<PAGE>
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 quarterly period ended April 30, 1999
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transitional period from ___________ to ___________
Commission File Number: 00-1033864
DocuCorp International, Inc.
------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 75-2690838
- ------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification number)
5910 North Central Expressway, Suite 800, Dallas, Texas 75206
-----------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(214) 891-6500
---------------------------------------------------------
(Registrant's telephone number including area code)
--------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) 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 period 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 _____
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: Common Stock,
$.01 par value, 15,811,131 shares as of April 30, 1999.
<PAGE>
DOCUCORP INTERNATIONAL, INC.
TABLE OF CONTENTS
FORM 10-Q
April 30, 1999
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of April 30, 1999 and July 31, 1998 2
Interim Consolidated Statements of Operations for the three and nine
months ended April 30, 1999 and 1998 3
Interim Consolidated Statements of Cash Flows for the nine months
ended April 30, 1999 and 1998 4
Notes to Interim Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 7
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
</TABLE>
<PAGE>
DOCUCORP INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
April 30, July 31,
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 7,966,024 $ 14,439,807
Short-term investments 5,720,186 0
Accounts receivable, net of allowance
of $700,000 and $950,000, respectively 13,907,522 11,926,007
Other current assets 2,999,267 2,419,819
------------ ------------
Total current assets 30,592,999 28,785,633
Fixed assets, net of accumulated depreciation
of $4,242,290 and $3,257,705, respectively 3,442,096 2,979,648
Software, net of accumulated amortization of $8,498,056
and $7,047,098, respectively 7,858,685 8,136,574
Goodwill, net of accumulated amortization of $2,143,580 and
$1,126,924, respectively 10,028,337 11,021,993
Other assets 867,226 996,653
------------ ------------
$52,789,343 $51,920,501
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,632,951 $ 1,750,098
Accrued liabilities 3,393,500 2,284,525
Deferred revenue 8,880,629 8,476,022
Other current liabilities 409,836 287,018
------------ ------------
Total current liabilities 14,316,916 12,797,663
Other long-term liabilities 639,404 690,058
Stockholders' equity:
Common stock, 50,000,000 shares authorized at
$.01 par value, 16,593,849 and 16,525,561
shares issued, respectively 165,938 165,256
Additional paid-in capital 47,942,926 47,561,714
Treasury stock, 782,718 shares at cost (3,604,142) 0
Retained deficit (6,610,024) (9,228,765)
Notes receivable from stockholders (61,675) (65,425)
------------ ------------
Total stockholders' equity 37,833,023 38,432,780
------------ ------------
$52,789,343 $51,920,501
------------ ------------
------------ ------------
</TABLE>
SEE ACCOMPANYING NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
2
<PAGE>
DOCUCORP INTERNATIONAL, INC.
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
April 30, April 30,
--------------------------- --------------------------
1999 1998 1999 1998
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
REVENUES
Professional services $ 6,949,925 $ 6,010,710 $20,205,847 $18,995,851
License 2,907,656 2,515,007 8,454,467 6,335,350
Maintenance and other recurring 3,367,573 2,779,624 9,787,033 8,023,889
------------ ------------ ----------- -----------
Total revenues 13,225,154 11,305,341 38,447,347 33,355,090
------------ ------------ ----------- -----------
EXPENSES
Professional services 5,491,508 4,505,573 15,290,762 14,287,790
Product development and support 2,432,205 2,370,249 7,148,820 6,363,158
Selling, general and administrative 3,400,004 2,997,211 10,660,688 8,528,945
------------ ------------ ----------- -----------
Total expenses 11,323,717 9,873,033 33,100,270 29,179,893
------------ ------------ ----------- -----------
Operating income 1,901,437 1,432,308 5,347,077 4,175,197
Other income (expense), net 128,949 (58,196) 471,511 (339,977)
------------ ------------ ----------- -----------
Income before income taxes 2,030,386 1,374,112 5,818,588 3,835,220
Provision for income taxes 860,000 563,000 2,508,000 1,537,000
------------ ------------ ----------- -----------
Net income $ 1,170,386 $ 811,112 $ 3,310,588 $ 2,298,220
------------ ------------ ----------- -----------
Net income per share:
Basic $ 0.07 $ 0.07 $ 0.21 $ 0.20
------------ ------------ ----------- -----------
------------ ------------ ----------- -----------
Diluted $ 0.07 $ 0.05 $ 0.19 $ 0.17
------------ ------------ ----------- -----------
------------ ------------ ----------- -----------
Weighted average shares outstanding used
in the net income per share calculations:
Basic 15,896,133 12,382,391 16,140,712 11,308,949
------------ ------------ ----------- -----------
------------ ------------ ----------- -----------
Diluted 17,576,715 15,022,752 17,738,729 13,629,052
------------ ------------ ----------- -----------
------------ ------------ ----------- -----------
</TABLE>
SEE ACCOMPANYING NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
