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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 0-28480
EDIFY CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0250992
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2840 SAN TOMAS EXPRESSWAY
SANTA CLARA, CALIFORNIA 95051
(Address of principal executive offices)
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(408) 982-2000
(Registrant's telephone number, including area code)
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Indicate by checkmark whether the Registrant: (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
(1) Yes [X] No [ ]
As of March 31, 1999, there were 17,660,652 shares of the Registrant's common
stock outstanding.
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EDIFY CORPORATION
FORM 10-Q
INDEX
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<TABLE>
<CAPTION>
PAGE
PART I FINANCIAL INFORMATION NUMBER
<S> <C> <C>
ITEM 1: Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of March 31, 1999 and December
31, 1998................................................................... 3
Condensed Consolidated Statements of Operations for the three months
ended March 31, 1999 and 1998.............................................. 4
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 1999 and 1998.............................................. 5
Notes to Condensed Consolidated Financial Statements........................... 6
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations.............................................................. 9
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk..................... 18
PART II OTHER INFORMATION
ITEM 6: Exhibits and Reports on Form 8-K............................................... 19
Signatures..................................................................... 20
</TABLE>
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PART I: FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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EDIFY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
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<S> <C> <C>
ASSETS
Current assets:
Cash, cash equivalents and short-term investments ... $ 33,394 $ 34,837
Accounts receivable, net ............................ 18,739 22,629
Prepaid expenses and other current assets ........... 2,036 1,920
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Total current assets ........................... 54,169 59,386
Property and equipment, net ............................. 7,579 7,329
Other assets ............................................ 1,285 289
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Total assets ................................... $ 63,033 $ 67,004
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................... $ 3,461 $ 2,744
Current installments of capital lease obligations ... 180 257
Accrued expenses .................................... 7,218 7,749
Unearned revenue .................................... 5,574 4,475
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Total current liabilities ...................... 16,433 15,225
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Deferred rent ........................................... 60 50
Capital lease obligations, excluding current installments 5 20
Commitments and contingencies
Stockholders' equity:
Common stock ........................................ 18 17
Additional paid-in capital .......................... 70,245 69,070
Deferred compensation and other ..................... (45) (63)
Accumulated deficit ................................. (23,683) (17,315)
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Total stockholders' equity ..................... 46,535 51,709
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Total liabilities and stockholders' equity ..... $ 63,033 $ 67,004
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</TABLE>
See notes to condensed consolidated financial statements.
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EDIFY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
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1999 1998
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<S> <C> <C>
Net revenues:
License .................................................. $ 7,796 $ 7,058
Services and other ....................................... 8,169 6,700
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Total net revenues ..................................... 15,965 13,758
Cost of license revenues .................................... 984 296
Cost of services and other revenues ......................... 8,117 4,870
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Gross profit ........................................... 6,864 8,592
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Operating expenses:
Product development ...................................... 3,184 2,534
Sales and marketing ...................................... 8,566 6,784
General and administrative ............................... 1,736 1,274
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Total operating expenses ............................... 13,486 10,592
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Loss from operations ................................... (6,622) (2,000)
Interest income, net ........................................ 350 480
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Loss before income taxes ............................... (6,272) (1,520)
Provision for income taxes .................................. 96 22
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Net loss ............................................... $ (6,368) $ (1,542)
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Basic and diluted net loss per share ........................ $ (0.36) $ (0.09)
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Shares used in computing basic and diluted net loss per share 17,577 16,770
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</TABLE>
See notes to condensed consolidated financial statements.
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EDIFY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
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1999 1998
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss .......................................................... $ (6,368) $ (1,542)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation and amortization ................................... 1,335 1,009
Deferred rent ................................................... 10 1
Changes in operating assets and liabilities:
Accounts receivable ........................................... 3,890 2,849
Prepaid expenses and other current assets ..................... (116) (123)
Accounts payable .............................................. 717 84
Accrued expenses .............................................. (531) (1,305)
Unearned revenue .............................................. 1,099 105
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Net cash provided by operating activities .................. 36 1,078
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CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment, net .......................... (1,567) (1,031)
Purchases of short-term investments ............................... (2,000) (1,998)
Sales and maturities of short-term investments .................... 7,598 9,333
Other assets ...................................................... (996) 4
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Net cash provided by investing activities .................. 3,035 6,308
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CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments under capital lease obligations ................ (92) (102)
Net proceeds from issuance of common stock ........................ 1,176 1,350
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Net cash provided by financing activities .................. 1,084 1,248
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Increase in cash and cash equivalents ................................. 4,155 8,634
Cash and cash equivalents at beginning of period ...................... 24,198 31,790
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Cash and cash equivalents at end of period ............................ $ 28,353 $ 40,424
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Supplemental schedule of cash flow information:
Cash paid during the period for interest .......................... $ 10 $ 27
Cash paid during the period for taxes ............................. $ 18 $ 141
</TABLE>
See notes to condensed consolidated financial statements.
