<PAGE> 1
CONFORMED
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ x ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the Period Ended September 30, 1998.
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the Transition Period From ____________ to
___________.
Commission file number 0-20981
DOCUMENT SCIENCES CORPORATION
Delaware 33-0485994
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or of organization) Identification No.)
6333 Greenwich Drive, Suite 200
San Diego, CA 92122
------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(619) 625-2000
--------------
(Registrant's telephone number, including area code)
Not applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
periods that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes (X) No ( )
The number of shares of the issuer's Common Stock outstanding as of October 26,
1998, was 10,851,893.
<PAGE> 2
DOCUMENT SCIENCES CORPORATION
INDEX
<TABLE>
<CAPTION>
Page
No.
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated balance sheets--September 30, 1998 and December 31, 1997 ................ 3
Consolidated statements of income--three and nine months ended
September 30, 1998 and 1997 .......................................................... 4
Consolidated statements of cash flows--nine months ended September 30, 1998 and 1997 . 5
Notes to consolidated financial statements ........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations ........................................................................ 7
PART II. OTHER INFORMATION
Item 5. Other Information ............................................................ 13
Item 6. Exhibits and Reports on Form 8-K ............................................. 14
Signature ............................................................................ 14
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1-Financial Statements (Unaudited)
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
(Unaudited) (Note)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,894,013 $ 3,526,301
Short-term investments 16,540,512 18,228,527
Accounts receivable, net 4,603,260 5,602,062
Due from affiliates 1,697,484 1,718,406
Unbilled revenue from service contracts 357,790 288,932
Deferred income taxes 326,500 326,500
Other current assets 1,481,067 279,888
------------ ------------
Total current assets 27,900,626 29,970,616
Property and equipment, net 2,208,316 2,135,930
Goodwill, net 952,518 1,005,111
Computer software costs, net 1,611,540 1,117,319
------------ ------------
Total assets $ 32,673,000 $ 34,228,976
============ ============
LIABILITIES
Current liabilities:
Accounts payable $ 983,886 $ 673,657
Accrued compensation 800,092 787,511
Other accrued liabilities 261,033 348,559
Deferred revenue 5,945,254 3,812,365
Current income tax payable to affiliate -0- 387,443
Current portion of obligations under capital leases 51,545 65,108
------------ ------------
Total current liabilities 8,041,810 6,074,643
Obligations under capital leases 16,099 52,236
Deferred income taxes 411,500 411,500
Stockholders' equity
Common stock, $.001 par value;
Authorized shares -- 30,000,000
Issued and outstanding shares -- 10,850,579 at
September 30, 1998, and 10,803,369 at December 31, 1997 10,851 10,803
Deferred compensation (158,966) (241,469)
Treasury stock (734,766) (240,515)
Unrealized gain on short-term investments 164,369 69,506
Additional paid-in capital 25,407,940 25,398,897
Retained earnings (accumulated deficit) (485,837) 2,693,375
------------ ------------
Total stockholders' equity 24,203,591 27,690,597
------------ ------------
Total liabilities and stockholders' equity $ 32,673,000 $ 34,228,976
============ ============
</TABLE>
Note: The balance sheet at December 31, 1997 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. See notes to consolidated
financial statements.