DOCUCORP INTERNATIONAL, INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended
April 30,
-----------------------------
1999 1998
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,310,588 $ 2,298,220
Adjustments to reconcile net income to
net cash provided by operating activities:
Stock option compensation expense 9,286 15,698
Depreciation 984,585 1,142,098
Amortization of capitalized software 1,450,958 1,324,292
Amortization of goodwill 1,016,656 623,071
Decrease in goodwill due to release of valuation allowance 0 272,000
Increase (decrease) in allowance for doubtful accounts (250,000) 503,806
Changes in assets and liabilities:
Increase in accounts receivable (1,731,515) (1,727,832)
Increase in other assets (450,021) (188,800)
Increase (decrease) in accounts payable (140,147) 326,440
Increase in accrued liabilities 1,108,975 1,888,919
Increase in deferred revenue 404,607 1,088,579
Increase (decrease) in other liabilities 129,939 (268,936)
-------------- --------------
Total adjustments 2,533,323 4,999,335
-------------- --------------
Net cash provided by operating activities 5,843,911 7,297,555
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of short-term investments, net of maturities (5,720,186) 0
Purchase of fixed assets (1,447,033) (747,647)
Capitalized software development costs (1,173,069) (1,069,197)
Net cash acquired in business combinations 0 101,657
-------------- --------------
Net cash used in investing activities (8,340,288) (1,715,187)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of debt 0 (11,877,132)
Principal payments under capital lease obligations (57,775) (323,936)
Net proceeds from issuance of stock 0 18,572,565
Proceeds from exercise of stock options 558,000 763,626
Proceeds from repayment of note receivable from stockholders 3,750 5,750
Purchase of treasury stock (4,834,429) 0
Tax benefit related to stock option exercises 162,812 0
Proceeds from stock issued under Employee Stock Purchase Plan 190,236 0
-------------- --------------
Net cash provided by (used in) financing activities (3,977,406) 7,140,873
-------------- --------------
Net increase (decrease) in cash and cash equivalents (6,473,783) 12,723,241
Cash and cash equivalents at beginning of period 14,439,807 2,869,458
-------------- --------------
Cash and cash equivalents at end of period $ 7,966,024 $ 15,592,699
-------------- --------------
-------------- --------------
</TABLE>
SEE ACCOMPANYING NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
DOCUCORP INTERNATIONAL, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements include
the accounts of DocuCorp International, Inc. and its subsidiaries
(collectively, the "Company"). The Company was formed in connection with the
acquisition of FormMaker Software, Inc. ("FormMaker") by Image Sciences, Inc.
("Image Sciences") (the "Merger"). Consolidated results of FormMaker and its
subsidiary are included from the effective date of the Merger, May 15, 1997.
The financial information presented should be read in conjunction with the
Company's annual consolidated financial statements for the year ended July
31, 1998. The foregoing unaudited interim consolidated financial statements
reflect all adjustments (all of which are of a normal recurring nature) which
are, in the opinion of management, necessary for a fair presentation of the
results of the interim periods. The results for interim periods are not
necessarily indicative of results to be expected for the year.
NOTE 2 - NET INCOME PER SHARE
The Company's basic and diluted net income per share are computed in
accordance with Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128"). Concurrent with the completion of the
Company's initial public offering in April 1998, all outstanding shares of
Class B common stock were converted into shares of Common Stock on a
one-for-one basis. Both basic and diluted net income per share have been
computed assuming the conversion of Class B common stock occurred as of the
date of original issuance. Due to the adoption of SFAS 128 and the
conversion feature of Class B common stock into Common Stock, which
conversion occurred on April 9, 1998, the historical basic and diluted
calculations include the effect of conversion of Class B common stock as of
the date of original issuance, which were previously reported in pro forma
computations prior to conversion.
Basic net income per share is computed using the weighted average number of
common shares outstanding. Diluted net income per share is computed using
the weighted average number of common shares outstanding and the assumed
exercise of dilutive stock options and warrants (using the treasury stock
method). Following is a reconciliation of the shares used in computing basic
and diluted net income per share for the periods indicated:
<TABLE>
<CAPTION>
Three months ended Nine months ended
April 30, April 30,
----------------------------- -----------------------------
1999 1998 1999 1998
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Shares used in computing basic net income per
share 15,896,133 12,382,391 16,140,712 11,308,949
Dilutive effect of stock options and warrants 1,680,582 2,640,361 1,598,017 2,320,103
---------- ---------- ---------- ----------
Shares used in computing diluted net income
per share 17,576,715 15,022,752 17,738,729 13,629,052
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
5
<PAGE>
DOCUCORP INTERNATIONAL, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont.)
