EXHIBIT 13.1
ITEM 7. 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 herein, 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, attraction and retention
of technical employees, 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. Should one
or more of these risks or uncertainties, among others as set forth herein,
materialize, actual results may vary materially from those estimated,
anticipated, or projected. Although the Company believes that the expectations
reflected by such forward-looking statements are reasonable based on information
currently available to the Company, no assurance can be given that such
expectations will prove to have been correct. Cautionary statements identifying
important factors that could cause actual results to differ materially from the
Company's expectations are set forth herein. All forward-looking statements
included herein 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 International, Inc. ("DocuCorp" or the "Company") develops,
markets, and supports a portfolio of Internet and print, enterprise-wide
software products that enable users to acquire, manage, personalize, and present
information. In addition, the Company provides application service provider
("ASP") hosting of Internet-enabled solutions, consulting, application
integration, and training through a 190-person service organization. ASP hosting
is performed using the Company's software and facilities to provide processing,
print, mail, archival, and Internet delivery of documents for customers who
outsource this activity.
The Company was organized in connection with the May 15, 1997 acquisition
of FormMaker Software, Inc. ("FormMaker") by Image Sciences, Inc. ("Image
Sciences") (the "Merger"). In March 1998, the Company acquired all of the
capital stock of EZPower Systems, Inc. ("EZPower") and Maitland Software, Inc.
("Maitland"), and accordingly, the results of operations for all periods
subsequent to the acquisition date are included in the accompanying consolidated
financial statements.
The Company's software products support leading hardware platforms,
operating systems, printers, and imaging systems. These products are designed to
personalize, produce, and manage documents such as insurance policies, utility
statements, telephone bills, bank and mutual fund statements, invoices, direct
mail correspondence, bills of lading, and other customer-oriented documents. The
Company's ASP offerings include customer statement and bill generation,
electronic bill presentment and payment, insurance policy production, and
electronic document archival. The Company currently has an installed base of
approximately 900 customers. More than half of the 200 largest North American
insurance companies use the Company's software products and services, including
eight of the ten largest life and health insurance companies and nine of the ten
largest property and casualty insurance companies. Many of the largest North
American utilities companies, major international financial services
institutions, and clients in higher education and the telecommunications
industries use the Company's products and services.
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The Company derives its revenues from license fees, recurring maintenance
fees, professional services fees, and ASP hosting 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, and
education services. ASP hosting revenues consist of fees earned from customers
who outsource document automation applications.
Results of Operations
Historical Operating Results of the Company
The following table sets forth for the periods indicated selected
consolidated statements of operations data. The information presented below,
expressed in dollars and as a percentage of total revenues for the periods
indicated, has been derived from the consolidated financial statements of the
Company.
Years ended July 31,
-------------------------------
(dollars in thousands) 2000 1999 1998
------- ------- -------
Revenues
ASP hosting $ 9,642 $ 6,220 $ 8,162
Professional services 19,016 21,120 17,371
License 8,711 11,403 8,885
Maintenance and other recurring 14,962 13,183 10,829
------- ------- -------
Total revenues $52,331 $51,926 $45,247
======= ======= =======
Percentage relationship to total revenues
Revenues
ASP hosting 18% 12% 18%
Professional services 36 41 38
License 17 22 20
Maintenance and other recurring 29 25 24
------- ------- -------
Total revenues 100 100 100
------- ------- -------
Expenses
ASP hosting 16 10 14
Professional services 30 31 28
Product development and support 19 18 18
Selling and marketing 16 16 14
General and administrative 11 11 14
------- ------- -------
Total expenses 92 86 88
------- ------- -------
Operating income 8 14 12
Other income (expense), net 1 1 0
------- ------- -------
Income before income taxes 9 15 12
Provision for income taxes 4 6 5
------- ------- -------
Net income 5% 9% 7%
======= ======= =======
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Fiscal Year Ended July 31, 2000 Compared to Fiscal Year Ended July 31, 1999
Revenues
Total revenues increased 1% for the year ended July 31, 2000 as compared
to the prior year due primarily to increased ASP hosting revenues and
maintenance revenues, offset by decreased professional services and license
revenues. ASP hosting revenues increased 55% due to the Company's focus on
expanding this business and adding several new significant customers during
fiscal 2000. Maintenance revenues increased 13% due to an expanding customer
base. As a result of Y2K concerns, many customers and prospects delayed
licensing and implementation of software until the passage of January 1, 2000.
This led to a 24% decrease in license revenues and a 10% decrease in
professional services revenues. The Company believes, based on activity in the
fourth quarter of fiscal 2000, that Y2K will not have a material impact on
future financial results.
Backlog for the Company's products and services of approximately $40.6
million as of July 31, 2000, of which approximately $22.8 million is scheduled
to be satisfied within one year, is primarily composed of recurring software
license and maintenance revenues for ongoing maintenance and support, software
implementation and consulting services, and ASP hosting 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 principally performed under time and material agreements, of which
some have cancellation provisions. ASP hosting agreements generally provide that
fees are charged on a per transaction basis. The estimated future revenues with
respect to software implementation and ASP hosting services are based on
management's estimate of revenues over the remaining life of the respective
contracts.
FormMaker historically distributed its line of Document Automation
Platform software products to the insurance industry in North America through an
exclusive marketing agreement with MYND, formerly Policy Management Systems
Corporation. 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 the Company and MYND allows MYND to market all of
the Company's software products to insurance and financial services companies
worldwide. The Company generated revenues of approximately $2.8 million and $3.7
million for the years ended July 31, 2000 and 1999, respectively, under the new
agreement.
ASP hosting expense
ASP hosting expense is composed primarily of personnel costs,
facility-related costs, postage, and supplies expense related to the Company's
two ASP hosting centers. ASP hosting expense increased 69% for the year ended
July 31, 2000 due primarily to personnel, facility, and computer costs
associated with opening a second ASP hosting facility in Dallas, Texas in March
2000. ASP hosting expense also increased as a result of approximately $1.8
million of additional postage and supplies expense related to increased ASP
hosting revenues. For the fiscal years ended July 31, 2000 and 1999, ASP hosting
expense represented 87% and 80% of ASP hosting revenues, respectively. The
increase in cost as a percentage of revenues is mainly due to additional costs
incurred with expanding the Company's ASP hosting capacity. The Company expects
ASP hosting expense to increase as ASP hosting revenues increase.