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EDIFY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION
The Company's unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
and, in the opinion of management, reflect all adjustments (consisting only of
normal recurring adjustments) considered necessary to fairly state the Company's
financial position, results of operations and cash flows for the periods
presented. These consolidated financial statements should be read in conjunction
with the Company's audited consolidated financial statements included in the
Company's Form 10-K for the fiscal year ended December 31, 1998. The results of
operations for the three-month period ended March 31, 1999 are not necessarily
indicative of the results to be expected for any subsequent quarter or for the
entire fiscal year ending December 31, 1999. The December 31, 1998 balance sheet
was derived from audited consolidated financial statements, but does not include
all disclosures required by generally accepted accounting principles.
(2) NET LOSS PER SHARE
The computation of diluted net loss per share does not include common
stock issuable under the exercise of outstanding stock options because the
inclusion of these securities would have an anti-dilutive effect. As of March
31, 1999 and 1998, there were 3,859,033 and 2,766,078 stock options outstanding
with weighted-average exercise prices of $7.27 and $8.37, respectively.
(3) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which provides
guidance on accounting for the costs of computer software intended for internal
use. Effective January 1, 1999, the Company adopted SOP 98-1. There was no
material change to the Company's consolidated results of operations or financial
position as a result of the adoption of SOP 98-1.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities," which provides guidance on the accounting for start-up
activities, including organization costs. Effective January 1, 1999, the Company
adopted SOP 98-5. There was no material change to the Company's consolidated
results of operations or financial position as a result of the adoption of SOP
98-5.
In December 1998, AcSEC issued SOP 98-9, "Software Revenue Recognition,
with Respect to Certain Arrangements," which requires recognition of revenue
using the "residual method" in a multiple element arrangement when fair value
does not exist for one
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or more of the delivered elements in the arrangement. Under the "residual
method," the total fair value of the undelivered elements is deferred and
subsequently recognized in accordance with SOP 97-2. There was no material
change to the Company's accounting for revenues as a result of the adoption of
SOP 98-9.
(4) COMMITMENTS
In April 1996, the Company received a letter from Lucent inviting the
Company to negotiate a license of Lucent's patents. Lucent asserted that certain
of the Company's products infringe certain of Lucent's patents and offered to
license those patents to the Company for a substantial payment. In November
1997, the Company received a letter from Lucent in which Lucent made similar
assertions with respect to other patents it holds. In November 1998, the Company
entered into an agreement with Lucent (the "Lucent Settlement"), under which
each party released the other from claims of past infringement and settled their
patent disputes. Under the Lucent Settlement, Edify paid Lucent a one-time fee
of $5 million, which was recorded as intellectual property settlement expense in
1998. The one-time settlement fee released the Company from all claims, demands
and rights of action which Lucent may have on account of any infringement or
alleged infringement of any of Lucent's patents that are covered by the Lucent
Settlement. In connection with the Lucent Settlement, the Company will pay
Lucent a minimum annual royalty fee of approximately $500,000 up to a maximum of
approximately $700,000 in each of the fiscal years from 1999 to 2004. In
addition, in fiscal years 2005 and 2006, if the Company exceeds certain revenue
targets that are specified under the Lucent Settlement, the Company will be
required to pay additional amounts.
The Company is party to various other matters arising in the ordinary
course of its business. In the opinion of management, these proceedings will not
have a material adverse effect on the Company's financial position or results of
operations.
(5) SEGMENT REPORTING
The Company has adopted the provisions of SFAS No. 131, "Disclosure
about Segments of an Enterprise and Related Information." SFAS No. 131
establishes standards for the reporting by public business enterprises of
information about operating segments, products and services, geographic areas
and major customers. The method for determining what information to report is
based on the way management organizes the operating segments within the Company
for making operating decisions and assessing financial performance.
The Company's chief operating decision-maker is considered to be the
Company's Chief Executive Officer ("CEO"). The CEO reviews financial information
presented on a consolidated basis accompanied by disaggregated information about
revenues by product and service line for purposes of making operating decisions
and assessing financial performance. The Company operates in three operating
segments: software, post-contract customer support services and application
development consulting services.