(UNAUDITED)
Options to purchase 42,853 shares of Common Stock at a weighted average
exercise price of $7.54 per option and expiration dates ranging from
2000-2006 at April 30, 1999 were anti-dilutive and not included in the
computation of diluted net income per share because the options' exercise
price was greater than the average market price of the Common Stock for the
period.
NOTE 3 - ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with a review conducted by the Securities and Exchange
Commission ("SEC") related to the Company's filing of its Annual Report on
Form 10-K for the year ended July 31, 1998, the Company is currently in
discussions with the SEC regarding the value ascribed to the technology
acquired as in-process research and development ("in-process R&D") in the May
1997 Merger. In connection with the Merger, the Company recorded in-process
R&D charges in the amount of $13.5 million in the fourth quarter of fiscal
1997. The Company understands that the SEC is engaged in similar discussions
with other companies, and is examining the basis for valuing in-process R&D
charges versus the SEC's recent guidance on the preferred calculation of
these charges. The Company is consulting with its independent accountants
and independent appraisers. The Company believes that the purchase price
allocations and related amortization charges stemming from the acquisition
were determined in accordance with generally accepted accounting principles.
Depending upon the outcome of the discussions with the SEC, the Company's
historical reported results could potentially be subject to restatement to
reflect a reduction of the in-process R&D charge. A reduction of the
in-process R&D charge would result in a corresponding increase in the amount
of goodwill, which is being amortized over a ten year period.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CERTAIN INFORMATION CONTAINED HEREIN MAY INCLUDE "FORWARD-LOOKING STATEMENTS"
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED,
AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. ALL
STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS INCLUDED IN THIS FORM
10-Q, ARE FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS ARE SUBJECT TO CERTAIN
RISKS AND UNCERTAINTIES, WHICH INCLUDE, BUT ARE NOT LIMITED TO, TECHNOLOGICAL
ADVANCES, DEPENDENCE UPON THE INSURANCE AND UTILITIES INDUSTRIES, INTEGRATION
OF OPERATING SUBSIDIARIES, FLUCTUATIONS IN OPERATING RESULTS, AND THE OTHER
RISK FACTORS AND CAUTIONARY STATEMENTS LISTED FROM TIME TO TIME IN THE
COMPANY'S PERIODIC REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS FORM 10-Q AND ALL SUBSEQUENT
ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS ACTING
ON ITS BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THESE CAUTIONARY
STATEMENTS.
OVERVIEW
DocuCorp develops, markets, and supports a portfolio of open-architecture,
enterprise-wide, document automation software products that enable its
customers to create, publish, manage, and archive complex, high-volume,
individualized documents. In addition, the Company provides document
automation consulting, application integration, and document processing,
printing, Internet, and mailing services through a 200-person service
organization. Document processing and printing services utilize the Company's
software to provide solutions for handling high-volume, complex print,
finish, and mailing for customers who outsource this activity.
DocuCorp was formed in connection with the acquisition of FormMaker Software,
Inc. ("FormMaker") by Image Sciences, Inc. ("Image Sciences") (the "Merger").
The Merger was treated as an acquisition of FormMaker by Image Sciences, and
accordingly, the Merger transaction was recorded under the purchase method of
accounting. The accompanying unaudited interim consolidated financial
statements include the accounts of the Company and its subsidiaries.
Consolidated results of FormMaker and its subsidiary are included from the
effective date of the Merger, May 15, 1997.
In March 1998, the Company acquired all of the capital stock of EZPower
Systems, Inc. ("EZPower") and Maitland Software, Inc. ("Maitland"). EZPower
develops, markets, and supports document management software products.
Maitland has developed a data acquisition and transformation program which
allows users the ability to more easily interface existing applications and
databases with document printing and publishing software. Both of these
acquisitions were recorded under the purchase method of accounting, and
accordingly, the results of operations of EZPower and Maitland for all
periods subsequent to the acquisition date are included in the accompanying
unaudited interim consolidated financial statements.
The Company derives its revenues from license fees, recurring maintenance
fees, and professional services fees related to its software products.
License revenues are generally derived from perpetual and term licenses of
software products. Maintenance and other recurring revenues consist primarily
of recurring license fees and annual maintenance contracts. Professional
services revenues include fees for consulting, implementation, print
outsourcing, and education services.