Professional services expense
Professional services expense is composed primarily of personnel expenses
related to implementation, education, and consulting services. Professional
services expense decreased 2%
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for the year ended July 31, 2000 due to decreased recruiting and travel costs,
offset by increased personnel costs associated with the expanded professional
services department. For the fiscal years ended July 31, 2000 and 1999,
professional services expense represented 82% and 76% of professional services
revenues, respectively. The increase in cost as a percentage of professional
services revenues is mainly due to lower utilization of consulting personnel as
a result of customers readjusting their focus until after the passage of January
1, 2000. The Company expects professional services expense 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 fiscal year ended
July 31, 2000, product development and support expense increased 8%. The
majority of the increase is related to additional personnel expenses for
continued development and support of the Company's products. The Company
anticipates continued increases in development efforts, including Internet
applications, integration of its existing product offerings, further development
of systems for use in industries such as utilities and financial services,
development of new software products, and continued support of its existing
product lines. Expenditures in this area are expected to increase in relation to
the anticipated growth in revenues.
Selling and marketing expense
In fiscal 2000, selling and marketing expense decreased 2% primarily due
to decreased third-party selling costs associated with the MYND marketing
agreement. Incentive compensation also decreased as a result of decreased
license revenues; however, personnel costs increased as a result of
international and vertical market expansion.
General and administrative expense
General and administrative expense remained substantially unchanged for
the year ended July 31, 2000. Legal and accounting fees and bad debt expense
decreased, which was offset by increased personnel costs.
Other income, net
Other income, net decreased approximately $10,000 for the year ended July
31, 2000 due primarily to a decrease in interest income. This decrease was
partially offset by a decrease in the loss on foreign exchange rate for the year
ended July 31, 2000.
Provision for income taxes
The effective tax rate for the years ended July 31, 2000 and 1999, was
approximately 45% and 43%, respectively. These rates differ from the federal
statutory rate due primarily to non-deductible goodwill amortization related to
the Merger and acquisitions of EZPower and Maitland. The Company used a portion
of its net operating loss carryforwards and outstanding tax credits to offset
its current tax liability for the years ended July 31, 2000 and 1999.
Net income
Net income decreased 44% for fiscal 2000. The decrease in net income is
primarily due to the impact of Y2K on software license and professional services
revenues and the increase in operating expenses associated with international,
ASP hosting, and vertical market expansion.
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Fiscal Year Ended July 31, 1999 Compared to Fiscal Year Ended July 31, 1998
Revenues
Total revenues increased 15% for the year ended July 31, 1999 as compared
to the prior year. An increase in large dollar software licenses in the
insurance market was primarily responsible for the 28% increase in license
revenues. Maintenance revenues increased 22% due to an expanding customer base.
For the year ended July 31, 1999, professional services revenues increased 22%
due to increased consulting and implementation services revenues in the
insurance and utilities markets. ASP hosting revenues decreased 24% due to the
approximate $4.4 million decline in ASP hosting revenues resulting from the May
1998 termination of the MYND print outsourcing agreement, partially offset by
increased ASP hosting revenues in the utilities market.
ASP hosting expense
ASP hosting expense is composed primarily of personnel costs,
facility-related costs, postage, and supplies expense related to the Company's
ASP hosting center. ASP hosting expense decreased 23% for the year ended July
31, 1999 due primarily to a decrease in postage and supplies expense associated
with the decrease in ASP hosting revenues. The decrease was partially offset by
increased personnel costs as the Company focused on expanding the ASP hosting
business. For the fiscal years ended July 31, 1999 and 1998, ASP hosting expense
represented 80% and 79% of ASP hosting revenues, respectively.
Professional services expense
Professional services expense is composed primarily of personnel expenses
related to implementation, education, and consulting services. Professional
services expense increased 27% for the year ended July 31, 1999 due to increased
personnel costs as the professional services department expanded both
domestically and internationally. For the fiscal years ended July 31, 1999 and
1998, professional services expense represented 76% and 73% of professional
services revenues, respectively.
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 fiscal year ended
July 31, 1999, product development and support expense increased 14%. The
majority of the increase is related to additional personnel expenses for
continued development and support of the Company's products, including
additional expenses arising from the acquisitions of EZPower and Maitland in
March 1998.
Selling and marketing expense
Selling and marketing expense increased 42% mainly due to additional
personnel expenses incurred as the departments expanded to meet the Company's
needs, and increased incentive compensation as a result of higher revenues. In
addition, the Company concentrated on increasing market awareness through
advertising, trade shows, and market research which increased these
expenditures.
General and administrative expense
In fiscal 1999, general and administrative expense decreased 8%. This is
primarily the result of a decrease in legal fees from fiscal 1998, which
included legal defense and settlement costs related to the resolution of two
litigation matters. The decrease in legal fees was partially
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offset by an increase in goodwill amortization resulting from the EZPower and
Maitland acquisitions in March 1998, and an increase in staffing levels within
the general and administrative departments.
Other income (expense), net
The significant increase in other income (expense), net was due to a
material amount of interest income generated during the fiscal year ended July
31, 1999 as compared with interest expense incurred during 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 fiscal
1998 due to higher cash, cash equivalent, and short-term investment balances
maintained by the Company. The Company repaid its 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 years ended July 31, 1999 and 1998, was
approximately 43% and 41%, respectively. Goodwill amortization related to the
acquisitions of EZPower and Maitland is non-deductible, which increased the
effective tax rate for the fiscal 1999 period. 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 years ended July 31, 1999 and 1998.
Net income
Net income increased 42% for fiscal 1999. The increase in net income is
due primarily to increased higher margin license fees, increased consulting
fees, elimination of the MYND generated ASP hosting and consulting revenues, and
increased interest income, partially offset by additional expenses required to
meet the revenue levels.
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 approximately $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 future 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-
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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.
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
values for incomplete R&D projects 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
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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.