3
<PAGE> 4
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Initial license fees $ 2,506,290 $ 1,599,055 $ 5,490,668 $ 5,288,435
Annual renewal license and support fees 1,452,139 1,307,589 4,324,680 3,274,509
Services and other 1,754,553 1,496,409 4,888,721 4,505,137
------------ ------------ ------------ ------------
Total revenues 5,712,982 4,403,053 14,704,069 13,068,081
Cost of revenues:
Initial license fees 599,536 139,231 1,079,142 577,646
Annual renewal license and support fees 198,253 247,437 592,354 528,687
Services and other 1,070,866 951,947 3,062,649 2,280,150
------------ ------------ ------------ ------------
Total cost of revenues 1,868,655 1,338,615 4,734,145 3,386,483
------------ ------------ ------------ ------------
Gross profit 3,844,327 3,064,438 9,969,924 9,681,598
Operating expenses:
Research and development 1,132,434 934,497 3,062,297 2,428,443
Selling, marketing and customer support 2,756,771 2,100,517 8,384,208 6,284,671
General and administrative 1,369,332 700,953 3,263,209 2,028,728
------------ ------------ ------------ ------------
Total operating expenses 5,258,537 3,735,967 14,709,714 10,741,842
------------ ------------ ------------ ------------
Loss from operations (1,414,210) (671,529) (4,739,790) (1,060,244)
Interest income, net 218,154 266,326 685,578 837,977
------------ ------------ ------------ ------------
Loss before income taxes (1,196,056) (405,203) (4,054,212) (222,267)
Benefit of income taxes (240,000) (152,100) (875,000) (231,000)
------------ ------------ ------------ ------------
Net income (loss) $ (956,056) $ (253,103) $ (3,179,212) $ 8,733
============ ============ ============ ============
Net income (loss) per share--basic $ (0.09) $ (0.02) $ (0.30) -0-
============ ============ ============ ============
Weighted average shares used in basic
calculation 10,637,041 10,737,982 10,715,536 10,746,944
============ ============ ============ ============
Net income (loss) per share--diluted $ (0.09) $ (0.02) $ (0.30) -0-
============ ============ ============ ============
Weighted average shares used in diluted
calculation 10,637,041 10,737,982 10,715,536 11,035,201
============ ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Nine Months
Ended Ended
September 30, September 30,
1998 1997
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ (3,179,212) $ 8,733
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 378,357 320,382
Amortization of goodwill 52,593 29,218
Amortization of computer software costs 149,434 70,454
Amortization of deferred compensation 82,503 82,503
Income taxes paid to affiliates (387,443) -0-
Provision for doubtful accounts 392,308 35,141
Changes in operating assets and liabilities:
Accounts receivable 606,494 (1,321,117)
Due from affiliates 20,922 751,195
Unbilled revenue from service contracts (68,858) -0-
Other current assets (1,201,179) (317,139)
Accounts payable 310,229 (36,871)
Accrued compensation 12,581 (268,309)
Other accrued liabilities (87,526) (419,930)
Deferred revenue 2,132,889 (520,472)
------------ ------------
Net cash used in operating activities (785,908) (1,586,212)
INVESTING ACTIVITIES
Purchases of short-term investments (12,269,863) (8,858,259)
Sales of short-term investments 11,197,878 8,539,624
Maturities of short-term investments 2,760,000 2,599,431
Purchases of property and equipment, net (450,743) (1,174,006)
Cash paid for acquired business -0- (507,000)
Unrealized gains on securities 94,863 96,199
Additions to computer software costs (643,655) (442,281)
------------ ------------
Net cash provided by investing activities 688,480 253,708
FINANCING ACTIVITIES
Principal payments under capital lease obligations (49,700) (44,989)
Purchase of treasury stock (494,251) (285,000)
Issuance of common stock 9,091 14,798
------------ ------------
Net cash used in financing activities (534,860) (315,191)
------------ ------------
Decrease in cash and cash equivalents (632,288) (1,647,695)
Cash and cash equivalents at beginning of period 3,526,301 2,465,694
------------ ------------
Cash and cash equivalents at end of period $ 2,894,013 $ 817,999
============ ============
Supplemental disclosure of cash flow information:
Interest paid $ 9,060 $ 13,965
============ ============
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998
Note A--Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. Certain amounts for 1997 have been reclassified to conform
with the 1998 presentation. The information included in this 10-Q should be read
in conjunction with the consolidated financial statements and notes thereto,
together with management's discussion and analysis included in the Company's
1997 Annual Report on Form 10-K. Operating results for the three and nine-month
periods ended September 30, 1998, are not necessarily indicative of the results
that may be expected for the year ending December 31, 1998.