7
<PAGE>
HISTORICAL OPERATING RESULTS OF THE COMPANY
The following table sets forth selected unaudited interim consolidated
statements of operations data of the Company expressed as a percentage of
total revenues for the periods indicated:
<TABLE>
<CAPTION>
Three months ended Nine months ended
April 30, April 30,
------------------- -------------------
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues
Professional services 53% 53% 53% 57%
License 22 22 22 19
Maintenance and other recurring 25 25 25 24
---- ---- ---- ----
Total revenues 100 100 100 100
---- ---- ---- ----
Expenses
Professional services 42 40 40 43
Product development and support 18 21 18 19
Selling, general and administrative 26 26 28 26
---- ---- ---- ----
Total expenses 86 87 86 88
---- ---- ---- ----
Operating income 14 13 14 12
Other income (expense), net 1 (1) 1 (1)
---- ---- ---- ----
Income before income taxes 15 12 15 11
Provision for income taxes 6 5 6 4
---- ---- ---- ----
Net income 9% 7% 9% 7%
---- ---- ---- ----
---- ---- ---- ----
</TABLE>
THREE AND NINE MONTHS ENDED APRIL 30, 1999 COMPARED TO THREE AND NINE MONTHS
ENDED APRIL 30, 1998
REVENUES
Total revenues increased 17% and 15% for the three and nine months ended
April 30, 1999, respectively, from the comparable prior year period.
Additional software licenses in the insurance market were largely responsible
for the 16% and 33% increase in license revenues for the three and nine
months ended April 30, 1999, respectively. Maintenance revenues increased 21%
and 22% for the three and nine months ended April 30, 1999, respectively, due
to an expanding customer base and reinstatement of several previously expired
maintenance contracts. For the three and nine months ended April 30, 1999,
professional services revenues increased 16% and 6%, respectively, due to
increased services revenues in the insurance and utilities markets. Print
outsourcing revenue increased for the three months ended April 30, 1999 due
to additional business in the utilities industry; however, the nine months
ended April 30, 1999 experienced a decrease. The Company anticipated a
decrease in print outsourcing revenue for the nine months ended April 30,
1999 resulting from the termination of the Policy Management Systems
Corporation ("PMSC") print outsourcing relationship in May 1998.
Backlog for the Company's products and services of approximately $34.1
million as of April 30, 1999, of which approximately $19.1 million is
scheduled to be satisfied within one year, is primarily comprised of
recurring software license and maintenance revenues for ongoing maintenance
and support, software implementation and consulting services, and print
outsourcing services. Software agreements for recurring license fees
generally have non-cancelable terms of up to five years. Annual maintenance
contracts may generally be terminated upon 30 days notice; however, the
Company has not historically experienced material cancellations of such
contracts. Software implementation and consulting services backlog is
8
<PAGE>
principally performed under time and material agreements, of which some have
cancellation provisions. Print outsourcing services agreements generally
provide that fees are charged on a per transaction basis. The estimated
future revenues with respect to software implementation and print outsourcing
services are based on management's estimate of revenues over the remaining
life of the respective contracts.
FormMaker, which was acquired by the Company in connection with the Merger,
historically distributed its line of Document Automation Platform ("DAP")
software products to the insurance industry in North America through an
exclusive marketing agreement with PMSC. Revenues from PMSC under this
agreement for the three and nine months ended April 30, 1998 were
approximately $1.6 million and $4.8 million, respectively. In September 1998,
both parties agreed to terminate the marketing agreement and enter into a new
non-exclusive marketing agreement. The new marketing agreement between
DocuCorp and PMSC allows PMSC to market all of the Company's software
products to insurance and financial services companies worldwide. For the
three and nine months ended April 30, 1999, the Company generated revenue of
approximately $900,000 and $2.6 million, respectively, through the PMSC
relationship.
In addition, PMSC terminated its print outsourcing agreement effective May
1998. Revenues from PMSC under this agreement for the three and nine months
ended April 30, 1998 were approximately $1.0 million and $4.0 million,
respectively. Print outsourcing revenues have declined from fiscal year 1998
levels while the Company replaces this business with new business.
PROFESSIONAL SERVICES EXPENSE
Professional services expense is composed primarily of personnel expenses
related to both consulting and print outsourcing services. Professional
services expense increased 22% and 7% for the three and nine months ended
April 30, 1999, respectively. For the three months ended April 30, 1999,
recruiting and staffing expenses increased due to significant additional
headcount required to meet business needs. For the nine months ended April
30, 1999, the increase is mainly due to increased personnel costs as the
professional services department expanded, offset by a decrease in postage
and supplies expense related to the decrease in print outsourcing revenues
for this period. The Company's international services expansion has also
increased costs for the current fiscal year. For the three months ended April
30, 1999 and 1998, professional services expense represented 79% and 75% of
professional services revenues, respectively. For the nine months ended April
30, 1999 and 1998, professional services expense represented 76% and 75% of
professional services revenues, respectively. The Company expects
professional services expenses to increase in order to meet additional
resource requirements as professional services activities increase
domestically and internationally.