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Net revenue information regarding the Company's operating segments are
as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
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1999 1998
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<S> <C> <C>
Net revenues:
Software ......................... $ 7,796 $ 7,058
Post-contract customer support ... 2,946 2,050
Application development consulting 4,512 3,916
Other ............................ 711 734
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Total net revenues .......... $ 15,965 $ 13,758
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</TABLE>
The Company's export sales are principally in Europe and Asia/Pacific.
In each of the quarterly periods ended March 31, 1999 and 1998, 2% or less of
the Company's total net revenues were derived from international sales.
Accordingly, the Company does not produce reports that measure performance of
revenues by geographic region.
The Company evaluates the performance of its operating segments based
on revenues only. The Company does not assess the performance of its segments on
other measures of income or expense, such as depreciation and amortization,
operating income or net income. In addition, as the Company's assets are
primarily located in its corporate office in the United States and not allocated
to any specific segment, the Company does not produce reports that measure the
performance based on any asset-based metrics.
Therefore, segment information is presented only for revenues.
No single customer accounted for greater than 10% of revenues in any
period presented.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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This Form 10-Q contains forward-looking statements that involve risks
and uncertainties. For example, statements including terms such as we "expect,"
"believe" or "anticipate" are forward-looking statements. Forward-looking
statements are subject to risks and uncertainties. Investors should be aware
that our actual results may differ materially from those indicated by these
statements. Factors that could cause or contribute to such differences include
those set forth below in "Factors That May Affect Future Operating Results" as
well as those discussed in the "Business Risks" section included in our Form
10-K for the fiscal year ended December 31, 1998.
RESULTS OF OPERATIONS
NET REVENUES
Total net revenues were $16.0 million for the quarter ended March 31,
1999 as compared to $13.8 million for the comparable 1998 quarter, representing
an increase of 16.0%. We derive our revenues principally from software licenses
and fees for services, which generally are charged separately. Revenues are
recorded net of reserves for potential product returns. In the quarters ended
March 31, 1999 and 1998, international sales accounted for 2% or less of our
total net revenues. Over time, we intend to expand our international operations
and enter additional international markets. International operations entail a
number of risks including those associated with product customization and
regulatory compliance, and we cannot assure you that our expansion will be
successful.
LICENSE REVENUES. License revenues were $7.8 million for the quarter
ended March 31, 1999 as compared to $7.1 million for the comparable 1998
quarter. The increase in license revenues was due to an increase in unit volume
as a result of the market's growing awareness and acceptance of Electronic
Banking System and Employee Service System and increased follow-on business from
existing customers. We do not believe that the historical growth rates of
license revenues are indicative of future results.
SERVICES AND OTHER REVENUES. Services and other revenues consist
primarily of fees from consulting, post-contract customer support and, to a
lesser extent, education services. Services and other revenues were $8.2 million
for the quarter ended March 31, 1999 as compared to $6.7 million for the
comparable 1998 quarter. Services and other revenues as a percentage of total
net revenues increased to 51.2% for the quarter ended March 31, 1999 from 48.7%
for the quarter ended March 31, 1998. The increase in services and other
revenues in absolute dollars and as a percentage of total net revenues occurred
primarily due to increased demand for consulting services and post-contract
customer support associated with the increased installed base of our software.
We do not expect historical growth rates of
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our services revenues to be sustainable. Overall gross profit margins may
decrease if services and other revenues becomes a higher percentage of total net
revenues.
COST OF REVENUES
COST OF LICENSE REVENUES. Cost of license revenues consists primarily
of the cost of product media, product duplication, documentation and royalties
paid to third parties under technology licenses. Cost of license revenues was
$984,000, or 12.6% of the related license revenues, for the quarter ended March
31, 1999, and $296,000, or 4.2% of the related license revenues, for the quarter
ended March 31, 1998. The increase in the cost of license revenues in absolute
dollars and as a percentage of license revenues for the comparable quarters was
due primarily to the increased number of software deals which incorporated
third-party speech-recognition products. As we expect to continue to use
third-party technologies as part of our Internet and voice e-Commerce solutions,
we anticipate that the cost of license revenues as a percentage of license
revenues for fiscal year 1999 will exceed what we experienced in fiscal year
1998.