The Company recognizes revenue in accordance with AICPA Statement of Position
(SOP) 97-2, Software Revenue Recognition. Initial license revenue is recognized
when a contract exists, the fee is fixed or determinable, software delivery has
occurred 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 fees are 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 services are recognized as the related
services are performed. However, when such consulting services are deemed to be
essential to the functionality of the delivered software product, revenue from
the entire arrangement is recognized in accordance with SOP 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts, and
Accounting Research Bulletin (ARB) No. 45, Long-Term Construction-Type
Contracts.
Note B--Transactions with Affiliates
Document Sciences Corporation (the "Company") has a strategic marketing alliance
with Xerox Corporation (Xerox) under which the parties have agreed to pay each
other fees on referrals that lead to the successful sale or licensing of
products. Included in services and other revenue in the accompanying condensed
consolidated statements of income are commissions earned from Xerox totaling
$56,800 and $130,800 for the three months ended September 30, 1998 and 1997,
respectively, and $211,600 and $544,200 for the nine months ended September 30,
1998 and 1997, respectively.
The Company has distribution agreements with affiliates which provide them with
the non-exclusive right to sub-license the Company's software in Canada,
Australia, New Zealand and Brazil. 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 $413,500 and
$263,500 for the three months ended September 30, 1998 and 1997, respectively,
and $1.4 million and $639,300 for the nine months ended September 30, 1998 and
1997, respectively. Related accounts receivable are $460,800 and $304,600 from
these revenues at September 30, 1998 and 1997, respectively.
The Company has distribution agreements with affiliates which provide them with
the non-exclusive right to sub-license the Company's software in Europe.
Revenues under these agreements totaled $765,600 and $447,700 for the three
months ended September 30, 1998 and 1997, respectively, and $1.9
6
<PAGE> 7
million and $1.4 million for the nine months ended September 30, 1998 and 1997,
respectively. Related accounts receivable are $717,100 and $461,100 at September
30, 1998 and 1997, respectively.
Note C--Net Income Per Share
The Company presents it's earnings per share information in accordance with FAS
No. 128, "Earnings per Share". Statement 128 replaced the previously reported
primary and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants, and convertible securities. Diluted
earnings per share, which includes the dilutive effects of options, warrants and
convertible securities, is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where necessary, restated to conform to the Statement 128
requirements.
The following table reconciles the shares used in computing basic and diluted
earnings per share for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------------- ----------------------------
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Weighted average common shares
outstanding used in basic earnings
per share calculation 10,637,041 10,737,982 10,715,536 10,746,944
Effect of dilutive stock options -0- -0- -0- 288,257
---------- ---------- ---------- ----------
Shares used in diluted earnings per
share 10,637,041 10,737,982 10,715,536 11,035,201
========== ========== ========== ==========
</TABLE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains certain trend analysis and other
forward-looking statements which involve risks and uncertainties. The Company's
actual results could differ materially from those anticipated in the
forward-looking statements as a result of various factors, including those set
forth in this discussion under "Certain Additional Business Risks" and other
risks detailed from time to time in the Company's SEC reports. In addition, the
discussion of the Company's results of operations should be read in conjunction
with the section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Company's Annual Report on Form 10-K
for the year ended December 31, 1997.
The Company has restated its numbers for the first two quarters of 1998 in
connection with a reevaluation of its revenue recognition in accordance with
AICPA Statement of Position on Software Revenue Recognition 97-2.
RESULTS OF OPERATIONS
The Company develops, markets and supports a family of document automation
software products and services used in high volume electronic publishing
applications. The Company was incorporated in Delaware in October 1991 as a
wholly-owned subsidiary of Xerox Corporation ("Xerox"), and Xerox currently owns
approximately 62% of the Company's outstanding shares of Common Stock.