PRODUCT DEVELOPMENT AND SUPPORT EXPENSE
Product development and support expense consists primarily of research and
development efforts, amortization of capitalized software development costs,
customer support, and other product support costs. For the three and nine
months ended April 30, 1999, product development and support expense
increased 3% and 12%, respectively. The majority of the increase is related
to additional personnel expenses arising from the acquisitions of EZPower and
Maitland in March 1998, as well as additional headcount for continued
development and support efforts of the Company's products. The Company
anticipates continued acceleration of development efforts, including Internet
applications, integration of its newly acquired document management and
workflow solutions with its existing offerings, further development of
systems for use in industries such as utilities and financial services,
development of new software products utilizing object-oriented technology,
and continued support of its existing product lines. Expenditures in this
area are expected to increase in relation to the anticipated growth in
revenues.
9
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense increased 13% and 25% for the
three and nine months ended April 30, 1999, respectively. This increase is
mainly due to increased incentive compensation as a result of higher
revenues, additional personnel expenses as the departments expand to meet the
Company's needs, and professional fees associated with accounting related
costs. In addition, goodwill amortization increased as a result of the
acquisitions of EZPower and Maitland in March 1998.
OTHER INCOME (EXPENSE), NET
The significant increase in other income (expense), net is due to a material
amount of interest income generated in the three and nine months ended April
30, 1999 compared with interest expense incurred in the comparable periods of
the prior year. As a result of the receipt of approximately $18.5 million of
Initial Public Offering ("IPO") proceeds in April 1998, interest income
increased as compared to corresponding periods of fiscal 1998 due to
significant cash, cash equivalent, and short-term investment balances
maintained by the Company. The Company repaid the Company's debt in April
1998 with proceeds from the IPO leaving minimal interest expense which is
related to capital lease obligations.
PROVISION FOR INCOME TAXES
The effective tax rate for the three months ended April 30, 1999 and 1998 was
approximately 42% and 41%, respectively, and 43% and 40% for the nine months
ended April 30, 1999 and 1998, respectively. Goodwill amortization related to
the acquisitions of EZPower and Maitland is non-deductible, which increased
the effective tax rate for the fiscal 1999 periods. The majority of goodwill
amortization related to the Merger is also non-deductible. The Company used a
portion of its net operating loss carryforwards and outstanding tax credits
to offset its current tax liability for the three and nine months ended April
30, 1999 and 1998.
NET INCOME
Net income increased 44% for both the three and nine months ended April 30,
1999. The increase in net income for these periods is due to increased
revenue and increased interest income, partially offset by additional
expenses required to meet the revenue levels.
YEAR 2000
The Year 2000 computer issue is primarily the result of Information
Technology ("IT") or non-IT systems and programs with date sensitive devices,
such as embedded chips or code using a two digit format, as opposed to four
digits, to indicate the year. Such systems and programs may be unable to
correctly interpret dates beyond the year 1999, which could cause a system
failure or other errors, with the resultant disruption in the operation of
such systems. The Company has assembled an internally staffed team to address
and manage the Year 2000 project related to the Company's products and
services offerings, as well as any IT and non-IT internal systems supporting
the Company's operations.
With respect to the Company's product line and services offerings, current
versions of the Company's products are designed to be "Year 2000" compliant.
The Company is currently in the process of testing and upgrading, if
necessary, its product offerings. Customers using pre-Year 2000 compliant
versions of the Company's software products are entitled to receive upgraded
Year 2000 compliant software as part of their software support agreements
with the Company, as long as the customer support agreement remains in force.
The Company is currently in the process of assessing the extent to which its
services implementations are Year 2000 compliant. To the extent the Company
is directly involved in resolving any non-compliant services implementations,
generally the customer will be responsible for the fees associated with such
services. Accordingly, the Company does not currently believe that the
effects of any Year 2000 non-compliance in the Company's installed base of
products or services offerings will result in a material adverse impact on
the Company's business or financial condition.
