initial license revenues in 1993, 1994 and 1995 was
amortization of capitalized software development costs of $36,600, $103,500 and
$136,100, respectively.
Cost of annual renewal license and support fees. Cost of annual renewal
license and support fees consists principally of the employment-related costs
for the Company's technical support staff, which performs technical software
support services. These costs have increased on an absolute dollar basis from
1993 to 1995 due principally to increases in the Company's technical support
staff. As a percentage of annual renewal license and support fees revenues,
these costs were 22%, 18% and 19% in 1993, 1994 and 1995, respectively,
reflecting significantly increased technical support staff in 1995.
Cost of services and other. Cost of services and other consists
principally of the employment-related costs for the Company's staff of product
consultants and trainers. There are little or no costs related to commissions
from the sale of Xerox printers under the strategic marketing alliance. These
costs have ranged between 15% and 19% of services and other revenues during the
last three years. The increase in these costs in absolute dollars and as a
percentage of services and other revenues resulted principally from the
additional staffing required to perform the Company's professional services.
Operating Expenses
Research and development. Research and development expenses consist
primarily of personnel costs associated with developing new products, enhancing
existing products, testing software products and developing product
documentation as well as other costs directly related to product development.
The Company expenses all costs for research and development of new products
until technological feasibility has been assured. Thereafter, costs of
production are capitalized until general release of the product. The Company
capitalized $74,900, $164,000 and $291,000 in 1993, 1994 and 1995, respectively.
The capitalized costs of software production are amortized using the greater of
the amount computed using the ratio of current product revenues to estimated
total product revenues or the straight-line method over the remaining estimated
economic lives of the
22
<PAGE> 23
products. Research and development expenses increased 161% from $401,000 in 1993
to $1.0 million in 1994 and 67% to $1.7 million in 1995, representing 11%, 14%
and 17% of total revenues in these periods, respectively. The increase in these
expenses over this period resulted principally from the increase in the number
of engineering and technical employees and related costs. Engineering and
technical employees increased from 6 in 1993 to 15 in 1994 to 22 in 1995.
Selling and marketing. Selling and marketing expenses consist primarily of
salaries, commissions, marketing programs and related costs for pre- and
post-sales activity. These expenses increased 196% from $935,000 in 1993 to $2.8
million in 1994 and 60% to $4.4 million in 1995, representing 27%, 39% and 42%
of total revenues in these years, respectively. The growth of these expenses was
due principally to increases in domestic sales and sales support personnel and
related costs, as well as to increases in commissions associated with increased
revenues and increases in expenses for seminars, trade shows, advertising and
other marketing programs. The increase in these expenses as a percentage of
total revenues reflects additional personnel, from 13 in 1993 to 25 in 1994 and
55 in 1995, and expanded marketing programs necessary to address new sales
opportunities and to support an expanded customer base. See "Risk Factors --
Expansion of Sales and Distribution Channels."
General and administrative. General and administrative expenses consist of
employment-related costs for finance, administration and human resources, and
general corporate management and services. These expenses increased 28% from
$996,000 in 1993 to $1.3 million in 1994, and 19% to $1.5 million in 1995,
representing 28%, 18% and 14% of total revenues in 1993, 1994 and 1995,
respectively. The increase in these expenses in absolute dollars from 1993 to
1995 was due principally to growth in the Company's finance and administrative
operations necessary to support business growth. The decrease as a percentage of
total revenues reflects the benefits of economies of scale.
Interest Income (Expense), Net
Interest income (expense), net is primarily composed of interest income
from cash and cash equivalents, offset by financing charges related to equipment
leases and other debt. The Company generally invests cash not required for
immediate working capital needs in United States Government treasury bills,
money market accounts and other investment-grade securities. The amount of
interest income fluctuates based upon the amount of funds available for
investment and the prevailing interest rates.
Provision for Income Taxes
The Company's effective tax rate was 41% in 1993, 47% in 1994 and 38% in
1995. The effective tax rates were based on the federal and state statutory
rates. The effective income tax rate for 1994 increased as a result of operating
losses incurred by the Company's foreign subsidiary. The tax benefits
attributable to these losses cannot be recognized as the realization of such
benefits is uncertain. From its inception to December 31, 1995, the Company's
taxes were included in the consolidated tax returns of Xerox. For reporting
purposes, the Company recognizes income tax expense on pretax income at the tax
rates in effect as if the Company were filing tax returns on a stand-alone
basis. The Company intends to repay its income tax liability to Xerox from the
proceeds of the initial public offering. At such time as Xerox owns less than
80% of the Common Stock of the Company, the Company will not be part of the
consolidated tax returns of Xerox. See "-- Liquidity and Capital Resources,"
"Certain Transactions" and Note 8 of Notes to Consolidated Financial Statements.
SIX MONTHS ENDED JUNE 30, 1995 AND JUNE 30, 1996
Revenues
Total revenues increased 53% from $4.2 million in the first half of 1995 to
$6.3 million for the same period in 1996. Revenues from initial license fees,
annual license renewal and support fees
23
<PAGE> 24
and services and other increased 41%, 23% and 125%, respectively, from the first
half of 1995 to the first half of 1996, representing 55%, 17% and 28%
respectively, of total revenues. This growth in revenues reflected increases in
licenses of the Company's software products to new customers and additional
licenses to existing customers, annual renewal license fees from an expanded
installed customer base, increases in customer requirements for consulting
services, and the Company's increased focus on providing such services. The
Company also had significantly increased revenues from commissions from the sale
of Xerox printers, which are included in services and other, from $157,700 in
the first half of 1995 to $586,600 for the same period in 1996. In the
comparative periods, the Company's total revenues from Xerox and affiliates of
Xerox declined from $1.5 million in the first half of 1995 to $1.4 million in
the first half of 1996, due principally to substantially reduced sales through
Fuji Xerox Co. Ltd. in Australia and Xerox Canada Ltd. in Canada and, to a
lesser extent, to reduced European revenues from Xerox affiliates. These
decreases were substantially offset by the increased revenues from commissions
on sales of Xerox printers. In addition, the Company's revenues from European
VARs not affiliated with Xerox increased substantially in the first half of 1996
from the first half of 1995. The Company also recognized revenues from the
initial licenses of its DLS and DVS products in the first half of 1996.
Cost of Revenues
Total cost of revenues increased from $456,900 in the first half of 1995 to
$879,800 for the same period in 1996, representing 11% and 14% of total revenues
in the respective periods. These costs increased principally as a result of
expansion of technical support personnel necessary to support the expansion of
the installed customer base of the Company's software products as well as to
increase the level and quality of the technical support provided.
Cost of initial license fees. The cost of initial licenses increased from
$98,300 in the first half of 1995 to $313,700 for the same period in 1996,
representing approximately 4% and 9% of initial license revenues in the
respective periods. This increase was principally due to the changes in mix and
initial shipments of the DLS software, which has higher costs due to the use of
third party software.
Cost of annual renewal license and support fees. These costs increased
from $179,700 in the first half of 1995 to $244,600 in the same period in 1996,
representing approximately 20% and 22%, respectively, of annual renewal license
and support fee revenues in the comparative periods. These costs increased
principally as a result of expansion of technical support personnel necessary to
support the expansion of the installed customer base of the Company's software
products and to increase the level and quality of the technical support
provided.
Cost of services and other. These costs increased from $178,900 in the
first half of 1995 to $321,600 for the same period in 1996, representing 23% and
18%, respectively, of services and other revenues in the respective periods. The
increase in absolute dollars resulted principally from expansion of the
consulting personnel and the increase in the generally high levels of salaries
of the consulting personnel. The decrease as a percentage of related revenue was
the result of the higher percentage of commissions from the sale of Xerox
printers relative to the services revenue, since the cost of services and other
does not include any material expense associated with commissions from the sale
of Xerox printers. The cost of services for both the first half of 1995 and 1996
was 28% of services revenue.
Operating Expenses
Research and development. Research and development expenses increased from
$819,400 in the first half of 1995 to $1.1 million for the same period in 1996,
representing 20% and 17% of total revenues in the respective half year periods.
The increase in absolute dollars was the result of increases in the number of
engineering and technical employees and related costs which the Company incurred
to support the increased focus on product enhancements and product design.
24
<PAGE> 25
Selling and marketing. These expenses increased from $1.9 million in the
first half of 1995 to $3.2 million for the same period in 1996, representing 45%
and 51%, respectively, of total revenues in the respective periods. The increase
was due to higher personnel costs as a result of an increase in headcount from
48 to 68, higher travel costs, expanded marketing activities and the design and
implementation of professional services methodology, all in support of the
Company's strategy to expand its worldwide marketing, sales, consulting and
customer support infrastructure. See "Risk Factors -- Expansion of Sales and
Distribution Channels."
General and administrative. These expenses increased from $732,300 in the
first half of 1995 to $735,600 for the same period in 1996, representing 17% and
12%, respectively, of total revenue in the respective periods. These costs
remained relatively constant in absolute dollars and decreased significantly as
a percentage of total revenues reflecting the benefits of economies of scale.
SELECTED QUARTERLY OPERATING RESULTS
The following tables set forth certain unaudited consolidated financial
information by quarter for each of the six quarters through the quarter ended
June 30, 1996. This quarterly information has been prepared on a consistent
basis with the audited consolidated financial statements appearing elsewhere in
this Prospectus and, in the opinion of management, all necessary adjustments,
consisting only of normal recurring adjustments, have been included in the
amounts stated below to present fairly the unaudited quarterly results when read
in conjunction with the audited consolidated financial statements and related
notes thereto. The operating results for any quarter are not necessarily
indicative of results for any future period. See "Risk Factors -- Uncertainty of
Future Operating Results; Fluctuations in Quarterly Operating Results."
25
<PAGE> 26
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------------
1995 1996
-------------------------------------------- -------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30
------- ------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Initial license fees......................... $ 1,287 $ 1,205 $1,238 $ 2,568 $ 1,564 $ 1,939
Annual renewal license and support fees...... 430 464 514 534 545 555
Services and other........................... 273 505 539 954 579 1,168
------ ------ ------ ------ ------ ------
Total revenues....................... 1,990 2,174 2,291 4,056 2,688 3,662
------ ------ ------ ------ ------ ------
Cost of revenues:
Initial license fees......................... 55 43 34 217 86 228
Annual renewal license and support fees...... 82 97 86 104 134 111
Services and other........................... 75 104 115 130 139 182
------ ------ ------ ------ ------ ------
Total cost of revenues............... 212 244 235 451 359 521
------ ------ ------ ------ ------ ------
Gross profit................................... 1,778 1,930 2,056 3,605 2,329 3,141
------ ------ ------ ------ ------ ------
Operating expenses:
Research and development..................... 373 446 512 417 506 579
Selling and marketing........................ 803 1,063 1,058 1,491 1,462 1,787
General and administrative................... 342 391 387 401 341 395
------ ------ ------ ------ ------ ------
Total operating expenses............. 1,518 1,900 1,957 2,309 2,309 2,761
------ ------ ------ ------ ------ ------
Income from operations......................... 260 30 99 1,296 20 380
Interest income (expense), net................. 2 7 -- (4) 5 11
------ ------ ------ ------ ------ ------
Income before provision for income taxes....... 262 37 99 1,292 25 391
Provision for income taxes..................... 97 14 37 490 9 161
------ ------ ------ ------ ------ ------
Net income..................................... $ 165 $ 23 $ 62 $ 802 $ 16 $ 230
====== ====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------------
1995 1996
-------------------------------------------- -------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30
------- ------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
Initial license fees......................... 65% 56% 54% 63% 58% 53%
Annual renewal license and support fees...... 21 21 22 13 20 15
Services and other........................... 14 23 24 24 22 32
------ ------ ------ ------ ------ ------
Total revenues....................... 100 100 100 100 100 100
------ ------ ------ ------ ------ ------
Cost of revenues:
Initial license fees......................... 3 2 1 5 3 6
Annual renewal license and support fees...... 4 4 4 3 5 3
Services and other........................... 4 5 5 3 5 5
------ ------ ------ ------ ------ ------
Total cost of revenues............... 11 11 10 11 13 14
------ ------ ------ ------ ------ ------
Gross profit................................... 89 89 90 89 87 86
------ ------ ------ ------ ------ ------
Operating expenses:
Research and development..................... 19 20 22 10 19 16
Selling and marketing........................ 40 49 46 37 54 49
General and administrative................... 17 18 17 10 13 11
------ ------ ------ ------ ------ ------
Total operating expenses............. 76 87 85 57 86 76
------ ------ ------ ------ ------ ------
Income from operations......................... 13 2 5 32 1 10
Interest income (expense), net................. -- -- -- -- -- --
------ ------ ------ ------ ------ ------
Income before provision for income taxes....... 13 2 5 32 1 10
Provision for income taxes..................... 5 1 1 12 -- 4
------ ------ ------ ------ ------ ------
Net income..................................... 8% 1% 4% 20% 1% 6%
====== ====== ====== ====== ====== ======
</TABLE>
26
<PAGE> 27
The Company's total revenues and operating results can vary, sometimes
substantially, from quarter to quarter and are expected to vary significantly in
the future. The Company's revenues and operating results are difficult to
forecast. Future results will depend upon many factors, including the demand for
the Company's products, the level of product and price competition, the length
of the Company's sales cycle, the size and timing of individual license
transactions, the delay or deferral of customer implementations, the budget
cycles of the Company's customers, the Company's success in expanding its direct
sales force and indirect distribution channels, the timing of new product
introductions and product enhancements by the Company and its competitors, the
mix of products and services sold, levels of international sales, activities of
and acquisitions by competitors, the timing of new hires, changes in foreign
currency exchange rates, the ability of the Company to develop and market new
products and control costs, and general domestic and international economic
conditions. In addition, the Company's sales generally reflect a relatively high
amount of revenues per order, and the loss or delay of individual orders,
therefore, could have a significant impact on the revenues and quarterly
operating results of the Company. Moreover, the timing of license revenue is
difficult to predict because of the length of the Company's sales cycle, which
is typically three to twelve months from the initial customer contact. In
addition, a significant amount of the Company's revenues occur predominantly in
the third month of each fiscal quarter and tend to be concentrated in the latter
half of that third month.
The Company's business has experienced and is expected to continue to
experience seasonality, in part due to customer purchasing patterns and the
Company's expense patterns. The Company believes that fourth quarter revenues
are positively impacted by year-end capital purchases by large corporate
customers and strong fourth quarter sales of printers by Xerox (which may
generate sales of the Company's products), as well as the Company's sales
compensation plans. As reflected in the fourth quarter of 1995, these seasonal
factors have historically resulted in fourth quarter revenues being
substantially higher than revenues in the preceding three quarters, as well as
being higher than revenues in each of the first two quarters of the next year.
In addition, in the second and third quarters of 1995 and the first and second
quarters of 1996, the Company's operating profitability was substantially
dependent on commissions received from the sale of Xerox printers.
The Company's sales generally reflect a relatively high amount of revenues
per order. The loss or delay of individual orders, therefore, could have a more
significant impact on the revenues and quarterly results of the Company than on
those of companies with higher sales volumes and lower revenues per order. The
Company's software products generally are shipped as orders are received, and
revenues are recognized upon shipment of the products, provided no significant
vendor obligation exists and collection of the related receivable is deemed
probable. As a result, initial license revenues in any quarter are substantially
dependent on orders booked and shipped in that quarter. The timing of receipt of
initial license revenue is difficult to predict because of the length of the
Company's sales cycle, which is typically three to twelve months from the
initial contact. Because the Company's operating expenses are based on
anticipated revenue trends and because a high percentage of the Company's
expenses are relatively fixed, a delay in the recognition of revenue from a
limited number of initial license transactions could cause significant
variations in operating results from quarter to quarter and could result in
losses. To the extent such expenses precede, or are not subsequently followed
by, increased revenues, the Company's operating results would be materially
adversely affected. Further, the Company has experienced variability in quarter-
to-quarter operating expenses. This variability in research and development
expenses is due principally to the timing of completion of software development
projects and the allocation of the time of technical personnel who are
periodically assigned to such development projects. In addition, the Company's
selling and marketing expenses have increased significantly over the last six
quarters, reflecting a significant increase in the Company's sales, marketing
and customer support infrastructure designed to increase revenues. If such
revenue increase does not occur, the Company's operating results will be
materially adversely affected.
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Due to the foregoing factors, revenues and operating results for any
quarter are subject to significant variation, and the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Further, it is possible that in some future quarter or quarters the Company's
operating results will be less than the expectations of public market analysts
and investors. In such event, the price of the Company's Common Stock would
likely be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since inception through cash flow
from operations, bank lines of credit and long-term capital leases. The Company
has a line of credit with a commercial bank under which the Company may borrow
up to a total of $750,000, secured by substantially all assets of the Company at
the bank's prime rate of interest plus 1%. The Company currently has no
borrowings outstanding under the line of credit. The Company has entered into a
letter of intent to replace such line of credit with a new line of credit from a
commercial bank under which the Company may borrow up to $2,500,000 at the
bank's prime rate. This line of credit will be secured by substantially all
assets of the Company.
The Company generated $90,000, $1.3 million, $1.2 million and $614,100 from
operations in 1993, 1994, 1995 and the first half of 1996, respectively. These
amounts are principally the result of income from operations and increases in
deferred revenue partially offset by growth in accounts receivable, due to
increased revenue. In addition, Xerox paid the Company's current income taxes of
$136,000, $653,700 and $591,400 in 1993, 1994 and 1995, respectively, which the
Company has not been required to settle in cash, which has positively affected
cash generated from operating activities in such periods. Beginning January 1,
1996, the Company will be responsible for the payment of its income taxes, which
will affect cash generated from operations. The Company's investing activities
used cash of $95,400 in 1993, $411,300 in 1994, $588,900 in 1995 and $391,800 in
the first half of 1996. The principal investments have been in purchases of
property and equipment and computer software costs. See "Use of Proceeds."
The Company's financing activities provided $27,200 in 1995 and $116,800 in
1993. In 1995, cash was provided by issuance of common stock pursuant to
exercise of stock options offset by payments of capital lease obligations. In
1993, cash was provided by borrowings under the Company's line of credit offset
by payments of capital lease obligations. In 1994, cash used for financing
activities was $374,400. In this period, cash was used to repay net borrowings
under the Company's line of credit and capital lease obligations. In the first
half of 1996, cash used for financing activities was $27,600. In this period,
cash was used primarily to repay capital lease obligations.
At June 30, 1996, the Company had cash and cash equivalents of $1.5
million. The Company believes that the net proceeds from the sale of Common
Stock in this offering together with existing cash balances, anticipated cash
flow from operations, and its line of credit, will be sufficient to meet its
capital requirements for at least the next twelve months. The Company intends to
invest the Company's cash in excess of cash required for current operations in
short-term, investment grade securities.