7
<PAGE> 8
The following table sets forth the percentage of total revenues for certain
items in the Company's consolidated statements of income for the periods
indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Initial license fees 44% 36% 37% 41%
Annual renewal license and support fees 25 30 30 25
Services and other 31 34 33 34
---- ---- ---- ----
Total revenues 100% 100% 100% 100%
Cost of revenues:
Initial license fees 10% 3% 7% 5%
Annual renewal license and support fees 4 6 4 4
Services and other 19 21 21 17
---- ---- ---- ----
Total cost of revenues 33% 30% 32% 26%
---- ---- ---- ----
Gross profit 67% 70% 68% 74%
Operating expenses:
Research and development 19% 21% 21% 19%
Selling, marketing and customer support 48 48 57 48
General and administrative 24 16 22 15
---- ---- ---- ----
Total operating expenses 92% 85% 100% 82%
---- ---- ---- ----
Loss from operations (25)% (15)% (32)% (8)%
Interest income, net 4 6 5 6
---- ---- ---- ----
Loss before income taxes (21)% (9)% (27)% (2)%
Benefit of income taxes (4) (3) (6) (2)
---- ---- ---- ----
Net income (loss) (17)% (6)% (21)% 0%
==== ==== ==== ====
</TABLE>
REVENUES
Total revenues increased 29.8% to $5.7 million for the three months ended
September 30, 1998, from $4.4 million for the three months ended September 30,
1997 and increased 12.5% to $14.7 million for the nine months ended September
30, 1998, from $13.1 million for the nine months ended September 30, 1997.
Growth for the three-month period was due primarily to an increase in initial
license fees reflecting increased sales activity. Growth for the nine-month
period was due mainly to increased annual license fees as a result of the
increased installed base.
Sales Channels. 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. Revenues from export sales and sales through the Company's foreign
subsidiary increased 42.6% to $1.6 million for the three months ended September
30, 1998, from $1.1 million for the three months ended September 30, 1997 and
increased 27.5% to $4.7 million for the nine months ended September 30, 1998,
from $3.7 million for the nine months ended September 30, 1997. This growth was
principally due to a more established and experienced VAR channel in Europe.
Revenues from export sales were 28% and 26% of total revenues for the three
months ended September 30, 1998 and 1997, respectively, and 32% and 28% of total
revenues for the nine months ended September 30, 1998 and 1997, respectively.
The Company has entered into distributorship agreements with various Xerox
foreign affiliates to remarket 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 increased 65.8% to
$1.2 million for the three months ended September 30, 1998, from $711,200 for
the three months ended September 30, 1997 and increased 57.3% to $3.3 million
for the nine months ended September 30,
8
<PAGE> 9
1998, from $2.1 million for the nine months ended September 30, 1997. These
increases are due principally to increased sales through Xerox Canada Ltd. and
revenues from European Xerox affiliates.
Initial license fees. Initial license fee revenues increased 56.7% to $2.5
million for the three months ended September 30, 1998, from $1.6 million for the
three months ended September 30, 1997 and increased 3.8% to $5.5 million for the
nine months ended September 30, 1998, from $5.3 million for the nine months
ended September 30, 1997. These increases were mainly due to increased sales in
the United States and Canada and a realization of revenues due to the Company's
previous expansion into indirect distribution channels.
Annual renewal license and support fees. Revenues from annual renewal license
and support fees increased 11.1% to $1.5 million for the three months ended
September 30, 1998, from $1.3 million for the three months ended September 30,
1997 and increased 32.1% to $4.3 million for the nine months ended September 30,
1998, from $3.3 million for the nine months ended September 30, 1997. The
nine-month increase was due principally to the acquisition of Data Retrieval's
installed base of users.
Services and other. Revenues from services and other increased 17.3% to $1.8
million for the three months ended September 30, 1998, from $1.5 million for the
three months ended September 30, 1997, and increased 8.5% to $4.9 million for
the nine months ended September 30, 1998, from $4.5 million for the nine months
ended September 30, 1997. The increase for the nine month period ended September
30, 1998 when compared to the same period in 1997 was due to consulting services
representing a larger component of new customer orders.
Cost of Revenues
Total cost of revenues increased 39.6% to $1.9 million for the three months
ended September 30, 1998, from $1.3 million for the three months ended September
30, 1997, and increased 39.8% to $4.7 million for the nine months ended
September 30, 1998, from $3.4 million for the nine months ended September 30,
1997. The increase in cost of revenues resulted primarily from increased royalty
fees and the costs associated with professional consulting services.