COST OF SERVICES AND OTHER REVENUES. Cost of services and other
revenues consists primarily of personnel-related costs and fees for third-party
consultants incurred in providing consulting, post-contract customer support and
education services to customers. Cost of services and other revenues was $8.1
million, or 99.4% of the related services and other revenues, for the quarter
ended March 31, 1999, and $4.9 million, or 72.7% of the related services and
other revenues, for the quarter ended March 31, 1998. The increase in absolute
dollars for the comparable quarters was due primarily to the increase in
personnel-related costs as we continued to expand our consulting and customer
support organizations. The decrease in gross profit margins resulted primarily
from a mismatch between specific service resources available and the particular
customer service demands that we encountered during the quarter, and an increase
in non-billable service work to complete several significant projects. The cost
of services and other revenues as a percentage of services and other revenues
may vary between periods due to the amount and mix of services that we provide
and to varying levels of expenditures to build the services organization. Any
significant decline in the demand for our consulting services would have a
material adverse impact on our revenues and, as a result of the
under-utilization of consulting personnel, on our gross profit and results of
operations.
PRODUCT DEVELOPMENT
Product development expenses were $3.2 million, or 19.9% of total net
revenues, for the quarter ended March 31, 1999, and $2.5 million, or 18.4% of
total net revenues, for the quarter ended March 31, 1998. Product development
expenses consist primarily of salaries and other related expenses for research
and development personnel, as well as the cost of facilities and depreciation of
capital equipment. The increase in absolute dollars and as a percentage of total
net revenues for the comparable quarters was attributable primarily to increased
staffing related to ongoing development and enhancements of Electronic Workforce
and our application products, Electronic Banking System and Employee Service
System. We believe that significant investments in product development are
required to
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remain competitive. As a result, we expect that product development expenses
will increase in absolute dollars in the future and will not decline
significantly as a percentage of total net revenues from their current levels.
In accordance with SFAS No. 86, we expect to capitalize eligible
computer software development costs upon the achievement of technological
feasibility, subject to net realizable value considerations. We have defined
technological feasibility as completion of a working model. To date, we believe
our process for developing software was essentially completed concurrently with
the establishment of technological feasibility and, accordingly, no software
development costs have been capitalized in the accompanying consolidated balance
sheet.
SALES AND MARKETING
Sales and marketing expenses were $8.6 million, or 53.7% of total net
revenues, for the quarter ended March 31, 1999, and $6.8 million, or 49.3% of
total net revenues, for the quarter ended March 31, 1998. Sales and marketing
expenses consist primarily of salaries and commissions earned by sales and
marketing personnel and promotional expenses. The increase in absolute dollars
and as a percentage of total net revenues for the comparable quarters was due
primarily to the expansion of our field and indirect sales operations and
increased marketing activities. We expect to continue to expand our field sales
and marketing efforts, our third-party value added reseller (VAR) distribution
channel and our international operations and, therefore, we anticipate that
sales and marketing expenditures will increase in absolute dollars in the
future. In addition, sales and marketing expenses as a percentage of total net
revenues may fluctuate between periods due to varying levels of expenditures to
build the sales and marketing organizations.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $1.7 million, or 10.9% of
total net revenues, for the quarter ended March 31, 1999, and $1.3 million, or
9.3% of total net revenues, for the quarter ended March 31, 1998. General and
administrative expenses consist primarily of salaries and other related expenses
of administrative, executive and financial personnel and outside professional
fees. The increase in absolute dollars and as a percentage of total net revenues
for the comparable quarters was attributable primarily to the addition of a
business development function in 1999 and a general increase in other
infrastructure costs to support the growth of our business, which were offset
slightly by a decrease in the provision for doubtful accounts. We expect to
continue to expand our staffing and other areas related to infrastructure and,
therefore, we anticipate that general and administrative expenses will increase
in absolute dollars in the future.
INTEREST INCOME, NET
Interest income, net was $350,000 for the quarter ended March 31, 1999
as compared to $480,000 for the quarter ended March 31, 1998. For the quarter
ended March 31, 1999, interest income, net consists primarily of interest earned
from our cash, cash equivalents and short-term investments. The decrease in
absolute dollars is due to decreases in the average
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investment balance and average interest rate in the quarter ended March 31, 1999
as compared to the quarter ended March 31, 1998.