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BUSINESS
Document Sciences Corporation develops, markets and supports a family of
document automation software products and services used in high volume
electronic publishing applications. Document automation has become increasingly
important as more companies realize the benefits of automating the high volume
production of individually customized documents that require the precise layout
of information such as financial data, marketing text and graphs. Autograph, the
Company's document automation software architecture, enables personalized and
customized publishing solutions for many industries including insurance, managed
healthcare, financial services, telecommunications, manufacturing/distribution,
government and commercial print services. The Company's products enable an
important form of communication between organizations and customers by employing
enterprise database assets to produce high-quality documents that are ready to
print on demand and distribute in high volume. Additionally, the Company's core
technology is being applied to provide electronic document automation solutions
for the Internet, intranets and commercial on-line services. CompuSet,
Autograph's flagship product, is licensed by approximately 400 customers
worldwide who collectively produce an estimated one billion customized pages per
month. The fully portable Autograph platform enables cost-effective,
just-in-time, on-demand, high volume publishing that is fully automated, capable
of quality document composition, and flexible for end-user customization. The
Company's products are used in a wide array of computing environments from
client/server to large computer systems.
INDUSTRY BACKGROUND
In today's highly competitive and cost conscious marketplace, document
automation is becoming increasingly critical to organizations with large numbers
of customer and document distribution needs. The Company believes producing and
processing business documents may cost up to 15% of a document intensive
organization's revenue. Document automation can reduce labor, inventory, and
distribution costs often found in other forms of publishing. For many companies,
the document is the primary manifestation of the company's products or services.
For example, insurance companies communicate to their policy holders principally
through their insurance policy documents. The insurance company's policy and
periodic premium bill represents its products and services. The production of
these documents through powerful document automation processes can dramatically
improve the company's image in the eyes of its customers. In addition, the role
of the document is becoming increasingly important in helping companies provide
new products and services to their customers. Examples are financial statements
that provide periodic performance reports, suggested investment strategies, and
highly personalized marketing messages integrated into the statements. Using
these documents as cross-marketing tools incorporating information from database
marketing and data mining processes can result in improved customer acquisition
and retention.
Many organizations that rely on documents to communicate with their
customers are seeking solutions which can provide highly customized and
personalized documents. Some markets require documents to be produced in large
quantities and with strong visual appeal. These organizations typically produce
large quantities of documents which are uniquely tailored to each individual
customer, such as insurance policies, financial statements, bills, and high
quality specialized direct mailings. Traditionally, these types of documents
have been created using a variety of in-house software systems augmented with
manual processes, which can be time consuming, costly and inflexible, and then
output to high speed and large volume electronic printers. Introduced by Xerox
and IBM in the late 1970s, electronic printers provide cost and productivity
advantages as well as the ability to produce robust documents in comparison to
the previous generation of high speed electromechanical impact printers.
Nevertheless, in markets requiring personalized and customized documents, high
volume electronic printers are often underutilized when not operated in
conjunction with document automation software.
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To fully utilize electronic printers and economically produce documents,
organizations must address four processes: information creation, information
management, information formatting, and information presentation and output.
These processes, together with their primary forms or functions, are shown
below.
ELECTRONIC PUBLISHING PROCESS
CHART
Many organizations must manage these processes across a variety of
organizational units and computing systems. Companies producing documents in
large quantities must also consider the cost trade-offs between highly
customized and personalized documents versus reproducing standard documents.
Organizations seek to implement flexible document automation processes in order
to produce customized documents in large quantities without the high costs of
traditional production methods. Document automation enables cost effective
production of large volumes of highly personalized and customized documents,
often at production costs similar to mass produced standard documents.
Some organizations that have produced large quantities of customized and
personalized paper documents for communications and information distribution are
exploring alternative and emerging technologies. These emerging document
distribution technologies include CD-ROM, the Internet, intranets, and
commercial on-line services. For example, many organizations are replacing
printed internal documents with electronic postings on enterprise local area
networks (LANs) or intranets. In addition, many companies are beginning to
communicate externally through global electronic networks such as the Internet.
For example, according to a recent industry report, the worldwide installed base
of intranet servers is estimated to grow from 63,500 in 1995 to 8.8 million in
2000, and the worldwide installed base of intranet client browsers is estimated
to grow from 6.4 million in 1995 to 111.9 million in 2000. For some
applications, the cost of implementing and maintaining these document
distribution alternatives is offset by the elimination or reduction of
paper-based document production and distribution. In addition to cost savings,
these technologies enable organizations to provide higher quality and more
robust interactive documents than their paper based counterparts. These
technologies can lead to more effective communications and improved customer
satisfaction, retention, and acquisition.
The market for document automation software is growing rapidly as companies
recognize the need to increase document effectiveness through high quality
composition and assembly. Document automation capitalizes on the investments
companies have made in traditional mainframe and newer client/server computing
platforms. Growth in the paper-based portion of the market is also fueled by the
increasing popularity of lower-cost midrange electronic printers and the
continuing cost/performance improvements in computing and communications
technologies. Organizations are producing increasing amounts of data and
information and consequently are demanding more effective documents and
delivery. The improvements in effectiveness can result from customized and
personalized content, more robust documents, and improved forms of document
delivery. In addition, in many current and future applications, the fundamental
nature of the document is shifting from static paper-based documents to more
robust interactive electronic documents published on the Internet, intranets and
commercial on-line services.
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THE DOCUMENT SCIENCES SOLUTION
Document Sciences provides an integrated family of products and services
which address the enterprise need for document automation across mainframe and
client/server computing environments. The Company's software products and
services enable cost-effective composition and assembly of highly customized and
personalized documents rapidly and in very large quantities. The Company's
products comprise its Autograph document automation software architecture.
Document Sciences' products provide the following key business benefits for
a variety of document automation applications:
High Speed Personalization and Customization. The Company's products
enable large volumes of highly personalized and customized documents to be
composed and assembled faster than by interactive publishing methods and most
other types of current electronic publishing. For example, using CompuSet, more
than 50 complex personalized and customized pages per second can be composed and
assembled using data and information in corporate databases. The customer
satisfaction benefits of personalized and customized documents can be
substantial and can often provide the company's customers with a competitive
advantage.
Just-in-Time, On-Demand Processing. The Company's products are suited to
just-in-time, on-demand environments where customized and personalized documents
must be produced rapidly and in large quantities. Applications can be developed
which operate in both high-volume batch processing environments as well as
transaction initiated settings. Autograph's ability to support both environments
benefits the customer by providing the enterprise with a single document
automation solution which addresses on-demand publishing for both paper based
and electronic document distribution.
Portable, open and scaleable. The Company's software products operate
identically on a large number of computing and software operating systems, and
are easily migrated across heterogeneous computing environments. For example,
the Company's software products and applications operating on IBM mainframe
hardware and software products can be easily moved to industry standard Unix or
PC platforms with little or no modifications. In addition, Autograph supports
high speed electronic printers from Xerox, IBM, OCE (which has recently acquired
the electronic printer business of Siemens Nixdorf), and Hewlett-Packard, which
together account for a large majority of the world's installed base.
Lower Cost. The Company's software products enable significant cost
savings over traditional forms of document development, production and
archiving. Due to their automation capabilities, the Company's products require
less labor for certain applications when compared to other types of electronic
publishing such as interactive or desktop publishing. The on-demand production
capabilities of Autograph help reduce storage, inventory and obsolescence costs.
Document archiving systems that utilize the Company's electronic viewing
products can achieve significant cost savings compared to paper, microfiche, and
microfilm forms of archiving.
THE DOCUMENT SCIENCES STRATEGY
The Company's objective is to be the leading worldwide supplier of document
automation software and services. Autograph, the Company's document automation
software architecture, enables many industries including insurance, managed
health care, financial services, telecommunications, government agencies and
commercial print service bureaus to provide high volume customized and
personalized communication for their customers. The Company's strategy includes
extending its technology leadership, leveraging its installed base of customers,
expanding its distribution channels, expanding professional services and
expanding into electronic documents including the Internet, intranets and
commercial on-line services. The Company expects to invest significantly in
sales, marketing, professional services and product development infrastructure.
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Maintain and Extend Technology Leadership. The Company's technology
strategy is to continue to enhance its industry leading Autograph architecture
with the addition of new products, features, functions, and performance
improvements. The Company intends to enhance Autograph by extending
connectivity, support and compatibility with products and services provided by
complementary suppliers in the industry. The Company intends to continue porting
its software products to additional computing platforms as market needs develop.
Continuing investments will be made in graphical user interfaces for document
design, prototyping and system operation. The Company intends to extend and
modify its core document automation technology to provide support for paperless
document production and distribution. Paperless document production and
distribution include on-line viewing, customized documents prepared for
distribution on optical media such as CD-ROMs, and electronic documents accessed
and delivered via the Internet, intranets and commercial on-line services.
Leverage the Company's Installed Base. The Company has a large installed
base of customers within its targeted markets in the United States, Canada,
Europe, and Australia. In many cases, the Company's customers are expanding or
upgrading their document automation needs, which provides a market for
additional products from the Company. Recently introduced and planned products
and services can also be provided to the Company's current customers as
follow-on sales activities. The Company also intends to leverage this installed
base by utilizing it to facilitate the introduction of major new products into
the market, such as products and services for providing electronic document
distribution over the Internet, intranets and commercial on-line services. The
Company's strategy is to increase its account penetration horizontally and
across multiple departments through Autograph's "sell high, sell wide"
enterprise-wide sales strategy, by further up-market penetration through the
integration and delivery of the total solutions selling process, and by
down-market penetration through increasing product ease of use.
Leverage the Electronic Printing Installed Base. The Company believes that
the worldwide installed base of high speed electronic printers is under utilized
due to the lack of widespread use of high-end document automation software
products. The Company intends to leverage this opportunity by marketing the
benefits of document automation to the high speed electronic printing installed
base which has already made extensive investments in computing and printing
hardware.
Expand Distribution Channels. The Company currently markets and supports
its products in the United States, Canada, Western Europe, and Australia. It
intends to expand marketing, selling and support capacity in its existing
territories as well as expansion into territories not currently served. The
Company intends to expand its direct sales organization in the United States
with additional sales representatives and infrastructure. International sales
are accomplished primarily through indirect sales channels such as value added
resellers (VARs). The Company intends to expand direct sales channels in certain
markets. Both the domestic and international sales activities will continue to
be enhanced through strategic marketing relationships with suppliers of
complementary products and services.
Expand Professional Services. The Company's strategy is to position itself
as a document automation solution provider. Consulting services are currently
focused on assisting in the sale of high margin initial software licenses by
providing project management and application development. The Company intends to
expand consulting services to assist existing customers with the application of
new products offered by the Company. The Company believes this marketing
strategy will provide opportunities to expand the Company's services to include
document design, systems design and integration. In addition to consulting
services, the Company currently offers introductory-level customer education,
which is bundled with CompuSet initial licenses. Additional and advanced
training is provided at the Company's headquarters in San Diego and at customer
sites for additional fees. The Company intends to expand its curriculum to
provide advanced and specialized customer education in response to the unique
needs of certain customers. The Company believes that expanded Professional
Services will enable customers to deploy the Company's document automation
products more rapidly and effectively and will enable the Company to become a
solutions provider, accelerate the development of new products and earn
recurring revenue.
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Expand into Electronic Documents. To date, the Company's Autograph
architecture has been applied mainly to document automation applications
producing paper-based documents. The Company believes that its core technology
can be extended to the Internet, intranets and commercial on-line services, and
has recently begun initial development activity in this area. The short-term
strategy is to engage this emerging opportunity with two complementary
initiatives. First, the Company intends to work closely to define product
requirements with existing customers, many of whom have expressed interest in
using the Internet in their document automation solutions. Second, the Company
intends to develop incremental extensions to Autograph which can be readily
incorporated by current customers into existing document automation products
provided by the Company. These enhancements may provide support for Common
Gateway Interface (CGI) data capture in the Internet environment, support for
embedding links in the composed documents including Universal Resource Locators
(URLs) and multi-media links, and support for Portable Document Format (PDF)
from Adobe.
CUSTOMER CASE STUDIES
Representative examples of customers who are using the Company's products
to address their business production publishing needs are:
Insurance Services
Autograph architecture components such as CompuSet are used by insurance
companies worldwide. These include life insurance providers, property and
casualty insurers, as well as health insurers such as Blue Cross plans and
managed care providers such as HMOs. Autograph products have been used to
automate the production of insurance policies, insurance benefit booklets,
variable annuity statements, as well as personalized correspondence such as
renewal letters and claims processing documents.
A large life insurance company uses Autograph products for automated
insurance policy production. Prior to adopting Autograph, the insurer's process
required manual assembly using policy forms produced by an outside printer. The
number of these policy forms ranges well into the thousands since they vary for
each insurance product type, jurisdiction, and language. Because offset printing
costs necessitate large quantities, the thousands of pre-printed forms were kept
in a large and expensive warehouse facility. With Autograph, the insurer was
able to produce personalized life insurance policies for its clients, and
eliminate the warehouse expenses through on-demand electronic printing. In
addition, the high labor costs and errors inherent in manual document handling
have been minimized through document automation.
Financial and Banking Services
Personalized communications through document automation is rapidly becoming
a key differentiator for many financial and banking services companies as direct
person-to-person contact becomes reduced or eliminated. Reengineering the
document applications is also an opportunity to improve the quality and
readability through the use of composition and dynamic graphics.
Morgan Grenfell Asset Management (MGAM), headquartered in London, is one of
the largest asset management firms in Europe and uses Autograph products to
enhance the quality of its client communications as part of its total service
offering. MGAM was an early adopter of document automation technology and
realized the importance of generating personalized client reports enriched with
data-driven graphics. As part of the Autograph implementation, MGAM clients can
request specific reports which are produced immediately and printed on-demand.
In addition, the Autograph product suite is used to produce quarterly reports
with highly detailed and personalized information, as well as customized
presentation booklets that are distributed during client reviews.
A worldwide management and employee benefits consulting firm uses the
Autograph architecture to produce personalized employee benefit statements. As
part of a strategy to help its clients
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communicate with their employees, the firm produces a comprehensive employee
benefit suite of documents. Through Autograph document automation, the firm's
clients can effectively communicate the importance of retirement planning to the
clients' employees, and dynamically illustrate how each employee can take
advantage of client-sponsored benefit programs. The firm believes that this
level of personalization and the use of dynamic composition and data-driven
graphics increases employee satisfaction and participation in their retirement
options.
Commercial Print Services
Commercial print service bureaus have been at the forefront of developing
many document automation applications. Such bureaus include large automated
document factories capable of producing upwards of 100 million customized and
personalized pages per month, specialized consulting firms providing unique
document products, and many regional and local electronic printing operations
that cater to smaller mid-size businesses. The flexibility of the Autograph
architecture is ideally suited to such clients, which must produce many varying
document types and provide a superior product for competitive reasons.
International Billing Services, Inc. (IBS), a wholly-owned subsidiary of
USCS International, Inc., and a large provider of outsourced statement
presentment services in the United States, has begun using Autograph as an
important component of its processes. By incorporating Autograph into its
highly-automated statement production centers, IBS has been able to shorten the
time needed to convert new customers to its processes. IBS is also exploring the
use of Autograph to enhance the flexibility of its statement creation services
and to produce richer, more information-oriented documents which are tailored to
each individual customer.
The versatility of Autograph products has allowed Security Mailing
Corporation, a regional document automation provider in Australia that services
the Asia Pacific banking and financial services sectors, to produce a wide
variety of document formats for its many clients. This flexibility insures that
each client is able to differentiate itself from its competitors and achieve the
desired level of document quality and personalization. Security Mailing
Corporation has also extended its services by incorporating Autograph's Document
Viewing capabilities into its offering. As a result, its clients can integrate
electronic document archival and retrieval directly into their customer service
processes. The ability to create hardcopy client documents as well as exact
electronic duplicates for use in customer service applications provides Security
Mailing Corporation with an advantage over competing bureaus that cannot provide
electronic document options.
Communications Industry
An emerging market for Autograph is in the communications arena. The advent
of new technologies is forcing many communications companies such as telephone,
cellular and cable providers to reengineer their own client communications. The
design of these new communications requires flexibility to support increasingly
complex product options and personalization for cross-marketing opportunities.
CAM-NET Communications Network Inc. (CWKTF), one of Canada's top five
long-distance companies, uses the Autograph architecture to produce its
corporate information and billing documents. As CAM-NET grew in the early
1990's, the company realized that it needed a state-of-the-art billing system
that would meet the needs of its expanding customer base, as well as provide a
competitive advantage through improved client communications. By adopting
Autograph products, CAM-NET has provided fully automated bill production, and
has dramatically improved the design, appearance and effectiveness of its
billing documents. Simultaneously, Autograph has increased its processing
capacity by 200 percent. Autograph has also improved CAM-NET's client
satisfaction, by allowing its customers to choose their preferred billing
structure and format -- by area code, by frequently-called numbers, by
personalized billing code, as well as many other options.
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Manufacturing and Distribution
Autograph document automation is also well suited for long document
applications by enabling customization of long documents to reduce document size
and improve document effectiveness.
Ace Hardware Corporation, a dealer-owned multi-billion dollar Fortune 500
wholesale cooperative with more than 5,000 stores located in all 50 states and
55 foreign countries, has been using Autograph products such as CompuSet since
the early 1980's. This has enabled Ace Hardware to fully automate the creation
of its nine-volume product catalog for its membership, including pagination and
indexing, as well as inclusion of over 30,000 images. Because of regional
product offerings, customized catalogs are created for each of its 15 regional
retail support centers. In total, nearly 70,000 industrial items are composed
into over 98,000 CompuSet-generated pages. With CompuSet, Ace Hardware was able
to reduce turnaround time, particularly in the initial layout of the document,
which previously had been done with an expensive manual cut and paste process.
CUSTOMERS
The Company's products are currently licensed to approximately 400 end user
customers in a broad range of industries worldwide including insurance, managed
health care, commercial print services, telecommunication, utilities,
manufacturing, distribution, retail, publishing companies as well as
governmental agencies. The following is a representative list of the Company's
end user customers, each of which is currently paying license fees for the use
of the Company's products.
<TABLE>
<S> <C> <C>
INSURANCE COMMERCIAL PRINT SERVICES BANKING/FINANCE
Aetna Life Insurance Co. Groupe IST Inc. Allmerica Financial, Inc.
Basler Versicherungs Hewitt Associates LLC Banque Nationale de Paris
Gesellschaft International Billing Services, Canada Trust Company and
Chubb & Son, Inc. Inc. The Canada Trustco
Le Gan Moore Communication Services Mortgage Company
Metropolitan Life Insurance Output Technologies Inc. Capital One Bank
Company Paperstream CIBC Insurance
The Prudential Life Insurance R R Donnelley & Sons Merrill Lynch, Pierce, Fenner &
Company of America Standard Register Smith Incorporated
State Farm Insurance Company Thomson Publications Australia Janus Capital Corp.