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, 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 increased in excess of 160% in the
fiscal year ended July 31, 1998, as compared to the previous fiscal year, and
greater than 29% and 8% in each of the fiscal years ended July 31, 1999 and
2000, respectively. In addition, these releases of in-process R&D have resulted
in recent licenses to the financial services industry.
Most of the in-process R&D projects acquired in the Merger were completed
on schedule, but minor delays 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 5 of the notes to consolidated financial statements,
the Company has responded to inquiries by the Securities and Exchange Commission
("SEC") regarding the value ascribed to the technology acquired as in-process
R&D in connection with the Merger. To date, the Company has not received further
inquiries from the SEC. However, depending upon the outcome of any future
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.
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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 July 31, 2000, the Company's principal sources of liquidity consisted
of cash and cash equivalents of approximately $4.7 million and short-term
investments of approximately $7.8 million. Cash and cash equivalents for the
year ended July 31, 2000 decreased approximately $1.7 million due primarily to
the purchase of fixed assets and purchase of treasury stock under the Company's
stock repurchase program, offset by approximately $10.5 million of cash
generated from operations. Cash flows used in investing activities of
approximately $6.8 million were related to the purchase of short-term
investments, development of capitalized software, and purchase of fixed assets.
Specifically, the Company invested approximately $4.2 million in fixed assets
primarily related to the Company's opening of the Dallas ASP center, expanding
the Atlanta facilities, and purchase of ASP hosting equipment. Cash flows used
in financing activities of approximately $5.4 million primarily relates to the
purchase of treasury stock under the Company's stock repurchase program offset
by proceeds from exercise of stock options. As of July 31, 2000, the Company had
approximately 1,509,000 shares of treasury stock outstanding at an average per
share cost of $5.25. Since inception of the Company's stock repurchase program
in fiscal 1999, the Company has repurchased approximately 2,606,000 million
shares of stock at an average purchase price of $5.12. The Company's board of
directors has authorized the Company to repurchase up to an aggregate of
4,000,000 shares of stock
Working capital was approximately $14.0 million at July 31, 2000, compared
with approximately $15.5 million at July 31, 1999.
The Company's $3.5 million revolving credit facility bears interest at the
bank's prime rate less 0.25%, or 9.25% as of July 31, 2000, and has been renewed
and extended to November 2001. Under the credit facility, the Company is
required to maintain certain financial covenants. As of July 31, 2000 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,
selling and marketing costs associated principally with expansion in new
vertical and international markets, and purchase of treasury stock under the
Company's stock repurchase program. 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, short-term
investments, its existing credit facility, and cash generated from operations
will be sufficient to satisfy its operating cash needs for the foreseeable
future.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
================================================================================
Report of Independent Accountants
To the Board of Directors and Stockholders
of DOCUCORP INTERNATIONAL, INC.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and comprehensive income, of
changes in stockholders' equity and of cash flows present fairly, in all
material respects, the financial position of DocuCorp International, Inc. and
its subsidiaries at July 31, 2000 and 1999, and the results of their operations
and their cash flows for each of the three years in the period ended July 31,
2000 in conformity with accounting principles generally accepted in the United
States of America. 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 of these
statements in accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Dallas, Texas
September 7, 2000
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DocuCorp International, Inc.
Consolidated Balance Sheets
July 31, 2000 and 1999
(in thousands except share and per share amounts)
================================================================================
<TABLE>
2000 1999
-------- --------
<S> <C> <C>
Assets
Current assets
Cash and cash equivalents $ 4,739 $ 6,459
Short-term investments 7,754 6,914
Accounts receivable, net of allowance
of $600 and $675, respectively 13,469 14,436
Current portion of deferred taxes 653 469
Income tax refund receivable 424 729
Other current assets 1,837 1,806
-------- --------
Total current assets 28,876 30,813
Fixed assets, net of accumulated depreciation
of $6,309 and $4,584, respectively 6,039 3,570
Software, net of accumulated amortization
of $11,277 and $9,045, respectively 7,259 7,728
Deferred taxes 758 388
Goodwill, net of accumulated amortization
of $3,832 and $2,479, respectively 6,954 9,693
Other assets 390 726
-------- --------
$ 50,276 $ 52,918
======== ========
Liabilities and stockholders' equity
Current liabilities
Accounts payable $ 1,763 $ 1,692
Accrued liabilities
Accrued compensation 2,811 2,893
Other 994 1,262
Income taxes payable 318 364
Deferred revenue 8,981 9,089
-------- --------
Total current liabilities 14,867 15,300
Other long-term liabilities 724 624
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value, 1,000,000 shares
authorized; none issued 0 0
Common stock, $.01 par value, 50,000,000 shares
authorized; 16,593,849 shares issued 166 166
Additional paid-in capital 47,884 47,784
Treasury stock at cost, 1,508,777 and 1,170,275
shares, respectively (7,923) (5,539)
Retained deficit (5,366) (5,355)
Foreign currency translation adjustment (76) 0
Notes receivable from stockholders 0 (62)
-------- --------
Total stockholders' equity 34,685 36,994
-------- --------
$ 50,276 $ 52,918
======== ========
</TABLE>
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See accompanying notes to consolidated financial statements.
<PAGE>
DocuCorp International, Inc.
Consolidated Statements of Operations and
Comprehensive Income
For the Years Ended July 31, 2000, 1999, and 1998
(in thousands except per share amounts)
================================================================================
<TABLE>
<CAPTION>
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Revenues
ASP hosting $ 9,642 $ 6,220 $ 8,162
Professional services 19,016 21,120 17,371
License 8,711 11,403 8,885
Maintenance and other recurring 14,962 13,183 10,829
-------- -------- --------
Total revenues 52,331 51,926 45,247
-------- -------- --------
Expenses
ASP hosting 8,391 4,955 6,437
Professional services 15,674 16,003 12,595
Product development and support 10,224 9,492 8,318
Selling and marketing 8,275 8,437 5,955
General and administrative 5,790 5,808 6,341
-------- -------- --------
Total expenses 48,354 44,695 39,646
-------- -------- --------
Operating income 3,977 7,231 5,601
Other income (expense), net 612 622 (177)
-------- -------- --------
Income before income taxes 4,589 7,853 5,424
Provision for income taxes 2,080 3,340 2,240
-------- -------- --------
Net income $ 2,509 $ 4,513 $ 3,184
======== ======== ========
Other comprehensive income:
Foreign currency translation adjustment, net of tax (76) 0 0
-------- -------- --------
Comprehensive income $ 2,433 $ 4,513 $ 3,184
======== ======== ========
Net income per share:
Basic $ .16 $ .28 $ .25
======== ======== ========
Diluted $ .15 $ .26 $ .21
======== ======== ========
Weighted average shares outstanding used in the net
income per share calculation:
Basic 15,317 16,001 12,587
======== ======== ========
Diluted 16,872 17,570 14,865
======== ======== ========
</TABLE>
38
See accompanying notes to consolidated financial statements.