10
<PAGE>
With respect to the Company's internal IT and non-IT software systems and
hardware, the Company has identified non-compliant hardware and software
systems. The Company is in the process of implementing action plans for the
remediation of high risk areas and is scheduled to implement remediation
plans for medium to low risk areas during the remainder of fiscal 1999. The
Company believes there is not a significant exposure to the Company related
to non-compliant internal IT and non-IT software systems and hardware and
that the majority of identified non-compliant systems are planned to be
upgraded as part of its normal upgrade process in calendar year 1999. To
date, the Company has not incurred any material expense directly related to
Year 2000 compliance for its internal IT and non-IT computer systems.
Although the Company is undertaking efforts to ensure that all its systems
and programs are Year 2000 compliant, the Company has no control over
services, functions, and data provided by third-party vendors and others
which may result in the inability to provide services. The Company has
contacted and is working with its material customers and vendors to verify
their Year 2000 compliance. The Company has no control over third-parties as
to whether or not they will be Year 2000 compliant. Further, the Company is
unable to predict the impact, if any, on the Company's revenues as a result
of its customers being distracted from their document automation needs as
their attention is re-directed, or customer resources are diverted, to
becoming Year 2000 compliant. The extent to which third-party customers and
vendors do not become Year 2000 compliant on a timely basis or may be
indirectly impacted by the Year 2000 issue may have a material adverse effect
on the Company. The Company is currently developing contingency plans and
determining the extent of such plans.
No assurance can be given that the Company will not be exposed to potential
claims resulting from system problems associated with the century change.
However, the Company believes its Year 2000 compliance project will be
substantially completed by calendar year end and will not have a material
adverse effect on the Company.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT AND RELATED COSTS
Based on the results of an independent third-party appraisal, the Company
recorded charges of $13.5 million in the fourth quarter of fiscal 1997 to
expense in-process research and development ("in-process R&D") costs related
to the acquisition of FormMaker. The aggregate purchase price related to the
Merger, including direct acquisition costs, was $20.4 million which was
allocated to the fair value of the net identifiable assets acquired,
including in-process R&D. Acquired in-process R&D represents the present
value of the estimated cash flows expected to be generated by FormMaker
in-process R&D. The allocation of $13.5 million to in-process R&D
represented the estimated fair value based on risk-adjusted cash flows
related to the in-process R&D projects. In the opinion of management and
independent third-party appraisers, the development of these projects had not
yet reached technological feasibility and therefore, the in-process R&D had
no alternative future uses. Accordingly, these costs were charged to
operations on the closing date of the Merger.
The value assigned to purchased in-process R&D was determined by estimating
the costs to develop the purchased in-process R&D into commercially viable
products, estimating the resulting net cash flows from the projects, and
discounting the net cash flows to their present value. The revenue projection
used to value the in-process R&D was based on estimates of relevant market
sizes and growth factors, expected trends in technology, and the nature and
expected timing of new product introductions by FormMaker and its competitors.
The estimated revenues for the in-process R&D assumed a compound annual
growth rate of approximately 30% in the four years following introduction,
assuming the successful completion and market acceptance of the major R&D
programs. For each of the acquired in-process R&D efforts, the estimated
revenues for the in-process projects were expected to peak within three to
four years of acquisition and then decline as other new products and
technologies are expected to enter the market.
11
<PAGE>
The rates utilized to discount the net cash flows to their present value were
based on cost of capital calculations. Due to the nature of the forecast and
the risks associated with the projected growth and profitability associated
with FormMaker's in-process R&D, a discount rate of 27% was used to value
in-process R&D, and a discount rate of 20% was used for the existing products
and technology. This discount rate was commensurate with the acquired
in-process R&D projects' stages of development and the uncertainties in the
economic estimates described above. As of the date of the Merger, FormMaker
had spent approximately $1.3 million on in-process R&D projects. Subsequent
to the date of the Merger, the Company expended approximately $1.0 million
for the completion of the in-process R&D projects which approximated the
expected costs to complete such projects.
Milestones for the in-process R&D projects were also examined as of the date
of the Merger. For each in-process R&D project, Company engineers evaluated
the critical milestones. This included comprehensive analysis of each of the
acquired product lines' in-process R&D to clarify the technological hurdles
that the development team had overcome at the date of the Merger as well as
the hurdles that the engineers faced going forward to complete the remaining
development efforts. From this analysis, the overall significance of tasks
completed versus tasks remaining were assessed. For all categories, a
greater level of significance was associated with completed tasks. This
implied that a greater degree of overall value was attributable to the
completed tasks relative to those indicated by the cost metrics. Based on
estimates made by FormMaker's R&D professionals regarding technical
achievements completed as of the date of the Merger, the milestone percentage
was determined to be approximately 75%. Utilizing this milestone analysis for
the in-process R&D valuation resulted in incomplete R&D values which
approximated the $13.5 million appraisal value.