Sun Alliance Holdings Limited P/L Oppenheimer
United Services Automobile Primerica Life
Association Insurance Company and
Affiliates
Rothschild Australia Ltd.
Signet Bancard Corp.
Wells Fargo Bank
MANAGED CARE/HEALTH CARE MANUFACTURING/DISTRIBUTION TELECOMMUNICATIONS/TRANSPORTATION
Several Blue Cross/Blue Ace Hardware Corporation Bell Atlantic Services, Inc.
Shield Plans American Honda Motor CAM-NET Communications, Inc.
Cleveland Clinic Foundation Co., Inc. Chessie Computer Services,
Cost Care, Inc. Canadian Tire Corporation, Inc.
Foundation Health Limited Federal Express Corporation
Harvard Community Health Caterpillar Inc. France Telecom
Plans Circuit City Stores Official Airline Guides
HealthNet Compaq Computer Corporation (Business Men's Assurance
MaxiCare Health Plans, Inc. eR3 (Video International) Company of America)
Giant of Landover Inc. U.S. West Marketing
Thrifty Payless Inc. Resources Group
Westinghouse Electric
Corporation
</TABLE>
PRODUCTS
The Company's software products are included in its Autograph architecture,
which currently addresses three major functional areas: Document Composition and
Assembly, Document Management, and Document Viewing, as described below. All of
the Company's software products can be complemented by Professional Services.
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AUTOGRAPH ARCHITECTURE
[GRAPHIC]
The list price for an initial license fee for CompuSet, the Company's core
product, is currently $65,000 for an initial mainframe installation and ranges
down to $35,000 for an initial single PC; options currently range from $1,000 to
$50,000. The Company licenses its products for one year, after which an annual
renewal fee, usually in an amount equal to 15% of the initial license fee, is
required for continued use. A typical new sale is currently about $75,000 for
software licenses and approximately $25,000 for professional services.
Document Composition and Assembly
Composition and Assembly. CompuSet, the Company's flagship product,
automates document composition and assembly using data and information in
corporate databases. It is the Company's core technology. CompuSet software
consists of a rule-based language and a composition engine that provide high
speed composition and assembly of complex documents with high typographic and
aesthetic levels of quality. Information content is marked with CompuSet tags
which, in turn, are defined in logically separate style specifications. Without
requiring real-time user interaction, the composition engine then transforms the
tagged data and information into finished electronic documents that can be
composed and assembled at rates in excess of 50 pages per second, depending on
computing configuration and complexity of the document. Document construction
facilities are extensive, including the full support of dynamic data driven
graphics generation.
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CompuSet operates on a range of computers and operating systems including
mainframes, workstations, network servers and personal computers.
Data Capture and Setup. Data capture and setup products include CompuPrep
and a number of Importers, and prepare data and information for subsequent
composition and assembly by CompuSet. CompuPrep is an optional tool that enables
users to capture and tag raw data and information from a variety of sources,
including corporate databases, for subsequent processing by CompuSet. It is a
high level language that describes the data environment, related data processing
and the tagging instructions for CompuSet. Importers accept externally generated
document objects, including text, static graphics and scanned images, and
convert them into formats compatible with CompuSet. The Importers support Adobe
PostScript, Xerox Metacode and TIFF standard for scanned images.
Document Output and Merge. Emitters transform CompuSet's output into a
number of popular Page Description Languages (PDLs) for printing and viewing.
The PDLs provide instructions for rendering text, forms, bitmaps, and graphics
into documents. The PDL formats currently supported are Xerox Metacode, IBM AFP,
Adobe PostScript and HP PCL5. This part of the architecture is extensible and
new Emitters can be provided as required. For example, the Company expects to
provide support for PDF from Adobe during 1997.
Application Development Tools. CompuSeries applications development tools
run on Microsoft Windows and simplify document design and application
prototyping. CompuSeries currently consists of several modules. CompuSpec is a
tool for defining document formatting rules. Formatting specifications which are
selected from a menu are associated with tags which are referenced in the
document data. The results of the selected formatting specifications are
visually displayed in a preview window. CompuBuild uses a PC version of
CompuSet, combined with an editor to manipulate the tagged document data.
CompuBuild supports all the dynamic functions and features of the CompuSet
production engine. CompuMerge is a tool used to specify the placement of
variable data into fixed document components such as in form-fill applications.
CompuView Proof is a document proofing tool used to preview the document layout
on the computer screen prior to printing. These tools are currently being
integrated into a single Windows application, called CompuSeries II.
Document Management
Document Management tools provide client/server solutions for the creation,
revision and management of document components used in the Company's document
automation solutions. It consists of the Document Library Service (DLS) and
Desktop Document Manager (DDM). DLS manages the document component creation
process required by complex variable documents. In addition, DLS can be used to
define complex assembly rules required for interactive or fully automated
document composition and assembly with CompuSet. DLS uses a client/server
architecture for accessing data and files on a mainframe or network server.
Desktop Document Manager (DDM) is the client component of DLS and manages text
objects created with Microsoft Word. Text objects are tracked and managed in a
multi-author environment by providing access security, revision control and
approval levels. DDM also provides a criteria-based document object selection
capability for customized or personalized documents. These criteria are then
used by DLS to generate a CompuSet-ready tagged data file. The customized or
personalized document assembly can be directed to occur in a high-volume fashion
on the server or in a just-in-time, on-demand fashion on the local DDM PC. DLS
is in a controlled release with a small number of customers.
Document Viewing
Document Viewing enables on-line viewing and archiving of electronic
documents produced by document automation applications. It consists of the
Document Viewing Service (DVS) and CompuView Navigator. DVS uses a client/server
architecture for the creation and access of electronic document files. DVS is
available for a variety of mainframe, Unix and PC platforms. The
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<PAGE> 38
electronic document files are generated in a format called CCIF, which is
optimized for fast, memory-efficient viewing, transport and storage. CCIF files
can then be viewed by CompuView Navigator. CCIF files consist of three major
components: a PDL rendition of the pages for WYSIWYG viewing; various indices
for locating documents; and reusable document elements. CCIF files can also be
distributed, archived or printed through document distribution and archiving
systems offered by third party software developers that have integrated
CompuView Navigator. CompuView Navigator is a Windows application for viewing
CCIF files. The view of the document is virtually identical to the printed
document. CompuView Navigator may also be integrated with third party document
retrieval systems. The Company introduced the DVS in October 1995 and has had
limited installations to date.
The following process flow diagram describes each Autograph product within
the context of product functionality and the enterprise. It also includes
possible future Internet extensions, some of which are not currently under
active development. The Company believes that its core technology can be
extended to the Internet, intranets and commercial on-line services and has
recently begun initial development activity in this area, although there can be
no assurance that such development activity will result in commercially
successful products. See "Business -- Research and Development."
LOGO
PROFESSIONAL SERVICES
In addition to its software products, the Company provides a comprehensive
suite of services which can assist customers in the implementation of enterprise
wide and mission critical document automation applications. Professional
Services include on-site software installation, customer training programs,
telephone support programs and consulting services. Consulting services are
currently focusing on assisting in the sale of high margin initial software
licenses by providing
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<PAGE> 39
project management and application development. Eventually, the Company intends
to expand Professional Services to include document design, systems design and
integration. In addition to consulting services, the Company currently offers
introductory-level customer education, which is bundled with CompuSet initial
licenses. Additional and advanced classes are provided for additional fees at
the Company's headquarters in San Diego and at customer sites. The Company
intends to expand its curriculum to provide advanced and specialized customer
education in response to the unique needs of certain customers. The Company
believes that expanded Professional Services will enable customers to deploy the
Company's document automation products more rapidly and effectively, and assist
the Company in the development of new products and provide recurring revenue.
The Professional Services organization employed a staff of 20 as of June 30,
1996.
SALES AND MARKETING
The Company's sales and marketing organization targets vertical industry
segments that require document automation and high volume document
personalization and customization. The Company currently licenses its products
using a combination of direct sales and alternate channels. In the United
States, the Company markets its products through a direct sales force. Sales
representatives are provided with pre-sales technical support by regional
application specialists. Sales representatives and the regional application
specialists are located in Atlanta, Austin, Chicago, Cleveland, Dallas,
Minneapolis, New York City, Pittsburgh, Richmond, San Antonio, San Diego, San
Francisco, Seattle and Washington, D.C. The Company distributes its products
through VAR relationships with Xerox Canada, Limited in Canada and Fuji Xerox
Co., Ltd. in Australia. The Company's subsidiary, Document Sciences Europe,
markets and supports the Company's products in Europe by providing channel
management, technical support, fee based services, and defining European market
and product requirements. The Company licenses its products in Europe through
VARs and, to a lesser extent, direct sales. The VARs are principally Rank Xerox
Ltd. and other Xerox affiliates who remarket the Company's products. The
Company's revenues from such arrangements were $1.3 million, $3.1 million and
$675,900 in 1994, 1995 and the first half of 1996, respectively. The sales,
marketing, consulting and customer support organization currently employs a
staff of 68.
The Company intends to expand its sales and marketing organization to
provide direct sales and support services throughout the world. Such planned
expansion will occur by first addressing the unique product requirements of a
region followed by developing indirect sales channels to market in the region.
As the Company is able to increase its market presence, it may then augment its
alternate channels with a direct sales capability. See "Risk
Factors -- Expansion of Sales and Distribution Channels."
In addition, the Company intends to increase both its product offerings and
markets through marketing, sales and distribution and development relationships
with other companies. Current relationships include formal and informal
marketing and sales alliances with Xerox, IBM, Siemens Nixdorf, Computer
Associates, New Dimension, RSD, Data/Ware Development, and Data Retrieval. These
relationships provide sales leads for the Company's products and have extended
the Company's sales coverage and networking capabilities.
COMPETITION
The market for the Company's document automation products is intensely
competitive, subject to rapid change and significantly affected by new product
introductions and other market activities of industry participants. The
Company's software products are targeted at document intensive organizations
that require the ability to produce large quantities of customized and
personalized documents in paper or electronic form. The Company faces direct and
indirect competition from a broad range of competitors who offer a variety of
products and solutions to the Company's current and potential customers. The
Company's principal competition currently comes from (i) systems
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<PAGE> 40
developed in-house by the internal MIS departments of large organizations, (ii)
direct competition in a number of its vertical markets, including Image
Sciences, which is partially owned by Xerox, and FormMaker Software, Inc. in the
insurance industry, M&I Data Services, Inc. in banking and financial services
and Group 1 Software, Inc. in commercial direct mailing, and (iii) direct
competitors such as IBM's Direct Composition Facility (DCF) and Group 1's
recently introduced DOC1 product. The Company faces market resistance from the
large installed base of legacy systems because of the reluctance of these
customers to commit the time and effort necessary to convert their document
automation processes to the Company's document automation software. Several of
the Company's competitors have longer operating histories, significantly greater
financial, technical, marketing and other resources than the Company, greater
name recognition and a larger installed base of customers.
It is also possible that the Company will face competition from new
competitors. These include large independent software companies offering
personal computer-based application software solutions, such as Microsoft
Corporation and Adobe Corporation, and from large corporations providing
database management software solutions, such as Oracle Corporation. In addition,
Xerox, either directly or through affiliated entities, could compete with the
Company. Moreover, as the market for document automation software develops, a
number of these or other companies with significantly greater resources than the
Company could attempt to enter or increase their presence in the Company's
market either independently or by acquiring or forming strategic alliances with
competitors of the Company or to otherwise increase their focus on the industry.
In addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the
ability of their products to address the needs of the Company's current and
prospective customers, and it is possible that new competitors or alliances
among competitors may emerge and rapidly acquire significant market share.
Increased competition may result in price reductions, reduced gross margins and
loss of market share, any of which could have a material adverse effect on the
Company's business, operating results and financial condition. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures faced by the Company will
not materially adversely affect its business, operating results and financial
condition.
The Company believes that the principal competitive factors affecting its
market include products performance and functionality, ease of use, scalability,
operation across multiple computer and operating system platforms, product and
company reputation, client service and support, and price. Although the Company
believes that it currently competes favorably with respect to such factors,
there can be no assurance that the Company will be able to maintain its
competitive position against current and future competitors or that the Company
will be successful in the face of increasing competition from new products or
solutions introduced by existing competitors or by new companies entering the
market. Further, there can be no assurance that the Company can maintain its
position against current and future competitors, especially those with greater
financial, marketing, service, support, technical and other resources than the
Company.
RESEARCH AND DEVELOPMENT
In general, the Company's strategy is to build products that augment and
extend the document composition and assembly capabilities of its core products.
Initially, product development investments were primarily focused on completing
the Autograph architecture, which included delivering products for document
viewing as well as adding support for additional print environments. In
addition, there was a substantial investment in product maintenance and in
software integration, testing, and documentation. The Company supplements its
product development efforts by reviewing customer feedback on existing products
and working with customers and potential customers to anticipate future product
needs.
To date, the Company's Autograph architecture has been applied mainly to
document automation applications producing paper based documents. The Company
believes that its core technology
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<PAGE> 41
can be extended to provide document automation for the Internet, intranets, and
commercial on-line services. The short-term strategy is to engage this emerging
opportunity with two complementary initiatives. First, the Company intends to
work closely to define product requirements with existing customers, many of
whom have expressed interest in using the Internet in their document automation
solutions. Second, the Company intends to develop incremental extensions to
Autograph which can be incorporated by current customers into existing document
automation products provided by the Company. The Company believes that its core
technology can be extended to the Internet, intranets and commercial on-line
services, and has only recently begun initial development activity in this area.
There can be no assurance that the Company will be successful in developing,
introducing and marketing new products on a timely and cost-effective basis, if
at all, or that new products will achieve market acceptance. See "Risk
Factors -- Dependence on New Products and Product Enhancements."
The development organization is composed of self-directed teams, in which
representatives from various disciplines within the Company collectively take
responsibility for the development and delivery of each new feature or product.
The development process includes early review of prototypes and demonstrations
to incorporate customer feedback and provide an opportunity for management
review. A formal sequence of project phases organizes the development and review
process for each team. The Company has a formal release planning process for an
annual maintenance release, and delivers interim versions as needed to support
its customers. The development organization maintains a database of all customer
and internal requests which forms the basis for release planning.
The Company expects to continue to enhance its existing products and to
develop new products, particularly as they relate to electronic publishing
applications. Research and development expenditures have grown substantially
since the Company's inception. Such expenditures were $400,800 in 1993, $1.0
million in 1994, $1.7 million in 1995 and $1.1 million in the first half of
1996. These amounts do not include product support activities. The development
organization has grown from 6 people in 1993, to 15 in 1994, 22 in 1995 and 27
at June 30, 1996. The Company employs independent contractors as needed to
supplement the permanent development staff.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company's success is dependent, in part, on its ability to protect its
proprietary technology. The Company relies primarily on a combination of
copyright and trademark laws, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. The Company seeks to
protect its software, documentation and other written materials under trade
secret and copyright laws, which afford only limited protection. The Company
presently has no patents or patent applications pending. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that the
Company regards as proprietary.
Policing unauthorized use of the Company's products is difficult, and while
the Company is unable to determine the extent to which piracy of its software
products exists, software piracy can be expected to be a persistent problem. In
addition, the laws of some foreign countries do not protect the Company's
proprietary rights to as great an extent as do the laws of the United States.
There can be no assurance that the Company's means of protecting its proprietary
rights will be adequate or that the Company's competitors will not independently
develop similar technology. The Company is not aware that any of its products
infringes the proprietary rights of third parties. There can be no assurance,
however, that third parties will not claim infringement by the Company with
respect to current or future products. The Company expects that software product
developers will increasingly be subject to infringement claims as the number of
products and competitors in the Company's industry segment grows and the
functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time consuming, result in costly
litigation, cause product shipment delays or require the Company to enter into
royalty or licensing agree-
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<PAGE> 42
ments. Such royalty or licensing agreements, if required, may not be available
on terms acceptable to the Company or at all, which could have a material
adverse effect upon the Company's business, operating results and financial
condition.
In addition, the Company also relies on certain software that it licenses
from third parties, including software that is integrated with internally
developed software and used in the Company's products to perform key functions.
There can be no assurances that such firms will remain in business, that they
will continue to support their products or that their products will otherwise
continue to be available to the Company on commercially reasonable terms. The
loss or inability to maintain any of these software licenses could result in
delays or reductions in product shipments until equivalent software can be
developed, identified, licensed and integrated, which would adversely affect the
Company's business, operating results and financial condition.
EMPLOYEES
As of June 30, 1996 the Company had 105 employees including 68 in sales,
marketing, consulting and customer support, 27 in research and development, and
10 in finance and administration. None of the Company's employees is represented
by a labor union. The Company has experienced no work stoppages and believes its
relationship with its employees is good. Competition for qualified personnel in
the industry in which the Company competes is intensive. The Company believes
that its future success will depend in part on its continued ability to attract,
hire, and retain qualified personnel.
FACILITIES
The Company's principal administrative, sales, marketing, training, and
research and development facilities occupy approximately 15,000 square feet in
San Diego, California, pursuant to a lease which expires on January 31, 2000. In
addition, the Company's subsidiary in France occupies approximately 3,500 square
feet of office space with a renewable lease expiring in February 1999. Sales
representatives and field technical support personnel operate from their homes.
The Company believes its current facilities are adequate to meet its needs
through the next six months. The Company is exploring various alternatives to
house its planned expansion, and believes that additional facilities would be
available on acceptable terms.
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MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The directors, executive officers and key employees of the Company, and
their ages as of June 30, 1996 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------------ --- ------------------------------------------
<S> <C> <C>
Tony N. Domit............................. 58 President, Chief Executive Officer and
Director
Alfred G. Altomare, Jr. .................. 52 Vice President, Consulting
Barbara E. Amantea........................ 51 Vice President, Chief Financial Officer,
Treasurer and Secretary
Thomas Anthony............................ 61 Vice President, Sales
Peter L. Bradshaw......................... 41 Vice President, Development
Daniel J. Fregeau......................... 39 Vice President, Marketing
Judith A. O'Reilly........................ 53 Managing Director, Document Sciences
Europe
E. Mark Palandri, Ph.D. .................. 57 Chief Scientist
Robert V. Adams........................... 64 Chairman of the Board
Thomas L. Ringer(1)(2).................... 65 Director
Colin J. O'Brien(1)....................... 57 Director
James J. Costello(2)...................... 50 Director
Barton L. Faber(2)........................ 49 Director
</TABLE>
- ---------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Tony N. Domit, a Company founder, has served as President and Chief
Executive Officer since the Company's inception in October 1991. Previously, he
was an Executive Consultant with Xerox Technology Ventures. From 1990 to 1991,
Mr. Domit was President and CEO of Advanced Workstations Products, Inc., a
wholly-owned Xerox subsidiary. Prior to AWPI, Mr. Domit was employed by Xerox
Corporation for 22 years in a variety of Vice Presidential and managerial
positions primarily in the areas of product development and marketing. His
Xerox-related experiences were in the Company's electronic printing, publishing,
workstation and networking businesses. Prior to Xerox, Mr. Domit was an engineer
with Scientific Data Systems, Ampex Computer Products, and Litton Industries.