<PAGE>
DocuCorp International, Inc.
Consolidated Statements of Cash Flows
For the Years Ended July 31, 2000, 1999, and 1998
(in thousands)
================================================================================
<TABLE>
<CAPTION>
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 2,509 $ 4,513 $ 3,184
Adjustments to reconcile net income to
net cash provided by operating activities:
Stock option compensation expense 18 12 20
Depreciation 1,725 1,326 1,274
Amortization of capitalized software 2,232 1,998 1,787
Amortization of goodwill 1,353 1,352 966
Tax benefit from utilization of net operating loss 0 0 350
Tax benefit related to stock option exercises 501 192 531
Increase (decrease) in allowance for doubtful accounts (75) (275) 404
Changes in assets and liabilities, net of effects
from acquisitions:
(Increase) decrease in accounts receivable 1,042 (2,235) (3,234)
(Increase) decrease in income tax refund receivable 305 (23) (202)
Decrease in deferred tax assets 914 283 2
(Increase) decrease in other assets 305 (961) (45)
Increase (decrease) in accounts payable 71 (81) 508
Increase (decrease) in accrued liabilities (229) 1,803 (615)
Increase (decrease) in income taxes payable (46) 140 (188)
Increase (decrease) in deferred revenue (108) 613 1,667
-------- -------- --------
Total adjustments 8,008 4,144 3,225
-------- -------- --------
Net cash provided by operating activities 10,517 8,657 6,409
-------- -------- --------
Cash flows from investing activities
Purchase of short-term investments, net (840) (6,914) 0
Purchase of fixed assets (4,194) (1,916) (995)
Capitalized software development costs (1,763) (1,590) (1,515)
Net cash acquired in business combinations 0 0 31
-------- -------- --------
Net cash used in investing activities (6,797) (10,420) (2,479)
-------- -------- --------
Cash flows from financing activities
Repayment of debt 0 0 (11,877)
Principal payments under capital lease obligations (21) (62) (401)
Purchase of treasury stock (6,270) (7,076) 0
Proceeds from exercise of options 618 569 1,056
Net proceeds from issuance of stock 0 0 18,589
Proceeds from repayment of note receivable from stockholder 62 3 6
Proceeds from stock issued to employees under Employee
Stock Purchase Plan ("ESPP") 247 348 268
-------- -------- --------
Net cash provided by (used in) financing activities (5,364) (6,218) 7,641
-------- -------- --------
Effect of exchange rates on cash flows (76) 0 0
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (1,720) (7,981) 11,571
Cash and cash equivalents at beginning of year 6,459 14,440 2,869
-------- -------- --------
Cash and cash equivalents at end of year $ 4,739 $ 6,459 $ 14,440
======== ======== ========
</TABLE>
See non-cash activities disclosed in Notes 4 and 9.
39
See accompanying notes to consolidated financial statements.
<PAGE>
DocuCorp International, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended July 31, 2000, 1999, and 1998
(in thousands except share amounts)
================================================================================
<TABLE>
<CAPTION>
Additional Retained Currency
Common Paid-in Treasury Earnings Translation Notes
Stock Capital Stock (Deficit) Adjustment Receivable Total
--------- --------- --------- --------- ----------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at July 31, 1997 $ 51 $ 4,913 $ 0 $ (12,413) $ 0 $ (71) $ (7,520)
Exercise of stock options to purchase
885,993 shares of Common Stock 9 1,047 1,056
Conversion of 5,623,229 shares of
Class B common stock to Common Stock 56 19,063 19,119
Issuance of 4,000,000 shares of Common
Stock in initial public offering 40 18,549 18,589
Repayment of note receivable from
stockholder 6 6
Stock issued for acquisitions 8 3,172 3,180
Issuance of 62,982 shares of Common
Stock to employees under ESPP 1 267 268
Compensation expense related to
non-qualified stock options 20 20
Tax benefit from stock option
exercises 531 531
Net income 3,184 3,184
--------- --------- --------- --------- --------- --------- --------
Balance at July 31, 1998 165 47,562 0 (9,229) 0 (65) 38,433
Exercise of stock options to purchase
338,571 shares of Common Stock 1 210 1,132 (774) 569
Purchase of 1,522,526 shares of
Treasury Stock (7,076) (7,076)
Repayment of note receivable from
stockholder 3 3
Issuance of 81,968 shares of Common
Stock to employees under ESPP 405 (57) 348
Compensation expense related to
non-qualified stock options 12 12
Tax benefit from stock option exercises 192 192
Net income 4,513 4,513
--------- --------- --------- --------- --------- --------- --------
Balance at July 31, 1999 166 47,784 (5,539) (5,355) 0 $ (62) $ 36,994
Exercise of stock options and warrants to
purchase 671,324 shares of Common Stock 3,477 (2,859) 618
Purchase of 1,083,906 shares of Treasury
Stock (6,270) (6,270)
Repayment of note receivable from
stockholder 62 62
Issuance of 74,080 shares of Common
Stock to employees under ESPP 409 (162) 247
Compensation expense related to
non-qualified stock options 18 18
Tax benefit from stock option exercises 501 501
Expiration of repurchase right 82 82
Foreign currency translation adjustment (76) (76)
Net income 2,509 2,509
--------- --------- --------- --------- --------- --------- --------
Balance at July 31, 2000 $ 166 $ 47,884 $ (7,923) $ (5,366) $ (76) $ 0 $ 34,685
========= ========= ========= ========= ========= ========= ========
</TABLE>
40
See accompanying notes to consolidated financial statements.