PROVISION FOR INCOME TAXES
The provision for income taxes was $96,000 for the quarter ended March
31, 1999, and $22,000 for the quarter ended March 31, 1998. For the three months
ended March 31, 1999 and 1998, the provision for income taxes relates primarily
to state income and foreign withholding taxes.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, our cash, cash equivalents and short-term
investments totaled $33.4 million. At March 31, 1999, we also had available an
$8.0 million unsecured revolving bank line of credit agreement which expires in
December 1999 and contains certain financial covenants, with which we were in
compliance. Borrowings accrue interest at the bank's prime rate. As of March 31,
1999, there were no borrowings outstanding under this line of credit.
For the three months ended March 31, 1999, operating activities
provided cash of $36,000, resulting primarily from depreciation and amortization
of $1.3 million, a decrease in accounts receivable of $3.9 million and an
increase in unearned revenues of $1.1 million, which were offset by the net loss
of $6.4 million. Investing activities provided cash of $3.0 million from the net
sale and maturity of $5.6 million of short-term investments, which was offset by
the purchase of property and equipment of $1.6 million and an increase in other
assets of $996,000. We expect that our capital expenditures will increase as our
employee base grows. Net cash generated from financing activities of $1.1
million was related primarily to proceeds from the issuance of common stock
through our Employee Stock Purchase Plan.
At March 31, 1999, our working capital was $37.7 million. We have no
significant capital spending or purchase commitments other than normal purchase
commitments, commitments under our facilities and capital leases and our
commitment to pay royalty fees under our settlement with Lucent (see Note 4 of
the Condensed Consolidated Financial Statements). We believe that our working
capital, together with our bank line of credit and anticipated cash flows from
operations, if any, will be sufficient to meet our working capital and capital
expenditure requirements for at least the next twelve months.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Except for the historical information contained in this Form 10-Q, the
matters discussed herein are forward-looking statements. These forward-looking
statements concern matters which include, but are not limited to, the
sustainability of historical revenue growth rates, our expected mix of revenues,
expected gross margins on license revenues and services and other revenues,
expected operating expense levels and our liquidity and capital needs. These
matters involve risks and uncertainties that could cause actual results to
differ materially from those in the forward-looking statements. Investors should
be aware that
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revenue levels and results of operations achieved during the quarter ended March
31, 1999 do not necessarily indicate future financial results. We may be unable
to achieve or sustain profitability or experience growth in revenues in any
future quarter. Our revenues, margins and operating results have fluctuated in
the past, and are expected to continue to fluctuate in future periods due to
factors including, but not limited to, the following: demand for our products;
new products and product enhancements; sales force initiatives; transitions to
new products; the mix of products and services sold; the mix of distribution
channels through which our products are sold; customer order deferrals in
anticipation of new products or product enhancements; purchasing patterns of
value added resellers and customers; hiring and expense budgeting decisions and
competitive conditions in the industry. In particular, we plan to increase our
operating expenses to expand our sales and marketing operations, expand our
distribution channels, expand our international operations, fund greater levels
of product development, broaden our consulting services and customer support
capabilities and increase our administrative infrastructure. A relatively high
percentage of our expenses is fixed in the short term as our expense levels are
based, in part, on our expectations as to future revenues. If revenues fall
below expectations, expenditure levels could be disproportionately high as a
percentage of total net revenues, and operating results would be immediately and
adversely affected.
We historically have operated with little backlog because we generally
ship products as orders are received. As a result, license revenues in any
quarter depend on the volume and timing of, and our ability to fill, orders
received in that quarter. Individual orders for our products typically are for
relatively large dollar amounts. We also believe the purchase of our products is
relatively discretionary and generally involves a significant commitment of
capital resources. Therefore, any downturn in any potential customer's business,
or any loss or delay of individual orders for any reason, could have a
significant impact on our revenues and quarterly results. In addition, because
we typically recognize a substantial portion of our total revenue from
transactions booked and shipped in the last weeks, or even days, of the quarter,
the magnitude of quarterly fluctuations may not become evident until very late
in a particular quarter. Revenues are difficult to forecast because the market
for our products is rapidly evolving.
Based upon the above factors, we believe that our quarterly revenues,
expenses and operating results could vary significantly in the future and that
investors should not rely upon period-to-period comparisons as indications of
future performance. We may not be able to grow in future periods, sustain our
level of total net revenues or increase or sustain our rate of revenue growth on
a quarterly or annual basis. It is likely that, in some future quarters, our
operating results will fall below the expectations of stock market analysts and
investors, and consequently, the price of our common stock may decline.