Barbara E. Amantea has served as Vice President, Chief Financial Officer,
Treasurer and Assistant Secretary since the Company's inception in 1991. Prior
to the formation of the Company, Ms. Amantea served for nine months as a
financial consultant with Xerox Technology Ventures. From 1990 to 1991, Ms.
Amantea was Chief Financial Officer of Advanced Workstation Products, Inc., a
wholly-owned subsidiary of Xerox Corporation. From 1988 to 1990, Ms. Amantea was
Chief Financial Officer of Segue Software, Inc., a provider of automated testing
software. From 1977 to 1987, Ms. Amantea was Controller and Corporate Secretary
to Interactive Systems Corporation, a developer and supplier of UNIX operating
systems, which was subsequently acquired by Kodak Corporation.
Daniel J. Fregeau has served as Vice President, Marketing since 1994. From
1992 to 1994, Mr. Fregeau served as Vice President, Sales for the Company. Prior
to joining the Company, Mr. Fregeau was Marketing Manager for the Networking
Division of Sears Business Centers, San Diego, from 1990 to 1992. Mr. Fregeau
was a founder and principal of MicroAge in San Diego from 1988 to 1990. From
1982 to 1988, Mr. Fregeau held several positions with Xerox Corporation's
Electronic Publishing Business Unit including Manager of Systems Engineering and
Integration,
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<PAGE> 44
Technical Program Manager, and Project Manager. While at Xerox, Mr. Fregeau
designed and directed the development of several publishing products and was a
key contributor to the launch of the XICS (now CompuSet) product in the U.S. and
Canada.
Judith A. O'Reilly, a Company founder, has served as Managing Director of
Document Sciences Europe since its inception in 1993. Prior to the formation of
Document Sciences Europe, Ms. O'Reilly was Director of Customer Support from
1992 to 1993. From 1982 to 1992, Ms. O'Reilly held several positions in
development, product delivery and marketing at Xerox. Prior to joining Xerox,
Ms. O'Reilly was an applications developer for companies in the publishing,
manufacturing, and food sectors.
Alfred G. Altomare has served as Vice President, Consulting since January,
1996. Prior to joining the Company, Mr. Altomare was founder and principal of
Mariner Associates, a business consulting firm, from 1993 to 1996. From 1990 to
1993, Mr. Altomare was Vice President/General Manager, Indirect Channel
Operations of ICL Retail Systems. Prior to joining ICL, Mr. Altomare was Vice
President, Consulting at Gartner Group from 1989 to 1990. From 1985 to 1989, he
was founder and principal of VAR Strategies Group. Mr. Altomare was Principal
and Senior Vice President, Sales and Marketing for InfoCorp/Gartner Group (now
Infocorp/Computer Intelligence) from July 1982 to March 1985. Mr. Altomare
previously held a variety of sales, marketing and training positions with IBM.
Dr. E. Mark Palandri, a founder of the Company, has served as Chief
Scientist since 1992. Prior to joining the Company, Dr. Palandri held a variety
of software developer positions at Xerox Corporation from 1982 to 1992. From
1980 to 1982, Mr. Palandri worked at Composition Software Systems until its sale
to Xerox. While at CSS, Mr. Palandri began the development of CompuSet. From
1965 to 1973, Dr. Palandri worked on data handling systems in high energy
physics at the European Organization for Nuclear Research in Geneva,
Switzerland. From 1973 to 1990, Mr. Palandri was Senior Principal Research
Scientist in the Division of Computing Research in the Commonwealth Scientific
and Industrial Research Organization. Mr. Palandri holds a BS from the
University of Western Australia and a Doctorate in Applied Mathematics from
Cambridge University.
Thomas Anthony has served as Vice President, Sales since June 1994. Prior
to joining the Company, Mr. Anthony was Executive Vice President, Marketing and
Sales for Innovatech, Inc. from 1992 to 1994, Acer America from 1990 to 1992,
Sweda International from 1987 to 1990, and Frame Technologies from 1986 to 1987.
Mr. Anthony was Vice President, Sales for Altos Computer Systems from 1983 to
1986 and Vice President Marketing and Sales from 1979 to 1983 for Onyx Systems.
Prior to Onyx, Mr. Anthony was with National Semiconductor as a Vice President
and founder of the Datachecker Systems Business Unit.
Peter L. Bradshaw has served as Vice President of Development since March,
1994. Prior to joining the company, Mr. Bradshaw was manager of the Application
Software Team at Xerox from 1989 to 1994, where he was responsible for
integrating high volume printers with application software. From 1982 to 1989,
Mr. Bradshaw worked in Xerox' Workstation Business Unit where he managed the
development team responsible for the graphical user interface for the 6085
Workstation. From 1977 to 1980, Mr. Bradshaw was at Bell Telephone Laboratories
in system development. Mr. Bradshaw holds an M.S. in Computer, Information, and
Control Engineering and a B.S. in Computer Science and Mathematics from the
University of Michigan and an MBA from the Anderson Graduate School of
Management at UCLA.
Robert V. Adams has served as a director and Chairman of the Board of the
Company since 1991. Since 1989, Mr. Adams has served as President of Xerox
Technology Ventures, a venture capital unit of Xerox. Mr. Adams is also a
director of Tekelec, ENCAD, Inc. and Chairman of Documentum, Inc.
Thomas L. Ringer has been a director of the Company since 1991. Mr. Ringer
is currently Chairman of the Boards of Directors of Wedbush Corporation, Wedbush
Capital Corporation, M.S.
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Aerospace, Inc., Enterprise Solutions Limited and the Center for Innovation and
Entrepreneurship. In addition, he serves on the Boards of Directors of Wedbush
Morgan Securities, Inc. and Applied Retail Solutions.
Colin J. O'Brien has served as a director of the Company since May 1996.
Since 1992, Mr. O'Brien has been employed in various positions at Xerox and
currently serves as Vice President of Xerox and Chief Executive Officer of Xerox
New Enterprise Board. Prior to 1992, Mr. O'Brien was the founder and Chief
Executive Officer of Triax Corporation, an investment company specializing in
defense electronics companies. Prior to joining Triax Corporation, he was the
Chief Executive Officer of Times Fiber Communications Inc., a manufacturer of
fiber optic and coaxial telecommunications systems. Mr. O'Brien is also a
director of Documentum, Inc.
James J. Costello has served as a director of the Company since May 1996.
Since 1975, Mr. Costello has been employed in various positions at Xerox and
currently serves as Chief Financial Officer and Vice President of Xerox New
Enterprise Companies.
Barton L. Faber has served as a director of the Company since July 1996.
From April 1985 to June 1996, Mr. Faber held various positions with R.R.
Donnelley and currently serves as a member of the board of directors of
Alphagraphics, Inc., Dataware Technologies, Inc., GeoSystems Global Corporation
and Xeikon N.V. He is also chairman of the board of directors and a director of
Metromail. Prior to joining R.R. Donnelley, Mr. Faber held various positions
with Mobil Oil Corporation and Ramada Europe.
Executive officers of the Company are appointed by the Board of Directors
and serve at the discretion of the Board. There are no family relationships
among any directors or executive officers of the Company.
BOARD COMMITTEES
The Board of Directors has established an Audit Committee and a
Compensation Committee. The Audit Committee, consisting of Thomas L. Ringer,
Barton L. Faber and James J. Costello, recommends the selection of independent
public accountants to the Board of Directors, reviews the scope and results of
the audit and other services provided by the Company's independent auditors, and
reviews the Company's accounting practices and its systems of internal
accounting controls.
The Compensation Committee, consisting of Thomas L. Ringer and Colin J.
O'Brien, reviews and approves the salaries, bonuses and other compensation
payable to the Company's executive officers and administers and makes
recommendations concerning the Company's employee benefit plans.
NON-EMPLOYEE DIRECTOR COMPENSATION
In July 1996, the Company approved a non-employee director compensation
arrangement pursuant to which the non-employee directors will be compensated as
follows: (i) $4,000 annual retainer; (ii) $1,200 for each meeting of the Board
attended; and (iii) reimbursement for certain expenses in connection with
attendance at Board and committee meetings. In addition, in February 1995,
Thomas L. Ringer was granted an option to purchase 15,750 shares of Common Stock
at an exercise price of $0.17 per share and in July 1996, Barton L. Faber was
granted an option to purchase 10,000 shares of Common Stock at an exercise price
of $10.00 per share.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No member of the Compensation Committee of the Company serves as a member
of the board of directors or compensation committee of any entity that has one
or more executive officers serving as a member of the Company's Board of
Directors or Compensation Committee. See "Certain Transactions" for a
description of transactions between the Company and entities affiliated with
members of the Compensation Committee.
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LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company's Bylaws provide that the Company will indemnify its directors
and officers and may indemnify its employees and other agents to the fullest
extent permitted by Delaware law.
In addition, the Company's Amended and Restated Certificate of
Incorporation provides that, to the fullest extent permitted by Delaware law,
the Company's directors will not be liable for monetary damages for breach of
the directors' fiduciary duty of care to the Company and its stockholders. This
provision in the Amended and Restated Certificate of Incorporation does not
eliminate the duty of care, and in appropriate circumstances equitable remedies
such as an injunction or other forms of non-monetary relief would remain
available under Delaware law. Further, each director will continue to be subject
to liability for breach of the director's duty of loyalty to the Company, for
acts or omissions not in good faith or involving intentional misconduct or
knowing violations of law, for acts or omissions that the director believes to
be contrary to the best interests of the Company or its stockholders, for any
transaction from which the director derived an improper personal benefit, for
acts or omissions involving a reckless disregard for the director's duty to the
Company or its stockholders when the director was aware or should have been
aware of a risk of serious injury to the Company or its stockholders, for acts
or omissions that constitute an unexcused pattern of inattention that amounts to
an abdication of the director's duty to the Company or its stockholders, for
improper transactions between the director and the Company and for improper
distributions to stockholders and loans to directors and officers. This
provision also does not affect a director's responsibilities under any other
laws, such as the federal securities laws or state or federal environmental
laws.
The Company intends to enter into agreements to indemnify its directors and
officers, in addition to indemnification provided for in the Company's Bylaws.
These agreements, among other things, indemnify the Company's directors and
officers for certain expenses (including attorneys' fees), judgments, fines and
settlement amounts incurred by any such person in any action or proceeding,
including any action by or in the right of the Company, arising out of such
person's services as a director or officer of the Company, any subsidiary of the
Company or any other company or enterprise to which the person provides services
at the request of the Company. The Company believes that these provisions and
agreements are necessary to attract and retain qualified directors and officers.
There is no pending litigation or proceeding involving a director, officer,
employee or other agent of the Company as to which indemnification is being
sought, nor is the Company aware of any pending or threatened material
litigation that might result in a claim for such indemnification.
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<PAGE> 47
EXECUTIVE COMPENSATION
The following table sets forth all compensation earned by the Company's
Chief Executive Officer and the five other most highly compensated executive
officers (collectively, the "Named Executive Officers") whose salary and bonus
for the fiscal year ended December 31, 1995 were in excess of $100,000 for
services rendered in all capacities to the Company and its subsidiary for that
fiscal year:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------------- ------------------
NAME AND SECURITIES UNDERLYING ALL OTHER
PRINCIPAL POSITION SALARY($) BONUS($) OPTIONS(#) COMPENSATION($)(1)
- ----------------------------------- --------- -------- --------------------- ------------------
<S> <C> <C> <C> <C>
Tony N. Domit...................... $ 150,000 -- -- $ 6,348
President and Chief Executive
Officer
Thomas J. Anthony.................. 90,000 46,626 (2) -- 6,780
Vice President, Sales
Peter L. Bradshaw.................. 96,667 5,000 -- 3,286
Vice President of Development
Daniel J. Fregeau.................. 90,000 60,558 (2) 30,000 3,436
Vice President, Marketing
Judith A. O'Reilly................. 108,623 96,442 (2) -- 4,117
Managing Director, Document
Sciences Europe
E. Mark Palandri................... 141,567 -- 112,500 5,052
Chief Scientist
</TABLE>
- ---------------
(1) Includes $3,000 of Company contributions under its 401(k) Plan and the
balance represents life insurance premiums paid by the Company.
(2) Represents commissions earned during the fiscal year ended December 31,
1995.
OPTION GRANTS DURING 1995
The following tables set forth certain information concerning stock options
granted during the fiscal year ended December 31, 1995 to each of the Named
Executive Officers:
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
------------------------------------------------------------ VALUE AT ASSUMED
NUMBER OF ANNUAL RATES OF STOCK
SECURITIES PERCENTAGE OF PRICE APPRECIATION
UNDERLYING TOTAL OPTIONS EXERCISE FOR OPTION TERM(4)
OPTIONS GRANTED IN PRICE EXPIRATION ---------------------
NAME GRANTED(#)(1) FISCAL 1995(2) ($/SH)(3) DATE 5% 10%
- ----------------------- ------------- ------------------ --------- ----------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Tony N. Domit.......... -- -- -- -- -- --
Thomas J. Anthony......
Peter L. Bradshaw...... -- -- -- -- -- --
Daniel J. Fregeau...... 30,000 13% $0.17 1/5/05 $ 3,144 $ 7,969
Judith O'Reilly........ -- -- -- -- -- --
E. Mark Palandri....... 112,500 48 0.17 1/5/05 11,792 29,883
</TABLE>
- ---------------
(1) These options are non-statutory stock options granted pursuant to a written
compensatory arrangement and vest over no more than four years.
(2) In 1995, the Company granted options to purchase an aggregate of 232,575
shares.
(3) In determining the fair market value of the Company's Common Stock, the
Board of Directors considered various factors, including the Company's
financial condition and business pros-
47
<PAGE> 48
pects, its operating results, the absence of a market for its Common Stock
and the risks normally associated with high technology companies.
(4) Potential Realizable Value is based on certain assumed rates of appreciation
pursuant to rules prescribed by the Securities and Exchange Commission (the
"SEC"). Actual gains, if any, on stock option exercises are dependent on the
future performance of the stock. There can be no assurance that the amounts
reflected in this table will be achieved. In accordance with rules
promulgated by the SEC, Potential Realizable Value is based upon the
exercise price of the options, which is substantially less than the initial
public offering price. If the Potential Realizable Value is calculated based
on the initial public offering price of $12.00 per share and the assumed
rates of appreciation over the ten-year term of the options, the resulting
stock price at the end of the term would be $19.55 and $31.12 per share at
5% and 10%, respectively.
AGGREGATED OPTIONS EXERCISED IN 1995 AND YEAR-END OPTION VALUES
The following table sets forth for each of the Named Executive Officers the
shares acquired and the value realized on each exercise of stock options during
the year ended December 31, 1995 and the number and value of securities
underlying unexercised options held by the Named Executive Officers at December
31, 1995:
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS
NUMBER OF DECEMBER 31, 1995 AT DECEMBER 31, 1995($)(2)
SHARES ACQUIRED VALUE ---------------------------- ----------------------------
NAME ON EXERCISE REALIZED($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------- ---------------- -------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Tony N. Domit.. 562,500 $ 75,000 -- -- -- --
Thomas J.
Anthony...... 21,249 -- 1,251 37,500 208 6,250
Peter L.
Bradshaw..... 25,530 -- 2,688 36,282 448 6,047
Daniel J.
Fregeau...... 60,000 8,000 26,250 18,750 6,375 3,125
Judith
O'Reilly..... 95,466 12,729 2,034 -- 610 --
E. Mark
Palandri..... 205,620 12,729 4,380 -- 1,001 --
</TABLE>
- ---------------
(1) Based on the difference between the fair market value on the date of
exercise and the exercise price.
(2) Based on the difference between the fair market value on December 31, 1995
($0.33 per share) and the exercise price.
COMPENSATORY AND SEVERANCE ARRANGEMENTS
The Company has entered into an agreement with Mr. Tony N. Domit, the
Company's Chief Executive Officer, terminable at will by either the Company or
Mr. Domit. The agreement provides for a base salary, effective March 1, 1993, of
$142,800, and a potential annual incentive bonus based on achievement of the
Company's operating plan and other mutually agreed upon objectives as evaluated
by the Board. Pursuant to the agreement, in the event Mr. Domit were terminated,
he would receive a severance payment equal to six months of his salary.
The Company has entered into an agreement with Mr. Thomas J. Anthony, the
Company's Vice President of Sales, terminable at will by either the Company or
Mr. Anthony. The agreement provides for a base salary, effective May 25, 1994,
of $90,000, and a commission equal to 0.75% of domestic booked revenue.
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<PAGE> 49
The Company has entered into an agreement with Mr. A.G. Altomare, the
Company's Vice President of Consulting Services, terminable at will by either
the Company or Mr. Altomare. The agreement provides for a base salary, effective
January 15, 1996, of $85,000, and a commission equal to 1.5% of recognized
consulting revenue for fiscal 1996. In addition, Mr. Altomare will receive 2.75%
of profit earned on consulting revenue, not to exceed $25,000 per year. Pursuant
to such agreement, Mr. Altomare was granted an option to purchase 24,000 shares
of Common Stock at an exercise price of $0.17 per share.
The Company has entered into an agreement with Ms. Judith A. O'Reilly,
currently the Managing Director of Document Sciences Europe, terminable at will
by either the Company or Ms. O'Reilly. The agreement provides for a base salary,
effective January 2, 1992, of $86,492 and a commission based on certain foreign
revenue.
The Company has entered into an agreement with Mr. Daniel J. Fregeau, the
Company's Vice President of Marketing, terminable at will by either the Company
or Mr. Fregeau. The agreement provides for a base salary, effective January 2,
1992, of $75,000, and a commission based on worldwide revenue.
EMPLOYEE BENEFIT PLANS
1995 Stock Incentive Plan
In October 1995, the Company adopted the Company's 1995 Stock Incentive
Plan (the "1995 Plan") under which 779,250 shares were reserved for issuance
upon exercise of options and purchase rights granted to employees, directors and
consultants. The shares reserved for issuance under the 1995 Plan include 29,250
shares which were previously reserved for issuance under the Company's 1993
Stock Option Plan (the "1993 Plan"). The 1995 Plan supersedes the 1993 Plan;
provided, however, that all outstanding options previously issued under the 1993
Plan shall be exercisable according to their terms. The 1995 Plan will terminate
in June 2005, unless sooner terminated by the Board of Directors.
The 1995 Plan provides for grants of incentive stock options intended to
qualify as such under Section 422 of the Internal Revenue Code of 1986, as
amended (the "Code"), non-statutory stock options, and rights to purchase Common
Stock. The 1995 Plan may be administered by the Board or a committee approved by
the Board and is currently administered by the Board of Directors. Subject to
the limitations set forth in the 1995 Plan, the Board or its designated
committee has the authority to select the persons to whom grants are to be made,
to designate the number of shares to be covered by each grant, to determine
whether an option is to be an incentive stock option or a non-statutory stock
option, to establish vesting schedules, to specify the exercise price of options
and purchase rights, the type of consideration to be paid to the Company upon
exercise, and, subject to certain restrictions, to specify other terms of
options and purchase rights.