<PAGE>
Note 1 - Organization and Summary of Significant Accounting Policies
DocuCorp International, Inc. ("DocuCorp" or the "Company"), a Delaware
corporation, was organized on January 13, 1997 in connection with the
acquisition of FormMaker Software, Inc. ("FormMaker") by Image Sciences, Inc.
("Image Sciences") (the "Merger"). The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries, Image Sciences, FormMaker, EZPower Systems, Inc. ("EZPower"),
Maitland Software, Inc. ("Maitland"), and DocuCorp Europe Ltd. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
The Company's business includes developing, marketing, and supporting computer
software designed to automate the process of generating, storing, managing, and
distributing business documents. The Company also provides application service
provider ("ASP") hosting of Internet-enabled solutions, consulting, application
integration, and training. The majority of the Company's business is currently
derived from companies in the insurance industry.
Revenue recognition
Revenue from licensing of standard software is recognized upon shipment of the
software. Revenue from software licenses which include a cancellation clause is
recognized upon expiration of the cancellation period. Revenue derived from the
development and installation of software packages under long-term contracts is
recognized on a percentage-of-completion basis measured by the relationship of
hours worked to total estimated contract hours. Revenue related to products
still in the testing phase is deferred until formal acceptance of the product by
the purchaser. Anticipated losses, if any, on uncompleted contracts are
recognized in the period in which such losses are determined.
Revenue from maintenance contracts, and maintenance revenue that is packaged
with license fees, is recognized ratably over the term of the agreements. The
Company records deferred revenue for maintenance amounts invoiced prior to
revenue recognition. Revenue related to professional services, such as training
and consulting, and ASP hosting is recognized as the services are performed.
Cash equivalents
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents. Cash equivalents are
stated at cost, which approximates fair market value.
Short-term investments
The Company has the intent and ability to hold short-term investments to
maturity; consequently, such investments are carried at cost, which approximates
fair market value. At July 31, 2000, the Company held short-term investments
which totaled approximately $7.8 million. Interest income from such investments
was approximately $406,000, $244,000, and $0 in 2000, 1999, and 1998,
respectively.
Accounts receivable
Included in accounts receivable at July 31, 2000 and 1999 are unbilled amounts
of approximately $1.7 million and $2.5 million, respectively. Such amounts have
been recognized as revenue under the percentage-of-completion method or upon
execution of the contract and shipment of the software, but prior to contractual
payment terms.
Fair value of financial instruments
The Company's financial instruments consist primarily of cash, cash equivalents,
short-term investments, accounts receivable, accounts payable, and accrued
liabilities. The current carrying amount of these instruments approximates fair
market value due to the relatively short period of time to maturity for these
instruments.
41
<PAGE>
Fixed assets, depreciation, and amortization
Property and equipment are carried at cost, less accumulated depreciation and
amortization. Depreciation and amortization are computed over the estimated
service lives using the straight-line method. Amortization of assets recorded
under capital leases is included in depreciation expense. Estimated service
lives are as follows:
Computer equipment 4-5 years
Furniture and fixtures 5 years
Leasehold improvements life of lease
Leased equipment under capital leases 3-5 years
Repairs and maintenance are expensed as incurred. Major renewals and betterments
are capitalized and depreciated over the assets' remaining estimated service
lives. Upon retirement or sale of an asset, the cost and accumulated
depreciation are removed from the accounts with any resulting gain or loss
included in income.
Software
Software development costs are accounted for in accordance with either Statement
of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed," or with Statement of
Position No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." After the technological feasibility of the software
has been established, material software development costs which include salaries
and related payroll costs incurred in the development activities are
capitalized. Research and development costs incurred prior to the establishment
of the technological feasibility of a product are expensed as incurred. The cost
of capitalized software is amortized on a straight-line basis over its estimated
useful life, generally four to six years, or the ratio of current revenues to
current and anticipated revenues from the software, whichever provides the
greater amortization. During 2000, 1999, and 1998, the Company charged to
expense approximately $6.3 million, $5.9 million, and $5.2 million,
respectively, for research and development costs incurred prior to the
establishment of the technological feasibility of products. Such expense is
included in product development and support on the Consolidated Statements of
Operations and Comprehensive Income.
Goodwill
Goodwill is amortized on a straight-line basis over eight to ten years. The
carrying value of goodwill is evaluated periodically in relation to the
operating performance and anticipated future undiscounted net cash flows of the
related business. In the event that assets are found to be carried at amounts
which are in excess of estimated gross future cash flows, the intangible assets
are adjusted for impairment to a level commensurate with a discounted cash flow
analysis of the underlying assets.
Impairment of long-lived assets
The Company has adopted Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-lived Assets and Assets to be Disposed
of." Under the provisions of this statement, the Company has evaluated its
long-lived assets for financial impairment, and will continue to do so as events
or changes in circumstances indicate that the carrying value of such assets may
not be fully recoverable.
42
<PAGE>
Translation of foreign currencies
Assets and liabilities of foreign subsidiaries whose functional currency is
other than the U.S. dollar are translated at year-end rates of exchange and
revenues and expenses are translated at average exchange rates prevailing during
the year. Foreign currency transaction gains and losses are recognized in income
as incurred.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income",
which established new rules for the reporting and display of comprehensive
income and it components. SFAS 130 requires unrealized gains or losses on the
Company's foreign currency translation adjustments to be accumulated in
stockholders' equity as part of other comprehensive income.
Income taxes
Income taxes are presented pursuant to Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 uses an
asset and liability approach to account for income taxes. In the event
differences between the financial reporting basis and the tax basis of the
Company's assets and liabilities result in deferred tax assets, an evaluation of
the probability of being able to realize the future benefits indicated by such
assets is required. A valuation allowance is provided for the deferred tax
assets when there is sufficient uncertainty regarding the Company's ability to
recognize the benefits of these assets in future years.