Operating Expenses
Research and development. The Company capitalized $97,900 and $231,800 of
software costs for the three month periods ended September 30, 1998 and 1997,
respectively, and $643,700 and $442,300 for the nine months ended September 30,
1998 and 1997, respectively. Because the Company believes its current process
for developing software is essentially completed concurrently with the
establishment of technological feasibility, the Company anticipates little, if
any, capitalization to occur in the near future. Research and development
expenses increased 21.2% to $1.1 million for the three months ended September
30, 1998, from $934,500 for the three months ended September 30, 1997 and
increased 26.1% to $3.1 million for the nine months ended September 30, 1998,
from $2.4 million for the nine months ended September 30, 1997. The increase in
these expenses resulted principally from the concentration of effort in software
maintenance costs and from the expansion of engineering staff related costs.
Selling, marketing and customer support. Selling, marketing and customer support
expenses increased 31.2% to $2.8 million for the three months ended September
30, 1998, from $2.1 million for the three months ended September 30, 1997 and
increased 33.4% to $8.4 million for the nine months ended September 30, 1998,
from $6.3 million for the nine months ended September 30, 1997. The growth of
these expenses was due principally to increased customer support and marketing
personnel and commissions and related costs associated with increased revenues.
General and administrative. General and administrative expenses increased 95.4%
to $1.4 million for the three months ended September 30, 1998, from $701,000 for
the three months ended September 30, 1997
9
<PAGE> 10
and increased 60.9% to $3.3 million for the nine months ended September 30,
1998, from $2.0 million for the nine months ended September 30, 1997. The
three-month increase was primarily the result of increased provisions for bad
debts and services of outside consultants. The nine-month increase was due to a
one-time charge of $459,000 for severance and recruiting costs, as well as
increased provisions for bad debts and services of outside consultants.
Benefit of income taxes. For the nine months ended September 30, 1998, the
Company has recognized a tax benefit as a result of the net operating loss and
non-taxable municipal bond interest.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents and short-term investments totaled $19.4
million at September 30, 1998, representing 60.2% of total assets. The Company
intends to continue to invest in short-term, interest-bearing, investment grade
securities.
The Company believes that its existing cash balances and anticipated cash flows
from operations will be sufficient to meet its anticipated cash needs for
working capital and capital expenditures for at least the next twelve months.
The Company has no significant capital spending or purchase commitments other
than normal purchase commitments and commitments under facilities and capital
leases for the remainder of the year.
CERTAIN ADDITIONAL BUSINESS RISKS
The Company's business, financial condition and operating results may be
impacted by a number of factors, including but not limited to those set forth
below, any one of which could cause the Company's actual results to vary
materially from recent results.
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. 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 relatively high
revenue 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.
Initial license fee revenue is dependent on when orders are received and
shipped. However, because of the Company's sales model, the customer's
implementation schedule and the complexity of the implementation process,
revenue from some software shipments may not be realized in the same quarter as
the shipment occurs. The Company's operating expenses are primarily based on
anticipated revenue levels. Since a high percentage of those expenses are fixed,
a delay in the recognition of revenue from license transactions could cause
significant variations in operating results from quarter to quarter and
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<PAGE> 11
may result in losses. To the extent such expenses precede increased revenues,
the Company's operating results would be materially adversely affected.
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.
Control by Xerox. Xerox owns approximately 62% of the outstanding shares of
Common Stock of the Company. Consequently, Xerox controls the Company, is able
to elect the entire Board of Directors of the Company and could have significant
input into the Company's operations. In addition, Xerox is 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.
Reliance on Relationships with Xerox; Development of Independent Sales and
Marketing Channels. The Company currently has a variety of contractual and
informal relationships with Xerox and affiliates of Xerox, including a
Cooperative Marketing 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. For the first nine
months of 1998, total revenues derived from relationships with Xerox and
affiliates of Xerox accounted for approximately $3.9 million, representing 26.5%
of the Company's total revenues. Further, the commissions received by the
Company from sales of Xerox printers under the strategic marketing alliance,
which were $211,600 for the first nine months of 1998, 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. 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. Though the Company 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 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.