The maximum term of options granted under the 1995 Plan is ten years. The
aggregate fair market value of the stock with respect to which incentive stock
options are first exercisable in any calendar year may not exceed $100,000. No
person may be granted options and purchase rights under the 1995 Plan covering
more than 100,000 shares during any one year period. Options and purchase rights
granted under the 1995 Plan are non-transferable. Options generally expire three
months after the termination of an optionee's service to the Company. In
general, if an optionee is permanently disabled or dies during his or her
service to the Company, such person's option may be exercised up to one year
following such disability or death.
The exercise price of incentive stock options must equal at least the fair
market value of the Common Stock on the date of grant. The exercise price of
non-statutory stock options and purchase rights may be determined by the Board
or its designated committee in its discretion. The exercise price of incentive
stock options granted to any person who, at the time of grant, owns stock
possessing more than 10% of the total combined voting power of all classes of
stock must be at
49
<PAGE> 50
least 110% of the fair market value of such stock on the date of grant; and the
term of these options cannot exceed five years.
As of June 30, 1996, the Company had outstanding options to purchase
191,217 shares of Common Stock under the 1993 Stock Option Plan and 152,151
shares of Common Stock under the 1995 Plan held by an aggregate 88 persons at a
weighted exercise price of $0.39 per share. As of June 30, 1996, options to
purchase an aggregate of 1,278,033 shares of Common Stock under the 1993 Stock
Option Plan and 3,624 shares of Common Stock under the 1995 Plan had been
exercised.
401(k) Plan
The Company contributes to an employee savings and retirement plan (the
"401(k) Plan") that is intended to be a tax-qualified plan, covering
substantially all of the Company's employees. Under the terms of the 401(k)
Plan, employees may elect to contribute up to 15% of their compensation, or the
statutorily prescribed limit, if less, to the 401(k) Plan as a savings
contribution. The Company may, in its discretion, match employee contributions,
at such rate as it determines, but no match will apply to deferrals in excess of
$3,000 or 10% of the employee's compensation. The 401(k) Plan has a profit
sharing element whereby the Company may, in its discretion, contribute annually
an amount determined by the Board of Directors. Such contributions, if any, are
allocated to the accounts of all eligible employees based on their compensation
and Company contributions to Social Security. An employee's interest in his or
her deferrals are vested when contributed. An employee's interest in matching
contributions and profit sharing contributions generally vest over 4 years from
the date of employment. The 401(k) Plan is intended to qualify under Section 401
of the Code. As such, contributions to the 401(k) Plan, and income earned on
such contributions, are intended not to be taxable to the employees until
distributed from the 401(k) Plan and contributions of the Company are intended
to be deductible when made. The 401(k) Plan has not been submitted to the
Internal Revenue Service for a determination letter on its qualified status
under the Code. If the 401(k) Plan is determined not to qualify under Section
401 of the Code, contributions to the 401(k) Plan and earnings on such
contributions would be taxable to the employees when made.
The 401(k) Plan is a single plan covering the employees of four entities
(including the Company) in which Xerox Corporation owns 80 percent or more of
the stock. Following this offering, for purposes of participation in the 401(k)
Plan, the Company will no longer be a part of the Xerox Corporation controlled
group. Accordingly, the Company intends to establish a new plan solely for the
benefit of its employees.
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<PAGE> 51
CERTAIN TRANSACTIONS
AGREEMENTS WITH XEROX
Transfer and License Agreement
In connection with the transfer of the Company's technology from Xerox, the
Company entered into a Transfer and License Agreement with Xerox in July 1992,
to expire upon the expiration of all of the rights in the items covered thereby.
This Agreement was subsequently amended in September 1994. Pursuant to the terms
of the Agreement, as amended: (i) Xerox transferred all worldwide copyrights in
and to the predecessor product of CompuSet (the "Transferred Software") and
granted the Company a non-exclusive license to use the Xerox trade secrets in
existence as of July 1992 pertaining to the Transferred Software; (ii) the
Company granted Xerox a non-exclusive royalty-free license to use and copy the
Transferred Software for internal purposes only, and to use portions of the code
of the Transferred Software in products of Xerox; (iii) Xerox granted the
Company a non-exclusive, royalty-free license to use, modify and reproduce the
source code of XPS and EVMS, two software products comprising a small portion of
the Company's current CompuSet products, and to distribute derivatives of XPS
and EVMS in object code format; (iv) the Company granted to Xerox ownership of
all technical information not primarily related to computer software that is
generated by the Company while Xerox continues to own a majority of the
outstanding capital stock of the Company, the Company retaining a non-exclusive
license to use such technical information outside of certain eastern Asian and
Pacific Rim countries; (v) the Company granted "most favored nation" status with
respect to the purchase price of software products sold by the Company to Xerox,
Rank Xerox Ltd., Fuji Xerox Co. Ltd., companies jointly owned by Xerox and the
Rank Organization Ltd. and 40% affiliates of the foregoing; and (vi) the Company
granted Fuji Xerox Co., Ltd. a right of first negotiation with respect to
exclusive distribution of the Company's products in certain eastern Asian and
Pacific Rim countries.
Strategic Marketing Alliance Agreement
In September 1993, the Company and Xerox entered into a Strategic Marketing
Alliance Agreement, pursuant to which the Company and Xerox agreed to pay each
other commissions on certain sales of products resulting from successful
referrals from each other. The Agreement may be terminated by either Xerox or
the Company upon thirty days' written notice in certain circumstances, or upon
ninety days' written notice at any time. The Company's revenues from the
strategic marketing alliance, principally commissions from sales of Xerox
printers, were $490,400 and $752,000 in 1994 and 1995, respectively, and
payments to Xerox under the Agreement were $113,500 and $167,200 in 1994 and
1995 respectively.
Relationship with Fuji Xerox Australia
The Company has an arrangement with Fuji Xerox Co., Ltd ("Fuji Xerox")
pursuant to which Fuji Xerox distributes the Company's products in Australia and
New Zealand. For each copy of the Company's products sublicensed by Fuji Xerox,
Fuji Xerox pays the Company initial and annual fees equal to the Company's list
price minus a percentage discount based on annual volume of sublicenses of the
Company's products. Fuji Xerox provides technical support to its end users, with
periodic software upgrades provided to Fuji Xerox by the Company. The
arrangement with Fuji Xerox is terminable at will by either party.
Xerox Canada Agreement
The Company's Value Added Remarketer Agreement with Xerox Canada Limited
("Canada VAR") appoints Xerox Canada as a non-exclusive VAR in Canada for the
Company's products. Under the agreement, Xerox Canada will add value to the
products by giving technical support, assisting end users with application
development, and providing first level hot-line support. For each
51
<PAGE> 52
copy of the Company's products sublicensed by Xerox Canada, Xerox Canada pays
the Company initial and annual fees equal to the Company's suggested retail
initial and annual license fees (net of the customer training uplift built into
the price), minus a percentage discount. The Canada VAR is due to expire in
January 1997; however, it is subject to automatic renewal for successive
one-year terms unless either party gives notice at least 90 days prior to the
expiration of the then current term that it will not renew the agreement.
EUROPEAN/SUB-SAHARAN AFRICA VAR AGREEMENTS
The Company has numerous Value Added Reseller and Value Added Remarketer
agreements in Europe and South Africa, Namibia and Swaziland, many of which are
with Rank Xerox, Ltd. and other Xerox affiliates. The rights granted to the
Company's resellers under these agreements are typically non-exclusive, although
the agreements covering the territories of England, Scotland, Northern Ireland
and Wales and South Africa, Namibia and Swaziland grant the reseller exclusive
rights in its territory. In the usual circumstance, the reseller purchases the
Company's products pursuant to purchase orders and redistributes the products in
its territory, with the reseller having no right to copy the Company's products.
The reseller performs front-line technical support for its end users, and
software upgrades are periodically provided to the reseller by the Company. Each
reseller agreement runs for either a two- or three-year term, with automatic
one-year renewals unless either party gives notice of non-renewal within a
specified period prior to renewal.
TAX SHARING AGREEMENT
Xerox and the Company have entered into a Tax Sharing Agreement (the "Tax
Sharing Agreement") that provides for the allocation between Xerox and the
Company of all responsibilities, liabilities and benefits relating to taxes paid
or payable by either Xerox or the Company for all taxable periods, whether
beginning before, on, or after this offering. Prior to the consummation of this
offering, the Company has been included in the consolidated tax returns of
Xerox. The Company's share of Xerox's consolidated income tax liability for the
pre-offering period has been determined on a separate company basis computed
under Internal Revenue Code and applicable state guidelines and was $136,000,
$653,700 and $591,400 for the years ended December 31, 1993, 1994 and 1995,
respectively. The Company intends to repay such liability from the proceeds of
the initial public offering. For the period from January 1, 1996 through the
consummation of this offering, the Company's separate tax liability will also be
settled with Xerox. For the post-offering period, the Company may file combined
state income tax returns. Pursuant to the Tax Sharing Agreement, adjustments
(for example, pursuant to an Internal Revenue Service audit) made during the
post-offering period, but relating to the pre-offering period, will be settled
between the Company and Xerox.
The Company has entered into employment agreements with certain of its
executive officers. See "Management -- Employment and Severance Arrangements."
The Company intends to enter into indemnification agreements with each of its
officers and directors. See "Management -- Limitation of Liability and
Indemnification Matters." Upon completion of this offering, the Company and
Xerox intend to enter into a Stockholder Rights Agreement that will provide
Xerox with certain rights with respect to the registration of its shares of
Common Stock under the Securities Act. The Company and Xerox will also agree to
indemnify each other against certain liabilities including liabilities under the
Securities Act. See "Description of Capital Stock -- Registration Rights."
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<PAGE> 53
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information known to the Company
with respect to the beneficial ownership of the Company's outstanding Common
Stock as of June 30, 1996, and as adjusted to reflect the sale of the Common
Stock being offered hereby by (i) each person (or group of affiliated persons)
who is known by the Company to own beneficially more than 5% of the Company's
Common Stock, (ii) each of the Company's directors, (iii) each of the Named
Executive Officers, (iv) all executive officers and directors of the Company as
a group, and (v) each of the Selling Stockholders. The table assumes the
conversion of all outstanding Preferred Stock into Common Stock upon the
completion of this Offering. Unless otherwise specified, the address of the
stockholder is the address of the Company as set forth herein.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED NUMBER OF SHARES OWNED AFTER
PRIOR TO OFFERING(1) BEING OFFERED OFFERING(2)
DIRECTORS, NAMED OFFICERS --------------------- ---------------- ---------------------
AND 5% STOCKHOLDERS NUMBER PERCENT NUMBER NUMBER PERCENT
- ---------------------------- --------- ------- ---------------- --------- -------
<S> <C> <C> <C> <C> <C>
Xerox Corporation(3)........ 7,143,000 83.7% 388,500 6,754,500 65.1%
800 Long Ridge Road
Stamford, CT 06904
Tony N. Domit(4)............ 562,500 6.6 23,370 539,130 5.2
Barbara E. Amantea.......... 105,000 1.2 4,330 100,670 1.0
Thomas J. Anthony(5)........ 32,499 * -- 32,499 *
Peter L. Bradshaw(6)........ 38,967 * -- 38,967 *
Daniel J. Fregeau(7)........ 91,251 1.1 3,750 87,501 *
Judith A. O'Reilly(8)....... 97,500 1.1 4,040 93,460 *
E. Mark Palandri............ 210,000 2.5 8,660 201,340 1.9
Thomas L. Ringer(9)......... 32,155 * 9,180 22,975 *
Robert V. Adams(10)......... 7,143,000 83.7 388,500 6,754,500 65.1
Colin J. O'Brien(10)........ 7,143,000 83.7 388,500 6,754,500 65.1
James J. Costello(10)....... 7,143,000 83.7 388,500 6,754,500 65.1
Barton L. Faber............. -- * -- -- *
Richard Busch(11)........... 52,374 * 2,020 50,354 *
James Cowell................ 45,000 * 1,730 43,270 *
Michael Kramer(12).......... 62,577 * 2,600 59,977 *
John Schermerhorn(13)....... 60,000 * 2,320 57,680 *
J.J. Keil(14)............... 32,157 * 12,000 20,157 *
All Directors and Executive
Officers as a group (13
persons)(15).............. 8,312,872 96.8% 441,830 7,871,042 75.5
</TABLE>
- ---------------
* Less than 1 percent
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Except as indicated by
footnote, and subject to community property laws where applicable, the
persons or entities named in the table above have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially owned by them. Percentage of beneficial ownership is based on
8,537,157 shares of Common Stock outstanding as of June 30, 1996 and
10,374,657 shares of Common Stock outstanding after completion of this
Offering.
(2) Assumes no exercise of the Underwriters' over-allotment option to purchase
up to an aggregate of 345,000 shares of Common Stock from the Company.
(3) Mr. Adams, a director of the Company, is a principal of Xerox Technology
Ventures, a unit of Xerox Corporation. Mr. O'Brien is a director of the
Company, is a corporate Vice President of Xerox Corporation and Chief
Executive Officer of Xerox New Enterprises Companies, a unit of Xerox
Corporation. Mr. Costello is a director of the Company and Chief Financial
Officer of Xerox New Enterprises Companies, a unit of Xerox Corporation.
Mr. Adams disclaims
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<PAGE> 54
beneficial ownership of such shares held by Xerox Corporation except to the
extent of his profit sharing interests therein. Messrs. O'Brien and
Costello disclaim beneficial ownership of such shares held by Xerox
Corporation.
(4) Pursuant to a trust, Mr. Domit and his spouse share voting and dispositive
powers as co-trustees with respect to 562,500 shares of Common Stock.
(5) Includes 2,499 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996.
(6) Includes 13,437 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996.
(7) Includes 31,251 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996.
(8) Includes 2,034 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996.
(9) Includes 985 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996. Pursuant to a trust, Mr.
Ringer and his spouse share voting and investment powers as co-trustees
with respect to 31,170 shares of Common Stock.
(10) Represents 7,143,000 shares and 6,754,500 shares held by Xerox Corporation
prior to and after the offering, respectively. See footnote (3) above.
(11) Includes 624 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996.
(12) Includes 7,077 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996.
(13) Includes 1,251 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996.
(14) Includes 633 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996.
(15) Includes 50,208 shares of Common Stock issuable pursuant to stock options
exercisable within 60 days of June 30, 1996 and 7,143,000 shares and
6,754,500 shares held by Xerox Corporation prior to and after the offering,
respectively. See footnote (3) above.
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<PAGE> 55
DESCRIPTION OF CAPITAL STOCK
The following description of the capital stock of the Company and certain
provisions of the Company's Amended and Restated Certificate of Incorporation
and Amended and Restated Bylaws is a summary and is qualified in its entirety by
the provisions of the Amended and Restated Certificate of Incorporation and
Bylaws, which have been filed as exhibits to the Company's Registration
Statement, of which this Prospectus is a part.
Upon the closing of this offering, the authorized capital stock of the
Company, after giving effect to the conversion of all outstanding Preferred
Stock into Common Stock, will consist of 30,000,000 shares of Common Stock,
$.001 par value, and 2,000,000 shares of Preferred Stock, $.001 par value.
COMMON STOCK
As of June 30, 1996 there were 8,537,157 shares of Common Stock outstanding
held of record by 30 stockholders.
The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Subject to
preferences that may be applicable to any then outstanding Preferred Stock,
holders of Common Stock are entitled to receive ratably such dividends as may be
declared by the Board of Directors out of funds legally available therefor. In
the event of a liquidation, dissolution or winding up of the Company, holders of
Common Stock are entitled to share ratably in all assets remaining after payment
of liabilities and the liquidation preferences of any outstanding shares of
Preferred Stock, if any. Holders of Common Stock have no preemptive rights and
no right to convert their Common Stock into any other securities. There are no
redemption or sinking fund provisions applicable to the Common Stock. All
outstanding shares of Common Stock are, and all shares of Common Stock to be
outstanding upon completion of the offering will be, fully paid and
nonassessable. The rights of holders of Common Stock are subject to, and may be
adversely affected by, the rights of any series of Preferred Stock which the
Company may issue in the future.
PREFERRED STOCK
Effective upon the closing of this offering, the Board of Directors will
have the authority, without further action by the stockholders, to issue up to
2,000,000 shares of Preferred Stock in one or more series, and to fix the
rights, designations, preferences, privileges, qualifications and restrictions
thereof, including dividend rights, conversion rights, voting rights, rights and
terms of redemption, liquidation preferences and sinking fund terms, any or all
of which may be greater than the rights of the Common Stock. The issuance of
Preferred Stock could adversely affect the voting power of holders of Common
Stock and the likelihood that such holders will receive dividend payments and
payments upon liquidation. Such issuance could have the effect of decreasing the
market price of the Common Stock. The issuance of Preferred Stock may have the
effect of delaying, deterring or preventing a change in control of the Company
without any further action by the stockholders. The Company has no present plans
to issue any shares of Preferred Stock.
REGISTRATION RIGHTS
Upon completion of this offering, the Company and Xerox intend to enter
into a Stockholder Rights Agreement providing Xerox with certain registration
rights. Under the Stockholder Rights Agreement, in the event that the Company
proposes to register any of its securities under the Securities Act, Xerox will
be entitled to notice of such registration and will be entitled to include its
shares of Common Stock in such registration, subject to certain marketing and
other limitations. Xerox will also have the right to require the Company, on no
more than three occasions, to file a registration statement under the Securities
Act in order to register its shares of Common Stock. Xerox may also require the
Company to file Form S-3 registrations with respect to its shares of
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<PAGE> 56
Common Stock. The Company may, under certain circumstances, defer such
registration, and the underwriters involved in such registrations have the
right, subject to certain limitations, to limit the number of shares included in
such registrations.
CERTAIN ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION,
BY-LAWS AND DELAWARE LAW
GENERAL
Certain provisions of the Delaware General Corporation Law and the
Company's Certificate of Incorporation and Bylaws could have the effect of
making it more difficult for a third-party to acquire, or of discouraging a
third-party to acquire, control of the Company. Such provisions could limit the
price that certain investors might be willing to pay in the future for shares of
the Company's Common Stock. These provisions of Delaware law and the Company's
Certificate of Incorporation and Bylaws may also have the effect of discouraging
or preventing certain types of transactions involving an actual or threatened
change of control of the Company (including unsolicited takeover attempts), even
though such a transaction may offer the Company's stockholders the opportunity
to sell their stock at a price above the prevailing market price. The
Certificate of Incorporation allows the Company to issue Preferred Stock with
rights senior to those of the Common Stock and other rights that could adversely
affect the interests of holders of Common Stock without any further vote or
action by the stockholders. The issuance of Preferred Stock, for example, could
decrease the amount of earnings or assets available for distribution to the
holders of Common Stock or could adversely affect the rights and powers,
including voting rights, of the holders of Common Stock. In certain
circumstances, such issuance could have the effect of decreasing the market
price of the Common Stock, as well as having the anti-takeover effect discussed
above.