At the time of the Merger, FormMaker offered a basic portfolio of document
automation processing and imaging software products. FormMaker's product
lines and related services stemmed from its DAP and Multi-user Archival &
Retrieval System ("MARS") technologies.
The acquired in-process R&D value was comprised of several ongoing projects
intended to address the issues of technological advances in the marketplace
such as new client/server architecture, new delivery mechanisms, the
Internet, emergence of the Windows NT operating system, object integration on
the desktop, and new standards such as Microsoft's Active-X, Microsoft's
ODBC, and Sun Microsystems' Java which were making the development and
implementation of new products increasingly complex. These advances in
technology required creating highly advanced products that could handle
substantial increases in demand, as well as end user requirements for more
complex graphics-intensive material. This led to development efforts which
centered around new DAP and MARS technologies and incorporated innovative new
features and a wide array of advanced functions. FormMaker was addressing
industry and technological trends by developing new delivery mechanisms via
the Internet, object integration on the desktop, new DAP architecture,
platform independence, improved workflow functionality, product
compatibility, DAP and MARS integration, and the development of migration and
upgrade paths.
At the Merger date, there were still significant efforts needed to bring the
acquired in-process technologies and projects to fruition. These efforts
principally related to the completion of planning, designing, architecturing,
coding, prototyping, scalability, verification, and testing activities that
were necessary to establish that the proposed technologies would meet their
design specifications. These projects had not yet reached technological
feasibility at the time of the Merger. Management expected to continue to
support these efforts and believed FormMaker had a reasonable chance of
successfully completing the R&D programs. However, there was risk associated
with the completion of the projects and there was no assurance that any would
reach either technological or commercial success. If these projects were not
successfully developed the sales and profitability of the combined company
could have been adversely affected in future periods.
12
<PAGE>
Subsequent to the Merger, the majority of the original R&D projects were
completed in accordance with FormMaker's plans. The fruition of these
projects resulted in advanced new product technologies represented by the
launch of the Internet Document Server ("IDS") versions 1.0 and 1.3, Bill
Print version 1.0 and 1.1, and which fueled the release of two new DAP
products.
The emergence of the IDS products represented the completion of a key
revolutionary technology. This new rules-based transaction processing
server, released in October 1997, allows for the dynamic generation of
documents in industry-standard Adobe PDF format for Web delivery and the
ability to archive documents in a pure "thin-client" fashion. The second
phase of ongoing projects aimed at addressing new Internet functionalities
pushed forward the release of IDS version 1.3 in December 1998, which further
addressed new delivery mechanisms and standards such as Microsoft's Active-X,
Microsoft's ODBC, and Sun Microsystem's Java and represents the completion of
the in-process R&D acquired in the Merger. The Company began recognizing
revenue related to IDS products during fiscal year 1998.
FormMaker's pre-acquisition efforts in developing new printing technologies
have resulted in the release of Bill Print versions 1.0 and 1.1 in October
1997 and March 1998, respectively, which address the high-volume complex bill
and statement printing needs of the utilities industry.
FormMaker's investments in developing innovative features, new workflow
capabilities, object-oriented desktop integration, multiple language system
communications, improved graphics capabilities and platform and hardware
adaptability proved fruitful in yielding new DAP releases in September 1997
that could adequately address international markets and open new industries,
such as utilities and financial services.
The release of Bill Print versions 1.0 and 1.1 and the new DAP releases have
contributed to a significant increase in revenues derived from the utilities
market. Revenues in this market have increased in excess of 160% in the
fiscal year ended July 31, 1998, as compared to the previous fiscal year, and
greater than 25% for the nine months ended April 30, 1999, as compared to the
corresponding period of last year. In addition, these releases of in-process
R&D have fueled recent licenses to the financial services industry.
Most of the in-process R&D projects acquired in the Merger have been
completed on schedule, but minor delays have occurred due to changes in
technological and market requirements for document automation processing and
imaging systems. Although all in-process R&D projects have been completed, no
assurance can be made that the Company's recent releases will be met with
market acceptance.
As discussed in Note 3 of the Notes to Interim Consolidated Financial
Statements, the Company is currently in discussions with the Securities and
Exchange Commission ("SEC") regarding the value ascribed to the technology
acquired as in-process R&D in connection with the Merger. Depending upon the
outcome of the discussions with the SEC, the Company's historical reported
results could potentially be subject to restatement to reflect a reduction of
the in-process R&D charge. A reduction of the in-process R&D charge would
result in a corresponding increase in the amount of goodwill, which is being
amortized over a ten year period.