Our future success will depend on our ability to develop, sell,
implement and support new software products and enhancements of our current
products on a timely basis. In June 1998, we began to ship the large-scale
version of our Electronic Workforce product, EWF/LS, for the high-end call
center market. In December 1998, we shipped Electronic Banking Release 3, which
incorporates end-to-end support for online bill presentment and payment and the
industry's first internet banking module designed specifically for commercial
banks' small business customers. In addition, in February 1999, we introduced
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Electronic Workforce Release 6, which contains speech-recognition capabilities
and software-only fax solution. Because these products are still relatively new,
many customers licensing these versions have not yet fully deployed these
products and undetected errors may remain in these versions. The existence of
any such errors may delay the release of future versions and adversely affect
the acceptance of these products, either of which could have a material adverse
effect on our business, operating results and financial condition. Furthermore,
we cannot assure you that we will be able to respond to changing customers
needs, competition, technological developments and emerging industry standards
and continue to develop new versions of these products successfully or in a
timely manner.
Our future success will depend also on our ability to convert existing
customers to the Microsoft Windows NT operating platform. Initial product
versions through 4.x of Electronic Workforce and 1.x of EBS and ESY run on IBM's
OS/2 operating system. In October 1997, we released our first version of
Electronic Workforce Release 5 for the Windows NT operating system, and
subsequently, in December 1997, we released initial Windows NT versions of EBS
and ESY. By transitioning to the Windows NT platform, our products are able to
provide an extended open architecture, enhanced visual development tools and
large-scale deployment for high-end applications. However, some features of the
OS/2 versions of our software are unavailable on currently available Windows
NT-based versions. Accordingly, we are devoting significant engineering and
development resources to enhance versions of our products that run on the
Windows NT operating system. Because our Windows NT-based product versions may
lack some features, potential customers may defer or forgo purchases of current
or future versions of these products, which could have a material adverse effect
on our business, financial condition and results of operations.
We intend to invest a significant majority of our product development
resources on products and product enhancements for the Windows NT operating
system. We must manage the effect on our existing OS/2 customers of this focus
on the Windows NT operating system. Updates to and enhancements for our
OS/2-based products may not be sufficient to encourage our OS/2 customers to
continue to purchase additional software or services from us. In addition, we
must provide our customers with an economically reasonable and technologically
feasible migration path from the OS/2-based products to the Windows NT-based
products. We cannot assure you that our OS/2 customers will migrate to our
Windows NT-based products. The failure of a significant number of our existing
OS/2 customers to purchase additional software or services from us, for any
reason, would have a material adverse effect on our business, operating results
and financial condition.
In April 1996, we received a letter from Lucent inviting us to
negotiate a license of Lucent's patents. Lucent asserted that some of our
products infringe some of Lucent's patents and offered to license those patents
to us for a substantial payment. In November 1997, we received a letter from
Lucent in which Lucent made similar assertions with respect to other patents it
holds. In November 1998, we entered into an agreement with Lucent, under which
each party released the other from claims of past infringement and settled our
patent disputes. Under the settlement agreement, we paid Lucent a one-time fee
of $5 million in 1998. The one-time settlement fee released us from all claims,
demands and rights of action which Lucent may have on account of any
infringement or alleged infringement of any of Lucent's patents that are covered
by the settlement agreement. In connection with the
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<PAGE> 15
settlement agreement, we will pay Lucent a minimum annual royalty fee of
approximately $500,000 up to a maximum of approximately $700,000 in each of the
fiscal years from 1999 to 2004. In addition, in fiscal years 2005 and 2006, if
we exceed certain revenue targets that are specified under the settlement
agreement, we will be required to pay additional amounts.
In the future, we may receive additional communications from other
parties asserting that our products, trademarks or other proprietary rights
require a license of intellectual property rights or infringe, or may infringe,
on their property rights. As the number of software products in the industry
increases, and the functionality of these products further overlaps, we believe
that software developers may become increasingly subject to infringement claims.
Any such claims, with or without merit, could be time consuming, result in
costly litigation, cause product shipment delays or require us to enter into
royalty or licensing agreements. If required, royalty or licensing agreements
with other parties may be unavailable on terms acceptable to us, or at all,
which could have a material adverse effect on our business, financial condition
and results of operations. In addition, we may initiate claims or litigation
against third parties for infringement of our proprietary rights or to validate
our proprietary rights. Litigation to validate any claims could result in
significant expense to us and divert the efforts of our technical and management
personnel from productive tasks, whether or not such litigation is determined in
our favor. If we receive an adverse ruling in any litigation, we may be required
to pay substantial damages, discontinue the use and sale of infringing products,
expend significant resources to develop non-infringing technology or obtain
licenses to infringing technology. Our failure to develop or license a
substitute technology could have a material adverse effect on our business,
financial condition and results of operations.