DELAWARE TAKEOVER STATUTE
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"), which prohibits a Delaware corporation from engaging in a
"business combination" with certain persons ("Interested Stockholders") for
three years following the date any such person becomes an Interested
Stockholder. Interested Stockholders generally include (i) persons who are the
beneficial owners of 15% or more of the outstanding voting stock of the
corporation, and (ii) persons who are affiliates or associates of the
corporation and who hold 15% or more of the corporation's outstanding voting
stock at any time within three years before the date on which such person's
status as an Interested Stockholder is determined. Subject to certain
exceptions, a business combination includes, among other things, (i) mergers or
consolidations, (ii) the sale, lease, exchange, mortgage, pledge, transfer or
other disposition of assets having an aggregate market value equal to 10% or
more of either the aggregate market value of all assets of the corporation
determined on a consolidated basis or the aggregate market value of all the
outstanding stock of the corporation, (iii) transactions that result in the
issuance or transfer by the corporation of any stock of the corporation to the
Interested Stockholder, except pursuant to a transaction that effects a pro rata
distribution to all stockholders of the corporation, (iv) any transaction
involving the corporation that has the effect of increasing the proportionate
share of the stock of any class or series, or securities convertible into the
stock of any class or series, of the corporation that is owned directly or
indirectly by the Interested Stockholder, of (v) any receipt by the Interested
Stockholder of the benefit (except proportionately as a stockholder) of any
loans, advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
Section 203 does not apply to a business combination if (i) before a person
becomes an Interested Stockholder, the board of directors of the corporation
approves the transaction in which the Interested Stockholder became an
Interested Stockholder or approved the business combination, (ii) upon
consummation of the transaction that resulted in the Interested Stockholder
becoming an Interested Stockholder, the Interested Stockholder owned at least
85% of the voting stock of the corporation outstanding at the time the
transaction commences, other than certain
56
<PAGE> 57
excluded shares, or (iii) following a transaction in which the person became an
Interested Stockholder, the business combination is (a) approved by the board of
directors of the corporation and (b) authorized at a regular or special meeting
of stockholders, and not by written consent, by the affirmative vote of the
holders of at least two-thirds of the outstanding voting stock of the
corporation not owned by the Interested Stockholder.
CERTIFICATE OF INCORPORATION AND BYLAWS
The Company's Bylaws also require that special meetings of the stockholders
of the Company may be called only by the Board of Directors, the Chief Executive
Officer of the Company or by any person or persons holding shares representing
at least 20% of the outstanding capital stock. The Company's Bylaws also require
advance written notice, which must be received by the Secretary of the Company
not less than 90 days prior to the meeting, by a stockholder of a proposal or
director nomination which such stockholder desires to present at an annual or
special meeting of stockholders. The Company's Certificate of Incorporation does
not include a provision for cumulative voting in the election of directors.
Under cumulative voting, a minority stockholder holding a sufficient number of
shares may be able to ensure the election of one or more directors. The absence
of cumulative voting may have the effect of limiting the ability of minority
stockholders to effect changes in the Board of Directors and, as a result, may
have the effect of deterring hostile takeover or delaying or preventing changes
in control or management of the Company.
The Company's Bylaws provide that the authorized number of directors may be
changed by an amendment to the Bylaws adopted by the Board of Directors or by
the stockholders. Vacancies in the Board of Directors may be filled either by
holders of a majority of the Company's voting stock or a majority of directors
in office, although less than a quorum.
TRANSFER AGENT AND REGISTRAR
U.S. Stock Transfer Corporation has been appointed as transfer agent and
registrar for the Company's Common Stock.
The Company's Common Stock has been approved for listing on The Nasdaq
National Market under the trading symbol DOCX.
57
<PAGE> 58
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for the Common
Stock. Future sales of substantial amounts of Common Stock in the public market
could adversely affect market prices prevailing from time to time. Furthermore,
since only a limited number of shares will be available for sale shortly after
this offering because of certain contractual and legal restrictions on resale
(as described below), sales of substantial amounts of Common Stock in the public
market after such restrictions lapse could adversely affect the prevailing
market price at such time and the ability of the Company to raise equity capital
in the future.
Upon completion of this offering, the Company will have outstanding an
aggregate of 10,374,657 shares of Common Stock assuming no exercise of the
Underwriters' over-allotment option and no exercise of outstanding options to
purchase Common Stock. Of these shares, the shares of Common Stock to be sold in
this offering will be freely tradable without restriction or further
registration under the Securities Act, unless such shares are held by
"affiliates" of the Company, as that term is defined in Rule 144 under the
Securities Act (the "Affiliates"). The remaining 8,074,657 shares held by
existing stockholders of the Company were sold by the Company in reliance on
exemptions from the registration requirements of the Securities Act and are
"restricted" securities within the meaning of Rule 144 under the Securities Act
(the "Restricted Shares"). Restricted Shares may be sold in the public market
only if registered or if they qualify for an exemption from registration under
Rules 144, 144(k) or 701 promulgated under the Securities Act, which rules are
summarized below. As a result of the contractual restrictions described below
and the provisions of Rules 144, 144(k) and 701, the Restricted Shares will be
available for sale in the public market as follows (based on the number of
shares outstanding as of June 30, 1996): (i) no Restricted Shares will be
eligible for immediate sale upon completion of this offering, and (ii) all
Restricted Shares will be eligible for sale upon expiration of the lock-up
agreements 180 days after the date of this Prospectus (regardless of whether
certain proposed amendments to Rule 144 are adopted in the currently proposed
form prior to such date).
Upon completion of this offering, Xerox, or certain transferees, will be
entitled to certain rights with respect to the registration of 6,754,500 shares
of Common Stock under the Securities Act. See "Description of Capital
Stock -- Registration Rights." Registration of such shares under the Securities
Act would result in such shares becoming freely tradable without restriction
under the Securities Act (except for shares purchased by Affiliates) immediately
upon the effectiveness of such registration.
All officers and directors, Xerox and substantially all other stockholders
and option holders of the Company have agreed not to sell, make any short sale
of, grant any option for the purchase of, or otherwise transfer or dispose of,
any shares of Common Stock or any securities convertible into or exercisable for
Common Stock held by such persons prior to the date hereof for a period of 180
days after the date of this Prospectus, without the prior written consent of
Deutsche Morgan Grenfell. When determining whether or not to release shares from
the lock-up agreements, Deutsche Morgan Grenfell will consider, among other
factors, the stockholder's reasons for requesting the release, the number of
shares for which the release is being requested and market conditions at the
time.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an Affiliate, who has beneficially owned
shares for at least two years is entitled to sell, within any three-month period
commencing 90 days after the date of this Prospectus, a number of shares that
does not exceed the greater of (i) 1% of the then outstanding shares of Common
Stock (103,746 shares immediately after this offering) or (ii) the average
weekly trading volume of the Common Stock on The Nasdaq National Market during
the four calendar weeks preceding such sale, subject to the filing of a Form 144
with respect to such sale. Sales under Rule 144 are also subject to certain
manner of sale provisions and notice requirements and to the availability of
current public information about the Company. Pursuant to a recent proposal of
the
58
<PAGE> 59
Securities and Exchange Commission (the "Commission") that has not yet been
adopted, the two-year holding period described in the preceding sentence would
be reduced to one year. In addition, a person who is not deemed to have been an
affiliate of the Company at any time during the 90 days preceding a sale, and
who has beneficially owned the shares proposed to be sold for at least three
years, would be entitled to sell such shares under Rule 144(k) without regard to
the requirements described above. Pursuant to a recent proposal of the
Commission that has not yet been adopted, the three-year holding period
described in the preceding sentence would be reduced to two years.
Under Rule 144(k), a person who is not deemed to have been an Affiliate of
the Company at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least three years
(including the holding period of any prior owner except an Affiliate), is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144. Therefore,
unless otherwise restricted, "144(k) shares" may be sold immediately following
completion of this offering. Under the proposed amendments to Rule 144, the
holding period applicable under Rule 144(k) would be reduced from three years to
two years. In general, under Rule 701 of the Securities Act as currently in
effect, any employee, consultant or advisor of the Company who purchased shares
from the Company in connection with a compensatory stock or option plan or
written employment agreement is eligible to resell such shares 90 days after the
effective date of this offering in reliance on Rule 144, but without compliance
with certain restrictions, including the holding period, contained in Rule 144.
Within 90 days of the date of this Prospectus, the Company intends to file
a registration statement under the Securities Act to register shares of Common
Stock reserved for issuance under its equity incentive plans, thus permitting
the resale of such shares by non-affiliates in the public market without
restriction under the Securities Act. See "Management -- Employee Benefit
Plans." Such registration statements will become effective immediately upon
filing. As of June 30, 1996, 373,368 options to purchase shares of Common Stock
were outstanding under the Company's stock option plans and agreements, none of
which are subject to the lock-up agreements described above.
59
<PAGE> 60
UNDERWRITING
The Underwriters named below, for whom Deutsche Morgan Grenfell/C. J.
Lawrence Inc., and SoundView Financial Group, Inc. are acting as representatives
(the "Representatives"), have severally agreed, subject to the terms and
conditions contained in the Underwriting Agreement (the form of which is filed
as an exhibit to the Company's Registration Statement, of which this Prospectus
is a part), to purchase from the Company and the Selling Stockholders the
respective number of shares of Common Stock indicated below opposite their
respective names. The Underwriters are committed to purchase all of the shares,
if they purchase any.
<TABLE>
<CAPTION>
NUMBER OF
SHARES
---------
<S> <C>
Deutsche Morgan Grenfell/C. J. Lawrence Inc...................... 600,000
SoundView Financial Group, Inc. ................................. 600,000
Alex. Brown & Sons Incorporated.................................. 100,000
Cowen & Company.................................................. 100,000
Donaldson, Lufkin & Jenrette Securities Corporation.............. 100,000
A.G. Edwards & Sons, Inc. ....................................... 100,000
Hambrecht & Quist LLC............................................ 100,000
Morgan Stanley & Co. Incorporated................................ 100,000
Prudential Securities Incorporated............................... 100,000
Robertson, Stephens & Company LLC................................ 100,000
William Blair & Company L.L.C. .................................. 60,000
First Albany Corporation......................................... 60,000
Furman Selz LLC.................................................. 60,000
Wedbush Morgan Securities Inc. .................................. 60,000
Wessels, Arnold & Henderson, L.L.C. ............................. 60,000
---------
Total.................................................. 2,300,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions.
The Representatives have advised the Company that the Underwriters propose
initially to offer the Common Stock to the public on the terms set forth on the
cover page of this Prospectus. The Underwriters may allow to selected dealers
(who may include the Underwriters) a concession of not more than $.50 per share.
The selected dealers may reallow a concession of not more than $.10 to certain
other dealers. After the initial public offering, the price and concessions and
re-allowances to dealers and other selling terms may be changed by the
Representatives. The Common Stock is offered subject to receipt and acceptance
by the Underwriters, and to certain other conditions, including the right to
reject orders in whole or in part. The Underwriters do not intend to sell any of
the shares of Common Stock offered hereby to accounts for which they exercise
discretionary authority.
The Company has granted options to the Underwriters to purchase up to a
maximum of 345,000 additional shares of Common Stock to cover over-allotments,
if any, at the public offering price, less the underwriting discount set forth
on the cover page of this Prospectus. Such options may be exercised at any time
until 30 days after the date of the Underwriting Agreement. To the extent the
Underwriters exercise these options, each of the Underwriters will be committed,
subject to certain conditions, to purchase such additional shares in
approximately the same proportion as set forth in the above table. The
Underwriters may purchase such shares only to cover over-allotments made in
connection with the Offering.
The Underwriting Agreement provides that the Company and the Selling
Stockholders will indemnify the several Underwriters against certain liabilities
including civil liabilities under the
60
<PAGE> 61
Securities Act of 1933, as amended, or will contribute to payments the
Underwriters may be required to make in respect thereof.
In connection with the Offering, the Company and the directors, executive
officers and stockholders of the Company have agreed not to offer, sell or
otherwise dispose of any shares of Common Stock for a period of 180 days after
the later of: (i) the date of this Prospectus; and (ii) the first date on which
shares of Common Stock hereby are offered to the public, without the prior
written consent of Deutsche Morgan Grenfell/C. J. Lawrence Inc.
Prior to this offering, there has been no public market for the Common
Stock. The initial public offering price was determined by negotiation between
the Company, the Selling Stockholders and the Representatives. The principal
factors considered in determining the public offering price include the
information set forth in this Prospectus and otherwise available to the
Representatives; the history and the prospects for the industry in which the
Company will compete; the ability of the Company's management; the prospectus
for future earnings of the Company; the present state of the Company's
development and its current financial condition; the general condition of the
securities markets at the time of the offering; and the recent market prices of,
and the demand for, publicly traded common stock of generally comparable
companies.
LEGAL MATTERS
Certain legal matters with respect to the validity of the issuance of the
shares of Common Stock offered hereby will be passed upon for the Company by
Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California. Certain legal matters in connection with this offering will be
passed upon for the Underwriters by Gray Cary Ware & Freidenrich, A Professional
Corporation, San Diego, California.
EXPERTS
The consolidated financial statements of Document Sciences Corporation at
December 31, 1994 and 1995, and for each of the three years in the period ended
December 31, 1995, appearing in this Prospectus and Registration Statement have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
report thereon appearing elsewhere herein, and are included in reliance upon
such report given upon the authority of such firm as experts in accounting and
auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), Washington, D.C. 20549, a Registration Statement on Form S-1
under the Securities Act, and the rules and regulations promulgated thereunder,
with respect to the Common Stock offered hereby. This Prospectus, which
constitutes a part of the Registration Statement, does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. Statements contained in the Prospectus as to the contents of
any contract or other document that is filed as an exhibit to the Registration
Statement are not necessarily complete and each such statement is qualified in
all respects by reference to the full text of such contract or document. For
further information with respect to the Company and the Common Stock, reference
is hereby made to such exhibits and schedules thereto, which may be inspected
and copied at the principal office of the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the Commission's regional offices at Seven World
Trade Center, 13th Floor, New York, New York 10048 and at Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of
each such document may be obtained from the Commission at its principal office
in Washington, D.C. upon payment of the charges prescribed by the Commission.
61
<PAGE> 62
DOCUMENT SCIENCES CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors..................................... F-2
Consolidated Balance Sheets........................................................... F-3
Consolidated Statements of Income..................................................... F-4
Consolidated Statements of Redeemable Preferred Stock and Stockholders' Equity........ F-5
Consolidated Statements of Cash Flows................................................. F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE> 63
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Document Sciences Corporation
We have audited the accompanying consolidated balance sheets of Document
Sciences Corporation as of December 31, 1994 and 1995, and the related
consolidated statements of income, redeemable preferred stock and stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1995. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits 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 Document
Sciences Corporation at December 31, 1994 and 1995, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1995, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
San Diego, California
July 12, 1996
F-2
<PAGE> 64
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
UNAUDITED
PRO FORMA
STOCKHOLDERS'
DECEMBER 31, EQUITY AT
------------------------- JUNE 30, JUNE 30,
1994 1995 1996 1996
---------- ---------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Assets (Note 4)
Current assets:
Cash and cash equivalents (Note 2)............. $ 583,834 $1,271,120 $ 1,465,784
Accounts receivable, less allowance for
doubtful accounts of $13,613, $22,957 and
$28,939 in 1994, 1995 and 1996,
respectively................................. 1,948,591 2,152,732 2,181,087
Due from affiliates (Note 9)................... 905,200 1,612,600 1,536,329
Deferred income taxes (Note 8)................. 62,700 79,200 79,200
Other current assets........................... 140,975 164,233 184,367
---------- ---------- ----------
Total current assets................. 3,641,300 5,279,885 5,446,767
Property and equipment, net (Note 2)........... 345,005 632,225 907,996
Computer software costs, net of accumulated
amortization of $144,651, $280,719 and
$333,568 in 1994, 1995 and 1996,
respectively................................. 222,260 377,172 428,559
Deferred financing costs....................... -- -- 318,806
---------- ---------- ----------
$4,208,565 $6,289,282 $ 7,102,128
========== ========== ==========
Liabilities, redeemable preferred stock and
stockholders' equity
Current liabilities:
Accounts payable............................... $ 119,522 $ 328,609 $ 471,015
Accrued compensation........................... 936,944 444,409 522,043
Other accrued liabilities...................... 146,623 130,487 371,833
Deferred revenue............................... 1,081,715 1,596,965 1,594,357
Current income tax expense payable to
affiliate.................................... 790,700 1,382,100 1,382,100
Current portion of obligations under capital
leases (Note 5).............................. 30,249 44,100 65,223
---------- ---------- ----------
Total current liabilities............ 3,105,753 3,926,670 4,406,571
Obligations under capital leases (Note 5)...... 20,490 98,500 144,902
Deferred income taxes (Note 8)................. 93,500 157,000 157,000
Commitments and contingencies
Series A Redeemable Preferred Stock, $.001 par
value; 2,000,000 shares authorized, issued
and outstanding (no shares issued and
outstanding pro forma); (liquidation
preference of $2,000,000) (Note 6)........... 917,750 1,250,750 1,417,250 $ --
Stockholders' equity (Note 7)
Common stock, $.001 par value;
Authorized shares -- 3,000,000
Issued and outstanding shares -- 3,000,
1,311,423 and 1,397,157 in 1994, 1995
and 1996, respectively (8,537,157 shares
issued and outstanding pro forma)............ 3 1,311 1,397 8,537
Additional paid-in capital..................... 45,593 110,550 557,065 1,967,175
Deferred compensation.......................... -- -- (406,475) (406,475)
Retained earnings.............................. 25,476 744,501 824,418 824,418
---------- ---------- ---------- ---------
Total stockholders' equity........... 71,072 856,362 976,405 2,393,655
========== =========
---------- ----------
$4,208,565 $6,289,282 $ 7,102,128
========== ========== ==========
</TABLE>
See accompanying notes.