Expansion of Sales and Distribution Channels. The Company has 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 is attempting to increase the
number of these strategic relationships as well as form alliances with system
integrators and consultants. Whether the Company
11
<PAGE> 12
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. There can be no assurance that
the Company will be able to maintain 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.
Dependence on Success of New Products and Utilization of Professional Services.
The Company's Autograph family of products 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.
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 development of Visual CompuSet and Data Prep
Tool and plans to devote a significant amount of future resources to developing
industry specific applications.
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.
International Operations. Revenues from export sales, including sales through
its foreign subsidiary accounted for 29% of the Company's total revenues for the
nine month period ending September 30, 1998. 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 (VARs) and to a lesser extent, direct sales. The VARs are
principally Xerox affiliates who re-market the Company's products. In Australia,
Canada and Brazil the Company distributes its products through Fuji Xerox Co.,
Ltd., Xerox Canada, Ltd., and Xerox Brazil, Ltd., respectively. Revenues
generated by these Xerox affiliates were $1.4 million for the nine-month period
ending September 30, 1998. In order to successfully expand export sales, the
Company must establish 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
12
<PAGE> 13
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.
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 Visual CompuSet and Data Prep Tool
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. 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.
Year 2000 Compliance. The Company is continuing to assess the potential impact
of Year 2000 software and operational compliance issues on its business and the
related expenses of remedying such impact. The Company is utilizing internal
resources to identify, modify or reprogram, and perform extensive testing on its
systems, in connection with the Year 2000 issue. The Company expects to have all
necessary changes implemented by 2000. The cost of the Year 2000 initiatives is
not expected to be material to the Company's results of operations or financial
position.
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
The Securities and Exchange Commission has recently amended Rule 14a-4(c)(1)
promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). As amended, Rule 14a-4(c)(1) provides that where a stockholder proponent
chooses not to use the procedures set forth in Rule 14a-8 under the Exchange Act
for placing such stockholder's proposal in a company's proxy materials, a proxy
may confer discretionary authority to vote on a matter presented at an annual
meeting of stockholders if the proponent fails to notify the company at least 45
days prior to the anniversary date of mailing of the prior year's proxy
statement. A statement conferring such discretionary authority must be made in
the proxy statement or proxy for such annual meeting. The proxy statement for
the Company's 1998 Annual Meeting of Stockholders was mailed to stockholders on
April 17, 1998. Accordingly, if a proponent does not notify the Company on or
before March 3, 1999 of a proposal to be presented at the 1999
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<PAGE> 14
Annual Meeting of Stockholders, the Company may use its discretionary voting
authority to vote on such proposal when and if presented at the 1999 Annual
Meeting of Stockholders.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended September 30, 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Document Sciences Corporation
(Registrant)
Date: October 26, 1998 /S/ John H. Wilson
- ----------------------- ----------------------------------------
John H. Wilson
Interim Chief Financial Officer
(Duly Authorized and Principal Financial
Officer)
14
<PAGE> 15
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
15
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,894,013
<SECURITIES> 16,540,512
<RECEIVABLES> 6,911,330
<ALLOWANCES> 610,586
<INVENTORY> 0
<CURRENT-ASSETS> 27,900,626
<PP&E> 3,546,625
<DEPRECIATION> 1,338,309
<TOTAL-ASSETS> 32,673,000
<CURRENT-LIABILITIES> 8,041,810
<BONDS> 0
0
0
<COMMON> 10,851
<OTHER-SE> 24,203,591
<TOTAL-LIABILITY-AND-EQUITY> 32,673,000
<SALES> 9,815,348
<TOTAL-REVENUES> 14,704,069
<CGS> 1,671,496
<TOTAL-COSTS> 4,734,145
<OTHER-EXPENSES> 14,709,714
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13,965
<INCOME-PRETAX> (4,054,212)
<INCOME-TAX> (875,000)
<INCOME-CONTINUING> (3,179,212)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,179,212)
<EPS-PRIMARY> (0.30)
<EPS-DILUTED> (0.30)
</TABLE>