LIQUIDITY AND CAPITAL RESOURCES
At April 30, 1999, the Company's principal sources of liquidity consisted of
cash and cash equivalents of $8.0 million and short-term investments of $5.7
million. The Company completed an IPO in the form of a rights offering to
Safeguard Scientifics, Inc. stockholders in April 1998. Net proceeds to the
Company from this offering, after deduction of the underwriting discount and
IPO expenses, were approximately $18.5 million.
Cash and cash equivalents for the nine months ended April 30, 1999 decreased
$6.5 million due to cash used by various investing and financing activities,
and was partially offset by cash provided by operating activities. Cash flows
provided by operating activities were $5.8 million as the result of profitable
13
<PAGE>
operations and various other cash operating activities. Cash flows used in
investing activities of $8.3 million was the result of the purchase of
short-term investments, development of capitalized software, and purchase of
fixed assets. Cash flows from financing activities used $4.0 million
primarily as the result of the repurchase of treasury stock under the
Company's stock repurchase program. As of April 30, 1999, the Company had
782,718 shares of treasury stock outstanding at an average per share cost of
$4.60.
Working capital was $16.3 million at April 30, 1999, compared with $16.0
million at July 31, 1998.
In connection with the Merger, the Company assumed a $10.0 million revolving
credit facility from FormMaker. This credit facility was renegotiated in
September 1997. In September 1998, the Company allowed $6.5 million of the
credit facility to expire under its normal terms. The remaining $3.5 million
bears interest at the bank's prime rate less 0.25%, or 7.50%, as of April 30,
1999 and was renewed and extended to March 2000. Under the credit facility,
the Company is required to maintain certain financial covenants. As of April
30, 1999 there were no borrowings under this credit facility.
The Company's liquidity needs are expected to arise primarily from funding
the continued development, enhancement, and support of its software offerings
and the selling and marketing costs associated principally with continued
entry into new vertical and international markets. Although the Company has
no current commitments or agreements with respect to any acquisition of other
businesses or technologies, a portion of the Company's cash could be used to
acquire complementary businesses or obtain the right to use complementary
technologies.
The Company currently anticipates that existing cash, cash equivalents,
short-term investment balances, its existing credit facility, and cash
generated from operations will be sufficient to satisfy its operating cash
needs for the foreseeable future.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130") and No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131"), were issued. SFAS 130
establishes standards for reporting comprehensive income and its components
with the same prominence as other financial statements. The Company adopted
SFAS 130 on August 1, 1998; however, the Company does not have any items of
comprehensive income in the periods presented. SFAS 131 establishes standards
for reporting information about operating segments in annual and interim
financial statements, although this statement need not be applied to interim
financial statements in the initial year of its application. SFAS 131 is
effective for fiscal years beginning after December 15, 1997, and therefore
the Company will adopt its requirements in connection with its annual
reporting for the year ending July 31, 1999.
Effective August 1, 1998, the Company adopted Statement of Position No. 97-2,
"Software Revenue Recognition" ("SOP 97-2") issued by the Accounting
Standards Executive Committee of the American Institute of Certified Public
Accountants, which supersedes Statement of Position No. 91-1 "Software
Revenue Recognition". The adoption of SOP 97-2 did not have a material effect
on the Company's financial position or results of operations during the three
or nine months ended April 30, 1999 and the Company does not anticipate it
will have a material impact in the future.
Also, effective December 15, 1998, the Accounting Standards Executive
Committee issued Statement of Position No. 98-9, "Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions" ("SOP
98-9") which amends Statement of Position 98-4, "Deferral of the Effective
Date of A Provision of SOP 97-2". Provisions of SOP 98-9 are effective for
transactions entered into during fiscal years beginning after March 15, 1999.
Accordingly, the Company will adopt SOP 98-9 for the year ending July 31,
2000 and the Company does not believe the adoption of SOP 98-9 will have a
material effect on the Company's financial position or results of operations.
14
<PAGE>
In March 1998, the Accounting Standards Executive Committee issued Statement
of Position No. 98-1, "Accounting for Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 requires costs related to
internal use software that are incurred in the preliminary project stage to
be expensed as incurred. SOP 98-1 is effective for financial statements for
fiscal years beginning after December 15, 1998. Accordingly, the Company
will adopt SOP 98-1 for the year ending July 31, 2000. The Company does not
believe the adoption of SOP 98-1 will have a material effect on the Company's
financial position or results of operations.
15
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27. Financial Data Schedule (for EDGAR filing purposes only).
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed by the Registrant during
the three months ended April 30, 1999.
16
<PAGE>
SIGNATURES
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.
DocuCorp International, Inc.
- ------------------------------------------
(Registrant)
/s/ Michael D. Andereck Date June 11, 1999
- ---------------------------------------------- -------------
President and CEO
17
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