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 ("IPO"), 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. 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 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 fiscal years
indicated (in thousands):
2000 1999 1998
------ ------ ------
Shares used in computing basic
net income per share 15,317 16,001 12,587
Dilutive effect of stock options and
warrants 1,555 1,569 2,278
------ ------ ------
Shares used in computing diluted
net income per share 16,872 17,570 14,865
====== ====== ======
Options to purchase 843,000, 246,000, and 69,289 shares of Common Stock at
average exercise prices of $4.79, $5.44, and $5.82 per share at July 31, 2000,
1999, and 1998, respectively, 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.
Stock-based compensation
The Company accounts for stock-based employee compensation in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") and its various interpretations, including Financial
Accounting Standards Board Interpretation No. 44, "Accounting for Certain
Transactions, Including Stock-Based Compensation." Under APB 25, compensation
cost is generally not recognized for fixed stock options in which the exercise
price
43
<PAGE>
is not less than the market price on the grant date. Compensation cost
recognized by the Company in accordance with APB 25 has not been significant in
any of the past three years.
Management estimates
The preparation of the Company's financial statements, in accordance with
accounting principles generally accepted in the United States of America,
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, and disclosure of contingent assets and
liabilities and the reported amounts of revenues and expenses at the date of the
financial statements. Actual results could differ from those estimates during
the reported periods.
Advertising costs
The Company's policy for advertising costs is to expense such costs as incurred.
Advertising expenses for 2000, 1999, and 1998 were approximately $1.1 million,
$995,000, and $324,000, respectively.
Recently issued accounting pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"), which requires all derivative instruments
be recorded on the balance sheet at fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, depending on the type of hedge transaction. This
statement, as amended, is effective for fiscal quarters of fiscal years
beginning after June 15, 2000; accordingly, the Company will adopt SFAS 133 in
the first quarter of fiscal 2001. The impact on the Company, if any, will be
dependent upon the extent to which the Company is a party to derivative
contracts or hedging activities covered by SFAS 133 at the time of adoption.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," ("SAB 101"),
which provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements filed with the Securities and Exchange
Commission ("SEC"). SAB 101 outlines the basic criteria that must be met to
recognize revenue and provides guidance for disclosures related to revenue
recognition policies. The Company is required to adopt SAB 101 no later than the
fourth quarter of the fiscal year ending July 31, 2001. The Company is in the
process of assessing the impact of adopting SAB 101.
Note 2 - Fixed assets
Fixed asset balances at July 31, 2000 and 1999 are as follows (in thousands):
2000 1999
-------- --------
Computer equipment $ 9,487 $ 6,409
Furniture and fixtures 1,875 1,439
Leasehold improvements 986 306
-------- --------
12,348 8,154
Less accumulated depreciation (6,309) (4,584)
-------- --------
$ 6,039 $ 3,570
======== ========
Note 3 - Initial Public Offering
The Company completed an IPO in the form of a rights offering to Safeguard
Scientifics, Inc. ("Safeguard") stockholders in April 1998. The Company's
Registration Statement on Form S-1 (File No. 333-44427) with respect to the IPO
was declared effective on February 24, 1998. The Company's Common Stock began
trading on the Nasdaq National Market under the symbol
44
<PAGE>
DOCC on April 6, 1998. The Company sold 4,000,000 shares of Common Stock at a
per share price of $5.00. Net proceeds to the Company, after deduction of the
underwriting discount and IPO expenses, were approximately $18.5 million.
Selling stockholders sold 3,460,000 shares at a per share price of $5.00. The
Company did not receive any proceeds from the sale of shares by the selling
stockholders.
Note 4 - Acquisitions
On March 31, 1998, the Company completed the acquisitions of EZPower and
Maitland. The Company acquired all of the outstanding capital stock of EZPower
in exchange for 650,000 shares of the Company's Common Stock, repayment of
approximately $2.5 million of EZPower's indebtedness, and potential payment of
certain contingent cash consideration based on future performance. The Company
issued 170,000 shares of its Common Stock as consideration for the Maitland
acquisition. The Company had the right to repurchase up to 100,000 of those
shares based upon cumulative licensing and maintenance of the Maitland software
product through the period ending July 31, 2001. In August 1999, the Company
waived its repurchase rights. Accordingly, additional goodwill in the
approximate amount of $82,000 was recorded and is being amortized over the
remaining amortization period. Both 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 consolidated financial statements. The aggregate purchase
prices, including direct acquisition costs, were approximately $5.9 million and
$605,000 which have been allocated to the fair value of net identifiable assets
in the acquisitions of EZPower and Maitland, respectively. The excess of the
purchase price over the fair value of the net identifiable assets acquired of
approximately $4.8 million and $583,000 related to the acquisitions of EZPower
and Maitland, respectively, has been recorded as goodwill and is being amortized
on a straight-line basis over eight years.
Note 5 - Acquired In-Process Research and Development
In connection with a review conducted by the SEC related to the Company's filing
of its Annual Report on Form 10-K for the year ended July 31, 1998, the Company
responded to the SEC regarding inquiries related to 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 has examined the basis for valuing
in-process R&D charges versus the SEC's most recent guidance on the preferred
calculation of these charges. The Company has consulted with its independent
accountants and independent appraisers and 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 any future 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.
45
<PAGE>
Note 6 - Lease Commitments
The Company leases computer and office equipment under noncancelable leases
which are classified as capital leases and included in fixed assets at July 31,
2000 and 1999 as follows (in thousands)
2000 1999
------ ------
Computer equipment $ 498 $ 498
Office equipment 326 326
------ ------
824 824
Less accumulated depreciation (824) (660)
------ ------
$ 0 $ 164
====== ======
Capital lease obligations of approximately $26,000 were paid during the year
ended July 31, 2000. As of July 31, 2000, there were no remaining capital lease
obligations.
Certain other equipment leases and the Company's obligation under leases for
office space are treated as operating leases and the rentals are expensed as
incurred. Rent expense on these operating leases for the years ended July 31,
2000, 1999, and 1998 totaled approximately $3.9 million, $2.9 million, and $2.6
million, respectively. Generally, the Company's leases provide for renewals for
various periods at stipulated rates.