F-3
<PAGE> 65
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------- -------------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues (Notes 3 and 9):
Initial license fees (including
$439,500, $1,098,400 and
$2,518,700 from affiliates in
1993, 1994 and 1995,
respectively)................... $1,979,776 $4,425,970 $6,299,230 $2,492,407 $3,503,292
Annual renewal license and support
fees (including $144,000,
$312,800, and $461,500 from
affiliates in 1993, 1994 and
1995, respectively)............. 980,729 1,521,389 1,942,353 894,021 1,100,355
Services and other (including
$216,900, $528,000 and $934,700
from affiliates in 1993, 1994
and 1995, respectively)......... 530,922 1,223,897 2,270,460 778,051 1,746,407
---------- ---------- ---------- ---------- ----------
Total revenues............. 3,491,427 7,171,256 10,512,043 4,164,479 6,350,054
Cost of revenues:
Initial license fees............... 144,991 273,667 350,860 98,332 313,664
Annual renewal license and support
fees............................ 217,312 266,902 369,732 179,675 244,588
Services and other................. 77,583 191,865 423,888 178,854 321,572
---------- ---------- ---------- ---------- ----------
Total cost of revenues..... 439,886 732,434 1,144,480 456,861 879,824
---------- ---------- ---------- ---------- ----------
Gross profit............... 3,051,541 6,438,822 9,367,563 3,707,618 5,470,230
Operating expenses:
Research and development........... 400,796 1,044,761 1,747,194 819,371 1,085,470
Selling and marketing (including
$113,500 and $167,200 to
affiliates in 1994 and 1995,
respectively) (Note 9).......... 934,897 2,765,414 4,415,158 1,866,071 3,249,009
General and administrative......... 996,195 1,274,847 1,519,865 732,274 735,617
---------- ---------- ---------- ---------- ----------
Total operating expenses... 2,331,888 5,085,022 7,682,217 3,417,716 5,070,096
---------- ---------- ---------- ---------- ----------
Income from operations............... 719,653 1,353,800 1,685,346 289,902 400,134
Interest income (expense), net....... (22,863) (9,125) 5,079 9,227 15,839
---------- ---------- ---------- ---------- ----------
Income before provision for income
taxes.............................. 696,790 1,344,675 1,690,425 299,129 415,973
Provision for income taxes (Note
8)................................. 283,400 632,900 638,400 110,959 169,556
---------- ---------- ---------- ---------- ----------
Net income........................... $ 413,390 $ 711,775 $1,052,025 $ 188,170 $ 246,417
========== ========== ========== ========== ==========
Pro forma net income per share....... $ .06 $ .09 $ .13 $ .02 $ .03
========== ========== ========== ========== ==========
Shares used to compute pro forma net
income per share................... 7,290,165 8,256,165 8,291,732 8,256,165 8,891,176
========== ========== ========== ========== ==========
</TABLE>
See accompanying notes.
F-4
<PAGE> 66
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
STOCKHOLDERS' EQUITY
-------------------------------------------------------------------------------
SERIES A DEFERRED
REDEEMABLE COMPENSATION TOTAL
PREFERRED STOCK COMMON STOCK ADDITIONAL RELATED TO RETAINED STOCKHOLDERS'
----------------------- ------------------- PAID-IN STOCK EARNINGS EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL OPTIONS (DEFICIT) (DEFICIT)
--------- ---------- --------- ------ ---------- ------------ --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December
31, 1992.......... 2,000,000 $ 251,750 3,000 $ 3 $ 45,593 $ -- $(433,689) $ (388,093)
Accretion on
Series A
Redeemable
Preferred
Stock........... -- 333,000 -- -- -- -- (333,000) (333,000)
Net income........ -- -- -- -- -- -- 413,390 413,390
--------- ---------- ------- ---- ---------- ---------- ---------- ----------
Balance at December
31, 1993.......... 2,000,000 584,750 3,000 3 45,593 -- (353,299) (307,703)
Accretion on
Series A
Redeemable
Preferred
Stock........... -- 333,000 -- -- -- -- (333,000) (333,000)
Net income........ -- -- -- -- -- -- 711,775 711,775
--------- ---------- ------- ---- ---------- ---------- ---------- ----------
Balance at December
31, 1994.......... 2,000,000 917,750 3,000 3 45,593 -- 25,476 71,072
Issuance of common
stock for
cash............ -- -- 1,308,423 1,308 64,957 -- -- 66,265
Accretion on
Series A
Redeemable
Preferred
Stock........... -- 333,000 -- -- -- -- (333,000) (333,000)
Net income........ -- -- -- -- -- -- 1,052,025 1,052,025
--------- ---------- ------- ---- ---------- ---------- ---------- ----------
Balance at December
31, 1995.......... 2,000,000 1,250,750 1,311,423 1,311 110,550 -- 744,501 856,362
Issuance of common
stock for cash
(unaudited)..... -- -- 85,734 86 6,515 -- -- 6,601
Accretion on
Series A
Redeemable
Preferred
Stock
(unaudited)..... -- 166,500 -- -- -- -- (166,500) (166,500)
Deferred
compensation
related to stock
options
(unaudited)..... -- -- -- -- 440,000 (440,000) -- --
Amortization of
deferred
compensation
related to stock
options
(unaudited)..... -- -- -- -- -- 33,525 -- 33,525
Net income
(unaudited)..... -- -- -- -- -- -- 246,417 246,417
--------- ---------- ------- ---- ---------- ---------- ---------- ----------
Balance at June 30,
1996
(unaudited)....... 2,000,000 $1,417,250 1,397,157 $1,397 $ 557,065 $ (406,475) $ 824,418 $ 976,405
========= ========== ======= ==== ========== ========== ========== ==========
</TABLE>
See accompanying notes.
F-5
<PAGE> 67
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
---------------------------------------- -----------------------
1993 1994 1995 1995 1996
----------- ----------- ---------- --------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................ $ 413,390 $ 711,775 $1,052,025 $ 188,170 $ 246,417
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization........... 33,040 63,102 141,685 58,408 113,560
Amortization of computer software
costs................................ 36,595 103,483 136,068 16,979 52,849
Amortization of deferred compensation... -- -- -- -- 33,525
Current income tax expense payable to
affiliate............................ 136,000 653,700 591,400 116,927 --
Deferred income taxes................... 147,400 (20,800) 47,000 (5,968) --
Provision for doubtful accounts......... 10,000 3,613 9,344 16,795 5,982
Changes in operating assets and
liabilities:
Accounts receivable.................. (1,037,103) (1,461,372) (920,885) 561,574 41,934
Other current assets................. (5,568) (114,934) (23,258) 25,385 (20,134)
Accounts payable..................... 28,728 82,693 209,087 15,743 (176,400)
Accrued liabilities.................. (7,109) 892,877 (508,671) (710,887) 318,980
Deferred revenue..................... 334,587 343,777 515,250 8,111 (2,608)
----------- ----------- ---------- ---------- ----------
Net cash provided by operating
activities.............................. 89,960 1,257,914 1,249,045 291,237 614,105
INVESTING ACTIVITIES
Purchases of property and equipment....... (20,504) (247,660) (297,964) (316,098) (287,562)
Additions to computer software costs...... (74,859) (163,629) (290,980) (128,991) (104,236)
----------- ----------- ---------- ---------- ----------
Net cash used for investing activities.... (95,363) (411,289) (588,944) (445,089) (391,798)
FINANCING ACTIVITIES
Proceeds from note payable to bank........ 120,000 100,000 -- -- --
Repayments of note payable to bank........ -- (445,000) -- -- --
Principal payments under capital lease
obligations............................. (3,209) (29,379) (39,080) (22,642) (34,244)
Issuance of common stock.................. -- -- 66,265 -- 6,601
----------- ----------- ---------- ---------- ----------
Net cash provided by (used for) financing
activities.............................. 116,791 (374,379) 27,185 (22,642) (27,643)
----------- ----------- ---------- ---------- ----------
Increase (decrease) in cash and cash
equivalents............................. 111,388 472,246 687,286 (176,494) 194,664
Cash and cash equivalents at beginning of
period.................................. 200 111,588 583,834 583,834 1,271,120
----------- ----------- ---------- ---------- ----------
Cash and cash equivalents at end of
period.................................. $ 111,588 $ 583,834 $1,271,120 $ 407,340 $1,465,784
=========== =========== ========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Interest paid............................. $ 22,863 $ 15,800 $ 12,283 $ 3,751 $ 12,246
=========== =========== ========== ========== ==========
Capital lease obligations entered into for
property and equipment.................. $ 12,269 $ 55,592 $ 130,941 $ -- $ 101,769
=========== =========== ========== ========== ==========
</TABLE>
See accompanying notes.
F-6
<PAGE> 68
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF JUNE 30, 1996 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Document Sciences Corporation (the "Company") was incorporated on October
18, 1991 in Delaware as a subsidiary of Xerox Corporation ("Xerox"). The Company
develops, markets and supports a family of document automation software products
and services used in high volume electronic publishing applications. Autograph,
the Company's document automation software architecture, enables personalized
publishing solutions for many industries including insurance, managed
healthcare, financial services, telecommunications, government agencies and
commercial print service bureaus.
The Company currently derives substantially all of its license revenues
from licenses of CompuSet, Autograph's flagship product, and related products
and from fees for services related to the CompuSet software. The Company's
financial performance will continue to depend, in significant part, on the
successful development, introduction and customer acceptance of new and enhanced
versions of the CompuSet software and related products. There can be no
assurance that the Company will continue to be successful in developing and
marketing CompuSet products and related services.
Management believes that fourth quarter revenues are positively impacted by
year-end capital purchases by large corporate customers, as well as the
Company's sales compensation plans. These seasonal factors typically result in
fourth quarter revenues being substantially higher than revenues in each of the
preceding three quarters.
The Company currently has a variety of contractual and informal
relationships with Xerox and affiliates of Xerox, including a strategic
marketing alliance agreement, a transfer and license agreement and various
distribution agreements. There can be no assurance that Xerox or its affiliates
will continue these relationships. The failure by the Company to maintain these
relationships with Xerox and its affiliates could have a material adverse effect
on the Company's financial statements.
BASIS OF PRESENTATION
In 1994, the Company established a wholly-owned subsidiary, Document
Sciences Europe, in Sophia Antipolis, France in order to market and support its
products to the European community. The accompanying consolidated financial
statements include the accounts of the Company and its subsidiary. Significant
intercompany accounts and transactions have been eliminated in consolidation.
INTERIM FINANCIAL INFORMATION
The financial statements at June 30, 1996 and for the six-month periods
ended June 30, 1995 and 1996 are unaudited, but include all adjustments
(consisting only of normal recurring adjustments) which management considers
necessary for a fair statement of the financial position at such dates and the
operating results and cash flows for such periods. Results for interim periods
are not necessarily indicative of results for the entire year or any future
periods.
F-7
<PAGE> 69
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
FOREIGN OPERATIONS
The functional currency of the Company's France subsidiary is the French
Franc. The balance sheet accounts of the subsidiary are translated into United
States dollars at exchange rates prevailing at the balance sheet dates.
Operating results are translated at weighted average exchange rates in effect
during the year. Net unrealized translation adjustments were insignificant in
1994, 1995 and the six month period ended June 30, 1996. Foreign currency
transaction gains and losses are included in the consolidated statements of
income and were not material during the years ended December 31, 1994 and 1995
and the six month periods ended June 30, 1995 and 1996.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments
which include debt securities with remaining maturities when acquired of three
months or less and are stated at market. The Company evaluates the financial
strength of institutions at which significant investments are made and believes
the related credit risk is limited to an acceptable level.
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity
Securities, and has classified its investments as available-for-sale in
accordance with that standard. Available-for-sale securities are carried at
amounts which approximate fair value. Unrealized gains and losses, net of tax,
are reported in stockholders' equity. Realized gains and losses and declines in
value judged to be other-than-temporary, if any, on available-for-sale
securities are included in investment income. The cost of securities sold is
based on the specific identification method.
CONCENTRATION OF CREDIT RISK
The Company sells its products primarily to large, multinational customers
in the United States, Europe, Canada and Australia. The Company derived 14%,
26%, 42% and 30% of its total revenues from customers outside the United States
in the years ended December 31, 1993, 1994 and 1995 and the six months ended
June 30, 1996, respectively. A significant concentration of the Company's
customers are in the insurance and commercial print service industries. No
customer has accounted for 10% or more of the Company's revenue in any one year.
Credit is extended based on an evaluation of the customer's financial
condition and a cash deposit is generally not required. The Company estimates
its potential losses on trade receivables on an ongoing basis and provides for
anticipated losses in the period in which the revenues are recognized. Credit
losses have historically been minimal and have been within management's
expectations.
F-8
<PAGE> 70
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
DEFERRED FINANCING COSTS
Costs incurred through June 30, 1996 in connection with the offering
contemplated by this Prospectus have been deferred. Such costs will be charged
against the proceeds of the offering upon completion, or expensed if the
offering is not completed.
ACCOUNTING STANDARD ON IMPAIRMENT OF LONG-LIVED ASSETS
In March 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, which requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amount. Statement 121 also addresses
the accounting for long-lived assets that are expected to be disposed of. The
Company adopted SFAS 121 in 1996 and the adoption had no impact on the Company's
financial statements.
COMPUTER SOFTWARE COSTS
In accordance with SFAS No. 86, Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed, costs incurred in the
research and development of new software products and significant enhancements
to existing software products are expensed as incurred until the technological
feasibility of the product has been established. After technological feasibility
has been established, direct production costs, including programming and
testing, are capitalized until general release of the product.
Capitalized software costs are amortized using the greater of the amount
computed using the ratio of current period product revenues to estimated total
product revenues or the straight-line method over the remaining estimated
economic lives of the products (generally five years). It is possible that
estimated total product revenues, the estimated economic life of the product, or
both, will be reduced in the future. As a result, the carrying amount of
capitalized software costs may be reduced in the future, which could result in
charges to the results of operations in future periods.
DEPRECIATION AND AMORTIZATION
Depreciation is provided on a straight-line method over the estimated
useful lives of the assets (generally five years). Amortization of leasehold
improvements is provided over the lesser of the remaining lease term or the
estimated useful life of the improvements.
REVENUE RECOGNITION
The Company recognizes revenue in accordance with AICPA Statement of
Position on Software Revenue Recognition No. 91-1. Initial licensing revenue is
recognized upon shipment of the product to customers if no significant Company
obligations remain and collection of the receivable is deemed probable. The
portion of the initial licensing revenue which represents the software support
for the first year is deferred and recognized ratably over the contract period.
In subsequent years, customers pay annual license fees for continued use and
support of licensed software. Annual renewal license and support revenue is
deferred and recognized ratably over the contract period. Revenues from
commissions paid by Xerox in connection with the sale of Xerox printer products
are
F-9
<PAGE> 71
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
recognized upon installation of the printer products. Revenues generated from
consulting and training services are recognized as the related services are
performed.
PRO FORMA NET INCOME PER SHARE
Pro forma net income per share is computed using the weighted average
number of common shares outstanding during the period and includes the effect of
dilutive common stock equivalents arising from stock options, using the treasury
stock method. Pursuant to the requirements of the Securities and Exchange
Commission, Common Stock issued by the Company during the twelve months
immediately preceding the initial public offering, plus the number of common
equivalent shares which became issuable during the same period pursuant to the
grant of stock options, have been included in the calculation of the shares used
in computing pro forma net income per share as if these shares were outstanding
for all periods presented using the treasury stock method. In addition, the
calculation of the shares used in computing pro forma net income per share also
includes the Series A Redeemable Preferred Stock, which will convert into Common
Stock upon completion of the initial public offering contemplated by this
Prospectus, as if they were converted into Common Stock as of the original dates
of issuance. Historical earnings per share have not been presented since such
amounts are not deemed meaningful due to the significant change in the Company's
capital structure that will occur in connection with the initial public
offering.
UNAUDITED SUPPLEMENTAL PRO FORMA NET INCOME PER SHARE
The computation of supplemental pro forma net income per share is based on
pro forma net income per share as described above, adjusted to assume the
repayment of the current income tax payable to affiliate out of the proceeds of
this offering. As a result, the shares used to compute supplemental pro forma
net income per share include 115,175 shares of the shares being offered by the
Company hereby which represent the shares deemed to be sold to fund such
repayment. Supplemental pro forma net income per share was $.06, $.09 and $.13
for the years ended December 31, 1993, 1994 and 1995, respectively, and $.02 and
$.03 for the six months ended June 30, 1995 and 1996, respectively.
STOCK OPTIONS
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based
Compensation, which is effective for the Company's 1996 consolidated financial
statements. SFAS 123 allows companies to either account for stock-based
compensation under the new provisions or under the provisions of APB 25, but
requires pro-forma disclosure in the footnotes to the financial statements as if
the measurement provisions of SFAS 123 had been adopted. The Company intends to
continue accounting for its stock-based compensation in accordance with the
provisions of APB 25. As such, the new provisions of SFAS 123 will not impact
the financial position or results of operations of the Company.
INCOME TAXES
The Company follows the liability method of accounting for income taxes, as
set forth in SFAS No. 109.
Xerox and the Company intend to enter into a Tax Sharing Agreement that
provides for the allocation between Xerox and the Company of all
responsibilities, liabilities and benefits relating to
F-10
<PAGE> 72
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
taxes paid or payable by either Xerox or the Company for all taxable periods,
whether beginning before, on, or after this offering. Through December 31, 1995,
the Company has been included in the consolidated tax returns of Xerox. The
Company's share of Xerox's consolidated income tax liability through December
31, 1995 has been determined on a separate company basis computed under Internal
Revenue Code guidelines and was $136,000, $653,700 and $591,400 for the years
ended December 31, 1993, 1994 and 1995, respectively, which has been accounted
for as a current liability. The Company intends to repay such liability from the
proceeds of the initial public offering contemplated by this Prospectus. For the
period from January 1, 1996 through the date on which Xerox owns less than 80%
of the Common Stock of the Company, the Company's separate tax liability will be
settled with Xerox in cash. The Company intends to pay any such liabilities with
cash generated from operations. At such time as Xerox owns less than 80% of the
Common Stock of the Company, the Company will not be part of the consolidated
tax returns of Xerox and will file separate tax returns.
2. FINANCIAL STATEMENT INFORMATION
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1994 1995
--------- --------- JUNE 30,
1996
----------
(UNAUDITED)
<S> <C> <C> <C>
Computer equipment.................. $ 338,310 $ 625,591 $ 783,454
Office furniture and fixtures....... 74,015 171,399 208,325
Office equipment.................... 32,075 46,367 166,770
Leasehold improvements.............. 16,642 46,590 120,729
--------- --------- ----------
461,042 889,947 1,279,278
Less accumulated depreciation and
amortization...................... (116,037) (257,722) (371,282)
--------- --------- ----------
$ 345,005 $ 632,225 $ 907,996
========= ========= ==========
</TABLE>
Equipment acquired under capital leases totaled $66,255, $145,112 and
$221,012 (net of accumulated amortization of $16,259, $35,085 and $60,954) at
December 31, 1994 and 1995 and June 30, 1996, respectively.
INVESTMENTS
Included in cash and cash equivalents were the following debt securities
which were classified as available-for-sale:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- JUNE 30,
1994 1995 1996
-------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
U.S. treasury securities.................. $ -- $398,889 $ --
U.S. government agency obligations........ 199,435 298,470 198,315
-------- -------- --------
$199,435 $697,359 $198,315
======== ======== ========
</TABLE>
As of December 31, 1994, 1995 and June 30, 1996, the difference between
amortized cost and the estimated fair value of the available-for-sale securities
was not material.