An integral part of our strategy is to develop multiple distribution
channels, including a field sales force, VARs and OEMs. We intend to increase
our reliance on third-party distribution partners in the future. We are
expending and intend to continue to expend significant resources to develop the
VAR channel. VARs and OEMs are not, however, subject to any minimum purchase or
resale requirements and can cease marketing our products at any time. Some VARs
and OEMs may offer competing products that they produce or that are produced by
third parties. We cannot assure you that our existing VARs will continue to
provide the level of services and technical support necessary to provide a
complete self service solution to our customers, that they will transition
smoothly to sales of new products or enhancements of existing products or that
they will not emphasize their own or third-party products to the detriment of
our products. The loss of VARs, the failure of such parties to perform under
agreements with us or our inability to attract and retain new VARs with the
technical, industry and application expertise required to market our products
successfully in the future could have a material adverse effect on our business,
financial condition and results of operations. If we increase our sales through
VARs, those sales will be at discounted rates, and our revenue for each VAR sale
will be less than if we had licensed the same products to the customer directly.
Many currently installed computer systems and software products are
coded to accept two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As the year 2000
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<PAGE> 16
approaches, many companies may need to upgrade their computer systems and
software to comply with such "Year 2000" requirements.
We are currently taking steps to address Year 2000 issues in the
following three areas: (1) our products; (2) internal systems; and (3) readiness
of third-party vendors and business partners. We have assigned a Year 2000
project team to develop and implement the Year 2000 readiness effort for our
domestic and international operations. The project has executive sponsorship and
is regularly reviewed by senior management, the Board of Directors and the Audit
Committee.
We have designed and tested our current products to be Year 2000
compliant. However, since we cannot anticipate all customer situations,
particularly those involving third-party products, we may see an increase in
warranty and other claims as a result of the Year 2000 transition. As such, the
impact of customer claims could have a material adverse impact on our business,
financial condition and results of operations.
Our internal systems include both information technology systems such
as financial and order entry systems and non-information technology systems such
as telephones and facilities. In August 1998, we completed the installation of a
Year 2000 compliant enterprise resource planning (ERP) system, which includes
our order entry, project accounting and financial systems. In addition, we have
substantially completed a comprehensive inventory and evaluation of all desktop
systems. We expect to resolve Year 2000 compliance issues that have been
identified substantially through normal replacement and upgrades of software by
June 1999. The remaining costs of remediation are not expected to be material to
our financial condition or results of operations. However, if we identify
significant new non-compliance issues, our business, financial condition and
results of operations could be materially adversely affected.
In December 1998, we completed the process of sending detailed
questionnaires to critical suppliers and business partners to certify Year 2000
compliance. Where practicable, we will attempt to mitigate our risk with respect
to the failure of suppliers and business partners to be Year 2000 ready.
However, such failures remain a possibility and could have an adverse impact on
our business, financial condition and results of operations.
We have estimated a preliminary budget of approximately $300,000 for
investigating and remedying issues related to Year 2000 compliance involving
software or systems used in our internal operations. Costs that have already
been incurred to replace and upgrade software and systems in our ordinary course
of business are excluded from the estimated budget. To date, we have incurred
expenditures of approximately $111,000 directly associated with Year 2000
issues. These costs were incurred primarily for outside consultants. We do not
track internal Year 2000 compliance costs, which consist principally of
payroll-related costs for our information systems group.
While we have dedicated substantial resources towards attaining Year
2000 compliance, our Year 2000 compliance program may not be completed on a
timely basis. In addition, we cannot assure you that there will not be
interruption of operations or other limitations of system functionality or that
we will not incur substantial costs to avoid such
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<PAGE> 17
limitations. Any failure to effectively monitor, implement or improve our
operational, financial, management and technical support systems could have a
material adverse effect on our business, financial condition and results of
operations. Furthermore, we believe that Year 2000 issues may affect the
purchasing patterns of customers and potential customers as companies may expend
significant resources to correct or patch their current software systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase software products such as those offered by us, which could have a
material adverse effect on our business, financial condition and results of
operations. In addition, even if our products are Year 2000 compliant, other
systems or software used by our customers may not be Year 2000 compliant. The
failure of such non-compliant third-party software or systems could affect the
perceived performance of our products, which could have a material adverse
effect on our business, financial condition and results of operations.