Future minimum lease obligations on leases in effect at July 31, 2000 are as
follows (in thousands):
Operating
Leases
-------------
2001 $ 2,817
2002 2,748
2003 1,641
2004 909
2005 794
Thereafter 2,918
-------------
Minimum lease payments $ 11,827
============
Note 7 - Revolving Credit Facility
The Company's $3.5 million revolving credit facility bears interest at the
bank's prime rate less 0.25%, or 9.25% as of July 31, 2000, and has been renewed
and extended to November 2001. Under the credit facility, the Company is
required to maintain certain financial covenants. As of July 31, 2000 there were
no borrowings under this credit facility.
Note 8 - Stockholders' Equity
Preferred stock
The Company has authorized 1,000,000 shares of preferred stock which the board
of directors of the Company may issue with such preferences and rights as it may
designate. As of July 31, 2000 and 1999, there were no issued or outstanding
shares of preferred stock.
Employee Stock Purchase Plan
During the year ended July 31, 1998, the Company adopted the Employee Stock
Purchase Plan which allows eligible employees to purchase Company Common Stock
at a 15% discount of
46
<PAGE>
market value. An aggregate of 600,000 shares of Common Stock have been reserved
for issuance upon purchases pursuant to the stock purchase plan. At July 31,
2000 and 1999, the Company has issued approximately 219,000 and 145,000 shares
under the plan, respectively.
Stock options
The Company provides equity incentives to employees and directors by means of
incentive stock options and non-qualified stock options which historically have
been provided under various stock option plans. The Company now issues options
from the 1997 Equity Compensation Plan. Stock options generally vest over a
period of three to five years. The Company may grant non-qualified stock options
at an option price per share determined by the board of directors. Under this
plan, the Company has reserved 1,730,000 shares for issuance as of July 31,
2000. Options generally expire ten years from the date of grant. Activity under
all plans is summarized as follows (in thousands except per share amounts):
Shares Under
Outstanding Options
----------------------------------
Weighted
Outstanding Average
Options Exercise Price
----------- --------------
Balances at July 31, 1997 2,970 $ 1.40
Granted 767 3.72
Exercised (886) 1.19
Expired (287) 3.34
----------- -------------
Balances at July 31, 1998 2,564 $ 1.91
Granted 557 4.60
Exercised (340) 1.67
Expired (69) 3.38
----------- -------------
Balances at July 31, 1999 2,712 $ 1.96
Granted 648 4.41
Exercised (582) 1.01
Expired (293) 4.51
----------- -------------
Balances at July 31, 2000 2,485 $ 3.06
=========== =============
The following table summarizes information about employee stock options
outstanding at July 31, 2000 (in thousands except per share amounts):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Weighted
Weighted Average Weighted
Range of Exercise Average Remaining Number Average
Prices Number Outstanding Exercise Price Contractual Life Exercisable Exercise Price
<S> <C> <C> <C> <C> <C>
$0.01 to $0.87 731 $0.44 4.21 728 $0.42
$3.40 to $4.73 1,550 $4.28 8.15 734 $3.81
$5.00 to $5.91 204 $5.15 8.17 90 $5.07
</TABLE>
47
<PAGE>
Stock-based compensation
Pursuant to Statement of Financial Accounts Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), the Company is required to report pro
forma information regarding net income and net income per share for awards
granted or modified in fiscal years 1996 and thereafter as if the Company had
accounted for its stock-based awards to employees under the fair value method of
SFAS 123. The weighted average fair value of options granted during fiscal 2000,
1999, and 1998 was $2.38, $1.84, and $0.59 per option, respectively. The fair
value of the Company's stock-based awards to employees was estimated using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 2000, 1999 and 1998, respectively: risk-free
interest rates of 6.21%, 4.96%, and 5.76%; no expected dividend yields; expected
lives of 4.50, 3.50, and 3.00 years; and volatility of 60%, 46.11%, and 0%. The
Black-Scholes model was not developed for use in valuing employee stock options,
but was developed for use in estimating the fair value of traded options that
have no vesting restrictions and are fully transferable. In addition, it
requires the use of subjective assumptions including expectations of future
dividends and stock price volatility. Such assumptions are only used for making
the required fair value estimate and should not be considered as indicators of
future dividend policy or stock price appreciation. Because changes in the
subjective assumptions can materially affect the fair value estimate, and
because employee stock options have characteristics significantly different from
those of traded options, the use of the Black-Scholes option-pricing model may
not provide a reliable estimate of the fair value of employee stock options.
For pro forma purposes, the estimated fair value of the Company's stock-based
awards to employees is amortized over the options' vesting period. Such pro
forma impact on net income and net income per share is not necessarily
indicative of future effects on net income or net income per share. The
Company's pro forma information for the years ended July 31 is as follows (in
thousands except per share amounts):
2000 1999 1998
--------- --------- ---------
Net income:
As reported $ 2,509 $ 4,513 $ 3,184
Pro forma $ 1,922 $ 3,972 $ 2,872
Net income per share:
As reported
Basic $ 0.16 $ 0.28 $ 0.25
Diluted $ 0.15 $ 0.26 $ 0.21
Pro forma
Basic $ 0.13 $ 0.25 $ 0.23
Diluted $ 0.11 $ 0.23 $ 0.19
Warrants
In connection with the Merger, the Company assumed warrants with a seven-year
term held by stockholders and a director of FormMaker to purchase Common Stock.
Additional warrants with a three-year term were issued by FormMaker to
stockholders immediately prior to the Merger in connection with $3.0 million of
subordinated notes. All of the above warrants were converted into warrants to
purchase approximately 627,000 shares of Common Stock based on the Merger
exchange ratios.
48
<PAGE>
The following warrants are outstanding as of July 31, 2000 (in thousands except
per share amounts):
Exercise
Price
Warrants Per Share
-------- ---------
Warrants to Safeguard,
Technology Leaders II, L.P., And Technology
Leaders II Offshore C.V 258 $ 0.03
Warrants to a director of the Company 123 $ 3.40
Warrants to Safeguard, Technology
Leaders II, L.P., and TL Venture Third Corp. 246 $ 4.25
-----
Total 627
=====
During fiscal 2000, warrants to purchase an aggregate of 732,000 shares of
Common Stock were exercised at an exercise price per share of $4.17.