F-11
<PAGE> 73
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
3. DOMESTIC AND FOREIGN OPERATIONS
The table below summarizes the Company's domestic operations and those of
its subsidiary, Document Sciences Europe.
<TABLE>
<CAPTION>
UNITED
STATES FRANCE ELIMINATIONS TOTAL
---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Year ended December 31,
1995
Sales to unaffiliated
customers............. $5,350,838 $1,246,305 $ -- $ 6,597,143
Sales to affiliates (Note
9).................... 1,929,300 1,985,600 -- 3,914,900
Transfers between
geographic areas...... 1,528,352 -- (1,528,352) --
---------- ---------- ----------- -----------
Revenues................. $8,808,490 $3,231,905 $(1,528,352) $10,512,043
========== ========== =========== ===========
Operating income (loss).. $1,696,153 $ (5,728) $ -- $ 1,690,425
========== ========== =========== ===========
Identifiable assets...... $4,748,787 $1,557,161 $ (16,666) $ 6,289,282
========== ========== =========== ===========
Year ended December 31,
1994
Sales to unaffiliated
customers............. $4,861,398 $ 370,658 $ -- $ 5,232,056
Sales to affiliates (Note
9).................... 1,405,800 533,400 -- 1,939,200
Transfers between
geographic areas...... 507,388 -- (507,388) --
---------- ---------- ----------- -----------
Revenues................. $6,774,586 $ 904,058 $ (507,388) $ 7,171,256
========== ========== =========== ===========
Operating income (loss).. $1,727,707 $ (383,032) $ -- $ 1,344,675
========== ========== =========== ===========
Identifiable assets...... $3,475,168 $ 750,063 $ (16,666) $ 4,208,565
========== ========== =========== ===========
</TABLE>
The Company uses affiliated distributors to sell its products in Canada,
Australia and New Zealand (See Note 9).
4. CREDIT FACILITY
The Company had an agreement with a bank to provide a working capital line
of credit which allows maximum borrowings at the lesser of $750,000 or 75% of
eligible accounts receivable (as defined). The agreement also provided for
letters of credit up to an aggregate of $100,000. Borrowings under the line of
credit are collateralized by substantially all assets of the Company and bear
interest at the bank's prime rate plus 1%. The line of credit agreement contains
certain covenants, including a limit on the amount of debt to tangible net worth
and restrictions on the payment of dividends. The line of credit is renewable
annually at the sole discretion of the bank and expired on July 5, 1996. The
Company had no outstanding borrowings or letters of credit as of December 31,
1995.
On July 8, 1996, the Company signed a letter of intent to renew the line of
credit to provide borrowings up to $2,500,000, with the line of credit to expire
in July 1997.
F-12
<PAGE> 74
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
5. LEASES
The Company leases its corporate office facilities in San Diego, California
under an operating lease, signed by Xerox, which expires in 2000. Under the
terms of the lease, effective February 1, 1997, monthly rental payments will be
increased annually by 4%. The lease provides the Company with an option to
extend the lease term for an additional three years at the base rent in effect
for the last year of the initial lease term. In addition, the Company may
exercise a one-time cancellation option effective any time after January 31,
1998 with the payment of certain penalties. The Company also leases certain
equipment under capital leases.
Annual future minimum lease payments, which include $121,400 for the effect
of the potential exercise of the cancellation option, are as follows:
<TABLE>
<CAPTION>
YEARS ENDING OPERATING CAPITAL
DECEMBER 31, LEASES LEASES
----------------------------------------------------- -------- --------
<S> <C> <C>
1996.............................................. $206,800 $ 58,700
1997.............................................. 214,300 46,100
1998.............................................. 177,600 41,300
1999.............................................. -- 27,500
-------- --------
$598,700 173,600
========
Less amount representing interest.................... (31,000)
--------
Present value of net minimum lease payments.......... 142,600
Less current portion................................. (44,100)
--------
Long-term portion of capital lease obligations....... $ 98,500
========
</TABLE>
Rent expense for the years ended December 31, 1993, 1994 and 1995 was
$126,441, $137,160 and $255,599, respectively. Rent expense for the six months
ended June 30, 1995 and 1996 was $114,967 and $134,317, respectively.
6. SERIES A REDEEMABLE PREFERRED STOCK
Each share of Series A Redeemable Preferred Stock is convertible into
Common Stock at the option of the holder. The initial conversion rate for the
Series A Redeemable Preferred Stock is on a one-to-one basis. The conversion
rate is subject to adjustment to take into account any dilutive issuance of
stock and will be 1.19 to 1 as a result of such dilutive issuance. The Series A
Redeemable Preferred Stock is automatically convertible into Common Stock, at
the then applicable conversion rate, upon the closing of an underwritten public
offering of shares of Common Stock of the Company for total gross offering
proceeds of not less than $5,000,000, but only if the public offering price of
the Company's Common Stock in such offering is not less than $1.00 per share.
Each share of Series A Redeemable Preferred Stock is entitled to one vote for
each common share into which it would convert. The Series A Redeemable Preferred
Stock is entitled to annual noncumulative dividends at $.017 per share, when, as
and if declared by the Board of Directors.
Upon dissolution, liquidation or winding up of the Company, before any
distribution or payment of amounts to the holders of Common Stock, the holders
of Series A Redeemable Preferred Stock are entitled to receive preference of
$.33 per share plus all declared but unpaid dividends on such shares.
F-13
<PAGE> 75
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
The holders of the Series A Redeemable Preferred Stock have an option, at
any time subsequent to March 31, 1998, to require the Company to repurchase up
to one-third of the shares at $.33 per share. In addition, one-third of the
shares can be redeemed at any time subsequent to each of March 31, 1999 and
March 31, 2000. The difference between the issuance price and the redemption
value is being amortized to retained earnings on a straight-line basis, which
approximates the interest method.
7. STOCKHOLDERS' EQUITY
STOCK SPLIT
On June 19, 1996, the Company's Board of Directors authorized a 3 for 1
stock split for all outstanding Common Stock and Series A Redeemable Preferred
Stock, subject to stockholder approval, to become effective on the date of this
Prospectus. All share and per share amounts in the accompanying consolidated
financial statements have been retroactively restated to reflect the stock
split. Upon completion of the public offering contemplated by this Prospectus,
the authorized capital stock of the Company will consist of 30,000,000 shares of
Common Stock and 2,000,000 shares of Preferred Stock.
STOCK INCENTIVE PLANS
The Company's Stock Incentive Plans (the "Plans") provide for the issuance
of incentive and nonstatutory options to purchase Common Shares to eligible
employees, officers, directors of, and consultants to, the Company. The
Company's 1993 Stock Incentive Plan (the "1993 Plan") provided for the issuance
of up to 1,500,000 shares. In October 1995, the Board of Directors approved the
1995 Stock Incentive Plan (the "1995 Plan"), which provided for the issuance of
an additional 779,250 shares, which include 29,250 shares previously reserved
for issuance under the 1993 Plan. The 1995 Plan replaces the 1993 Plan. All
outstanding options under the 1993 Plan remain exercisable in accordance with
their original terms. Terms of the stock purchase or stock option agreements,
including vesting requirements, are determined by the Board of Directors,
subject to the provisions of the 1995 Plan. The maximum term of options granted
under the 1995 Plan is ten years. The exercise price of incentive stock options
must equal at least the fair market value on the date of grant. The exercise
price of nonstatutory stock options and stock issued under purchase rights must
equal at least 85% of the fair market value on the date of grant or time of
issuance. The Company has the option, in the event of termination of employment,
to repurchase shares issued under stock purchase agreements or upon exercise of
stock options at the lesser of the original issue price or fair market value on
the date of termination of employment.
F-14
<PAGE> 76
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
The following table summarizes stock option activity under the stock
incentive plans:
<TABLE>
<CAPTION>
WEIGHTED
OPTION AVERAGE
PRICE PRICE PER
SHARES PER SHARE SHARE
---------- ------------- ---------
<S> <C> <C> <C>
Balance as of December 31, 1992 and 1993................ 1,207,500 $ .03 $ .03
Granted............................................... 251,250 $.03 - $ .17 $ .15
Canceled.............................................. (18,000) $ .17 $ .17
--------
Balance as of December 31, 1994......................... 1,440,750 $.03 - $ .17 $ .05
Granted............................................... 232,575 $ .17 $ .17
Exercised............................................. (1,308,423) $.03 - $ .17 $ .05
Canceled.............................................. (3,000) $ .17 $ .17
--------
Balance at December 31, 1995............................ 361,902 $.03 - $ .17 $ .09
Granted (unaudited)................................... 100,500 $.67 - $8.50 $1.09
Exercised (unaudited)................................. (85,734) $.03 - $ .17 $ .08
Canceled (unaudited).................................. (3,300) $.17 - $ .67 $ .21
--------
Balance at June 30, 1996 (unaudited).................... 373,368 $.03 - $8.50 $ .37
========
</TABLE>
As of June 30, 1996, 102,618 of the options were vested and exercisable and
623,475 shares were available for future grant.
Through June 30, 1996, the Company has recorded $440,000 of deferred
compensation on options granted to employees, representing the difference
between the option grant price and the deemed fair market value of the related
shares. The Company is amortizing such amount ratably over the vesting period of
the options, generally 48 months.
8. INCOME TAXES
The provision for income taxes is as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1993 1994 1995
-------- -------- --------
<S> <C> <C> <C>
Current:
Federal............................... $ 89,700 $542,000 $469,700
State................................. 46,300 111,700 121,700
-------- -------- --------
136,000 653,700 591,400
Deferred (credit):
Federal............................... 126,300 (16,200) 39,500
State................................. 21,100 (4,600) 7,500
-------- -------- --------
147,400 (20,800) 47,000
-------- -------- --------
$283,400 $632,900 $638,400
======== ======== ========
</TABLE>
Deferred income taxes reflect the net effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
F-15
<PAGE> 77
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
Significant components of the Company's deferred tax assets and liabilities
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1994 1995
--------- ---------
<S> <C> <C>
Deferred tax liability -- computer software
costs........................................... $ (93,500) $(157,000)
Deferred tax assets:
Foreign operating loss carryforwards............ 134,060 136,065
Accrued vacation................................ 55,500 75,000
Provision for doubtful accounts................. 7,200 4,200
--------- ---------
Total deferred tax assets......................... 196,760 215,265
Valuation allowance............................... (134,060) (136,065)
--------- ---------
Net deferred tax assets........................... 62,700 79,200
--------- ---------
Net deferred tax liability........................ $ (30,800) $ (77,800)
========= =========
</TABLE>
A valuation allowance has been recognized to offset the deferred tax assets
attributed to foreign operating loss carryforwards, as realization of such
assets is uncertain.
The differences between the Company's income tax provision and the amounts
computed by applying the statutory federal income tax rate (34% in 1993 and 35%
in 1994 and 1995) to income before income taxes are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1993 1994 1995
-------- -------- --------
<S> <C> <C> <C>
Provision at statutory rate............. $236,909 $470,636 $591,649
Benefit of graduated rates.............. -- (13,447) (16,904)
State income taxes, net of federal
benefit............................... 44,484 69,550 83,980
Increase in valuation reserves.......... -- 134,060 2,005
Benefit of research credits............. -- (57,733) (57,547)
Permanent differences and other......... 2,007 29,834 35,217
-------- -------- --------
Provision for income taxes.............. $283,400 $632,900 $638,400
======== ======== ========
</TABLE>
9. TRANSACTIONS WITH AFFILIATES
The Company has a strategic marketing alliance with Xerox under which the
parties have agreed to pay each other fees on referrals that lead to the
successful sale or licensing of each other's products. Included in services and
other revenue in the accompanying statements of income are commissions earned
from Xerox totaling $198,600, $490,400 and $752,000 in 1993, 1994 and 1995,
respectively, and $157,700 and $586,600 for the six months ended June 30, 1995
and 1996, respectively. Commissions related to referrals from Xerox are included
in selling and marketing expense in the accompanying statements of income and
totaled $113,500 and $167,200 in 1994 and 1995, respectively. There were no such
commissions in 1993.
The Company has distribution agreements with affiliates which provide the
affiliates with the non-exclusive right to sub-license the Company's software in
Australia, New Zealand and Canada. The terms of the distributor agreements
provide that the affiliates receive a discount from the list price of the
Company's products licensed, including maintenance and support. Revenues from
the affiliates under these agreements, net of discounts, were $284,100, $796,600
and $1,088,200 in
F-16
<PAGE> 78
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF JUNE 30 AND FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 1995 AND 1996 IS UNAUDITED)
1993, 1994 and 1995, respectively, and $523,300 and $136,300 for the six months
ended June 30, 1995 and 1996, respectively. Included in accounts receivable are
$121,400 and $193,500 from these revenues at December 31, 1994 and 1995,
respectively.
The Company has distribution agreements with affiliates which provide the
affiliates the non-exclusive right to sub-license the Company's software in
Europe. Revenues under these agreements totaled $198,900, $533,400 and
$1,985,600 in 1993, 1994 and 1995, respectively, and $625,100 and $539,600 for
the six months ended June 30, 1995 and 1996, respectively. Related accounts
receivable are $122,900 and $482,900 at December 31, 1994 and 1995,
respectively.
Under the terms of a separate agreement with Xerox, the Company provided
software support services for Xerox Publishing Systems' products. Included in
annual renewal license and support fees are revenues from Xerox under this
agreement of $118,800 in 1993 and 1994 and $89,100 in 1995, respectively, and
$59,400 for the six months ended June 30, 1995.
10. EMPLOYEE RETIREMENT PLAN
401(k) Plan
The Company has an employee savings and retirement plan (the "401(k) Plan")
that is intended to be tax-qualified covering substantially all of the Company's
employees. Under the terms of the 401(k) Plan, employees may elect to contribute
up to 15% of their compensation, or the statutorily prescribed limit, if less,
to the 401(k) Plan as a savings contribution. The Company may, in its
discretion, match employee contributions, at such rate as it determines, up to a
maximum of $3,000 or 10% of the employee's compensation. The 401(k) Plan has a
profit sharing element whereby the Company can contribute annually an amount
determined by the Board of Directors. An employee's interest in matching
contributions and profit sharing contributions generally vest over four years
from the date of employment.
F-17
<PAGE> 79
- ---------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY, THE SELLING STOCKHOLDERS OR THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF ANY
OFFER TO BUY, THE COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO
WHOM, IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. EXCEPT WHERE
OTHERWISE INDICATED, THIS PROSPECTUS SPEAKS AS OF THE EFFECTIVE DATE OF THE
REGISTRATION STATEMENT. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE
MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT
THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR IN
THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
- ---------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary................... 3
The Company.......................... 4
Risk Factors......................... 5
Use of Proceeds...................... 14
Dividend Policy...................... 14
Capitalization....................... 15
Dilution............................. 16
Selected Consolidated Financial
Data............................... 18
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 19
Business............................. 29
Management........................... 43
Certain Transactions................. 51
Principal and Selling Stockholders... 53
Description of Capital Stock......... 55
Shares Eligible for Future Sale...... 58
Underwriting......................... 60
Legal Matters........................ 61
Experts.............................. 61
Additional Information............... 61
Index to Consolidated Financial
Statements......................... F-1
</TABLE>
UNTIL OCTOBER 15, 1996 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- ---------------------------------------------------------
LOGO
2,300,000 SHARES
COMMON STOCK
DEUTSCHE MORGAN GRENFELL
SOUNDVIEW FINANCIAL GROUP, INC.
PROSPECTUS
SEPTEMBER 20, 1996
<PAGE> 80
APPENDIX TO ELECTRONIC DOCUMENT FORMAT
DESCRIPTION OF GRAPHICS
Pursuant to Paragraph 625 of the EDGAR User Manual, the following is an
explanation of the differences between the foregoing document in electronic
format and the corresponding printed document on paper.
1. Location: Outside Front Cover Page of Prospectus.
Description: Document Sciences Corporation logo, which is a
registered trademark of the Company, next to which the words
"DOCUMENT SCIENCES" are printed in bold, and beneath which words are
printed the word "CORPORATION."
2. Location: Inside Front Cover Page of Prospectus.
Description: A graphic headed with the Company's logo described in
paragraph 1 above, and entitled "The Power of Personalized
Communications." The graphic depicts information from databases,
on-line transmission and document management being input through the
Company's AUTOGRAPH product family, and creating personalized
documents through printers, CD-ROMs and on-line documents. At the
foot of the graphic are the words "Personalized Communications
through Document Automation," beneath which is the Company's Internet
address, "http://www.docscience.com."
3. Location: "Business -- Industry Background."
Description: A graphic entitled "The Electronic Publishing Process."
The graphic depicts four boxes across the page with arrows between
each box, and with the boxes containing the words "Information
Creation," "Information Management," "Information Formatting" and
"Information Presentation," respectively. Beneath the "Information
Creation" box are listed the words "Computers," "Scanners" and
"Communications." Beneath the "Information Management" box are listed
the words "Database," "Document Management" and "Multiauthoring
Environments." Beneath the "Information Formatting" box are listed
the words "Selection," "Assembly" and "Composition." Beneath the
"Information Presentation" box are listed the words "Printers and
Imagesetters," "Electronic On-Line Documents," "CD-ROM" and "Web."
4. Location: "Business -- Products."
Description: A graphic with symbols depicting Document
Management, Document Composition and Assembly, Data Capture and
Setup, Application Development Tools, Document Output and Merge, and
Document Viewing.
5. Location: "Business -- Products -- Document Viewing."
Description: A graphic with symbols depicting Document Management,
Data, Text and Importers flowing into CompuSet and CompuSeries,
from which flow the Document Outputs of Printing, Archival, Document
Viewing and Web.
6. Location: Inside Back Cover Page of Prospectus
Description: A graphic headed with the Autograph Product Family logo,
which is a registered trademark of the Company. The graphic depicts
seven boxes in two columns, with three boxes on the left and four on
the right. Arrows lead vertically from one box to the next. Product
functions are displayed inside each of the boxes. A phrase located to
the immediate right of each of the boxes describes how the product
functions perform. Outside the first box is the phrase "Define the
document layout with ease and precision". Outside the second box is
the phrase "Add any desired artwork and graphics". Outside the third
box is the phrase "Manage your library of merge components". Outside
the fourth box is the phrase "and specify the variable merge fields".
Outside the fifth box is the phrase "Build the document interactively
with WYSIWYG composition". Outside the sixth box is the phrase "Use
CompuSet for high-volume and fully automated production". Outside the
seventh box is the phrase "Select and review any page of any document
on-demand with complete information in real time".
7. Location: Outside Back Cover Page of Prospectus.
Description: Document Sciences Corporation logo, described in
paragraph 1 above.