The most likely worst case scenarios would include hardware failure and
the failure of infrastructure services provided by government agencies, systems
vendors and other third parties (e.g., electricity, telephone service, water
transport, internet services, etc.). We are in the process of completing our
contingency planning for high risk areas at this time, and we are scheduled to
commence contingency planning for medium to low risk areas in the second quarter
of this year. We expect our contingency plans to include, among other things,
manual "work-arounds" for software and hardware failures, as well as
substitution of systems, if necessary.
In addition to the conditions discussed above, other factors that could
cause actual results to differ materially include the following: demand for and
market acceptance of application products; our ability to deliver on time, and
market acceptance of, new products or upgrades of existing products; customer
order deferrals in anticipation of new products; the timing of, or delay in,
large customer orders; continued availability of technology and intellectual
property license rights; changes in the mix of distribution channels through
which our products are offered; competitive conditions in the industry; risks
associated with global operations; general economic conditions; and the
"Business Risks" listed from time to time in reports that we file with the U.S.
Securities and Exchange Commission, including but not limited to our Form 10-K
for the fiscal year ended December 31, 1998.
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<PAGE> 18
- --------------------------------------------------------------------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
MARKET RISK DISCLOSURES
The following discussion about our market risk disclosures contains
forward-looking statements. Forward-looking statements are subject to risks and
uncertainties. Actual results could differ materially from those discussed in
the forward-looking statements. We are exposed to market risk related to changes
in interest rates and foreign currency exchange rates. We do not have derivative
financial instruments for hedging, speculative or trading purposes.
INTEREST RATE SENSITIVITY
We maintain a short-term investment portfolio consisting mainly of
income securities with an average maturity of less than one year. These
available-for-sale securities are subject to interest rate risk and will fall in
value if market interest rates increase. We have the ability to hold our fixed
income investments until maturity, and therefore, we do not expect a sudden
change in market interest rates on our securities portfolio to affect our
operating results or cash flows significantly.
Our cash equivalents and short-term investments are classified as
available-for-sale. Gross unrealized gains and losses were not significant as of
March 31, 1999.
The following table presents the principal amounts and related
weighted-average yields for our fixed rate investment portfolio (in thousands,
except average yields):
<TABLE>
<CAPTION>
CARRYING AVERAGE
AMOUNT YIELD
------------ ------------
<S> <C> <C>
Cash equivalents:
Commercial paper $ 9,434 4.92%
Government agency securities 8,164 4.80%
Money market funds 4,614 5.57%
U.S. Treasury bills 623 4.81%
------------
Total cash equivalents 22,835 5.01%
Short-term investments:
Government agency securities 3,029 5.03%
Corporate bonds 2,012 5.18%
------------
Total short-term investments 5,041 5.09%
------------
Total cash equivalents and short-term investments $ 27,876 5.02%
============
</TABLE>
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<PAGE> 19
- --------------------------------------------------------------------------------
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are being filed as part of this Report:
27.1 Financial Data Schedule.
(b) Reports on Form 8-K:
No report on Form 8-K has been filed for the quarterly period
ended March 31, 1999.
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<PAGE> 20
- --------------------------------------------------------------------------------
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.
EDIFY CORPORATION
Date: May 13, 1999 By: /s/ Stephanie A. Vinella
----------------------------------------
Stephanie A. Vinella
Vice President of Finance and Administration,
Chief Financial Officer and Secretary
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<PAGE> 21
- --------------------------------------------------------------------------------
EDIFY CORPORATION
FORM 10-Q
EXHIBIT INDEX
- --------------------------------------------------------------------------------
EXHIBITS
27.01 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 28,353
<SECURITIES> 5,041
<RECEIVABLES> 20,925
<ALLOWANCES> (2,186)
<INVENTORY> 0
<CURRENT-ASSETS> 54,169
<PP&E> 20,556
<DEPRECIATION> (12,977)
<TOTAL-ASSETS> 63,033
<CURRENT-LIABILITIES> 16,433
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 46,517
<TOTAL-LIABILITY-AND-EQUITY> 63,033
<SALES> 7,796
<TOTAL-REVENUES> 15,965
<CGS> 984
<TOTAL-COSTS> 9,101
<OTHER-EXPENSES> 13,486
<LOSS-PROVISION> 241
<INTEREST-EXPENSE> (350)
<INCOME-PRETAX> (6,272)
<INCOME-TAX> 96
<INCOME-CONTINUING> (6,368)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,368)
<EPS-PRIMARY> (0.36)
<EPS-DILUTED> (0.36)
</TABLE>