Note 9 - Income Taxes
The provision for income taxes charged to operations was as follows (in
thousands):
<TABLE>
<CAPTION>
2000 1999 1998
------- ------- -------
<S> <C> <C> <C>
Current tax expense:
U.S. federal $ 1,012 $ 2,726 $ 1,004
State, local, and foreign 178 330 264
------- ------- -------
Total current 1,190 3,056 1,268
------- ------- -------
Deferred tax expense:
U.S. federal 829 266 1,056
State, local, and foreign 61 18 (84)
------- ------- -------
Total deferred 890 284 972
------- ------- -------
Total provision $ 2,080 $ 3,340 $ 2,240
======= ======= =======
</TABLE>
The provision for income taxes differs from the amount of income taxes
determined by applying the applicable U.S. statutory federal income tax rate to
pre-tax income as a result of the following differences (in thousands):
<TABLE>
<CAPTION>
2000 1999 1998
------- ------- -------
<S> <C> <C> <C>
Statutory U.S. tax rates $ 1,560 $ 2,670 $ 1,899
Increase (decrease) in rates resulting from:
Nondeductible items:
Goodwill 336 335 204
Other 33 51 70
State, local, and foreign taxes (net) 158 230 58
Other (7) 54 9
------- ------- -------
Effective tax rates $ 2,080 $ 3,340 $ 2,240
======= ======= =======
</TABLE>
49
<PAGE>
Deferred tax assets (liabilities) are composed of the following at July 31 (in
thousands):
2000 1999 1998
------- ------- -------
Gross deferred tax assets:
Deferred revenue $ 96 $ 84 $ 7
Loss carryforwards 3,280 3,833 4,209
Tax credit carryforwards 235 235 331
Accounts receivable allowance 305 246 347
Deferred lease costs 173 217 232
Compensation expense related to stock
options 533 994 1,155
Other 728 682 303
------- ------- -------
5,350 6,291 6,584
------- ------- -------
Gross deferred tax liabilities:
Capitalized software (2,832) (2,852) (2,965)
Other (307) (315) (130)
------- ------- -------
(3,139) (3,167) (3,095)
------- ------- -------
Net 2,211 3,124 3,489
Less valuation allowance (800) (2,267) (2,349)
------- ------- -------
Net deferred tax asset $ 1,411 $ 857 $ 1,140
======= ======= =======
At July 31, 2000, the Company had net operating loss carryforwards for federal
income tax purposes of approximately $9.0 million that generally expire in the
years ending 2007 through 2017.
During fiscal 2000 and 1998, the Company released the valuation allowance in the
amount of $1,467,000 and $893,000, respectively, based on management's
assessment of the likelihood of realizability of the Company's loss
carryforwards. In accordance with SFAS 109, the reduction of the valuation
allowance was recorded as a decrease in goodwill related to the Merger and the
acquisition of EZPower.
The Company has approximately $235,000 of general business credit carryforwards.
The tax credit carryforwards generally expire in the years ending 2007 through
2011.
Due to ownership changes, a portion of the Company's net operating loss and tax
credit carryforwards are subject to an annual cumulative limitation with respect
to the amounts which may be utilized in any one year. The Company believes
realization of the net deferred tax asset, net of valuation allowance, to be
more likely than not.
The Company made estimated and regular income tax payments of approximately $1.3
million, $2.6 million, and $525,000 during the years ended July 31, 2000, 1999,
and 1998, respectively.
Note 10 - Retirement Plan
The Company maintains a discretionary defined contribution plan (401(k) plan),
as defined by the United States Internal Revenue Code, which allows participants
to contribute a percentage of their compensation. The plan also allows for a
discretionary matching contribution by the Company as determined by the
Company's board of directors. The Company's matching contributions for the years
ended July 31, 2000, 1999, and 1998 were approximately $490,000, $340,000, and
$140,000, respectively.
50
<PAGE>
Note 11 - Major Customers and Related-Party Transactions
At July 31, 2000 and 1999, Safeguard owned approximately 20% of the Company's
fully diluted outstanding Common Stock. Technology Leaders II, L.P., Technology
Leaders II Offshore C.V., and TL Ventures Third Corp. owned approximately 7% and
5% of the Company's fully diluted outstanding Common Stock at July 31, 2000 and
1999, respectively.
FormMaker historically distributed its line of Document Automation Platform
software products to the insurance industry in North America through an
exclusive marketing agreement with MYND. Revenues from MYND under this agreement
for the year ended July 31, 1998 were approximately $5.5 million. 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 the
Company and MYND allows MYND to market all of the Company's software products to
insurance and financial services companies worldwide. For the years ended July
31, 2000 and 1999, the Company generated revenues of approximately $2.8 million
and $3.7 million, respectively, through the MYND relationship.
In May 1998, the MYND print outsourcing agreement was terminated. The Company
received no ASP hosting revenues from Mynd in fiscal years 2000 or 1999;
however, revenues from under the agreement for the year ended July 31, 1998 were
approximately $4.4 million.
For the year ended July 31, 1999, one customer accounted for approximately 10%
of the Company's total revenues.
Note 12 - Quarterly Financial Information (Unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands except per share amounts)
2000:
Total revenues $12,983 $11,938 $13,015 $14,395
Total expenses 11,666 11,829 12,154 12,705
Operating income 1,317 109 861 1,690
Net income 822 122 524 1,041
Net income per share:
Basic $ 0.05 $ 0.01 $ 0.03 $ 0.07
Diluted 0.05 $ 0.01 $ 0.03 $ 0.06
1999:
Total revenues $12,210 $13,012 $13,225 $13,479
Total expenses 10,602 11,174 11,324 11,595
Operating income 1,608 1,838 1,901 1,884
Net income 1,019 1,122 1,170 1,202
Net income per share:
Basic $ 0.06 $ 0.07 $ 0.07 $ 0.08
Diluted $ 0.06 $ 0.06 $ 0.07 $ 0.07
Net income per share calculations for each period are based on the weighted
average number of shares outstanding in each period; therefore, the sum of the
net income per share amounts for the quarters does not necessarily equal the
year-to-date net income per share amounts.
51
