<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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: 0-27358
DOCUMENTUM, INC.
(exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
Delaware 95-4261421
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6801 Koll Center Parkway, Pleasanton, California 94566-3145
(Address of principal executive offices) (Zip Code)
</TABLE>
(Registrant's telephone number, including area code): (925) 600-6800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Nasdaq National Market
Common Stock, $0.001 par value
(Title of Class)
Indicate by check mark whether the registrant 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.
Yes X No .
- ---
The number of outstanding shares of the registrant's Common Stock, par value
$0.001 per share, was 16,402,934 on September 30, 1999.
<PAGE>
FORM 10-Q
Index
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
<S> <C> <C>
Condensed Consolidated Balance Sheets as of September 30, 1999 and December
31, 1998........................................................................ Page 3
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 1999 and 1998............................................... Page 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 1999 and 1998..................................................... Page 5
Notes to Condensed Consolidated Financial Statements............................ Page 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations...................................................................... Page 9
Item 3. Qualitative and Quantitative Disclosures About Market Risk...................... Page 22
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................ Page 23
Signatures.................................................................................... Page 24
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ---------------------------------------------------
DOCUMENTUM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data; unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
------------- ------------
1999 1998
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................... $ 12,127 $ 16,240
Short-term investments...................................... 66,375 84,203
Accounts receivable, net of allowances of $2,425
and $2,496, respectively.............................. 34,623 32,745
Other current assets........................................ 8,481 8,192
--------- ---------
Total current assets..................................... 121,606 141,380
Property and equipment, net..................................... 25,904 13,426
Other assets.................................................... 6,168 5,843
========= =========
$ 153,678 $ 160,649
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................ $ 5,078 $ 3,176
Accrued liabilities......................................... 23,438 26,170
Deferred revenue............................................ 22,689 14,490
Current portion of long term debt........................... 145 -
--------- ---------
Total current liabilities................................ 51,350 43,836
--------- ---------
Long term debt.................................................. 147 -
--------- ---------
Stockholders' equity:
Preferred stock, $0.001 par value; 5,000 shares authorized
none issued and outstanding.............................. - -
Common stock, $0.001 par value; 100,000 shares authorized;
16,403 and 16,707 shares issued and outstanding.......... 16 17
Additional paid-in capital.................................. 129,729 135,849
Accumulated other comprehensive income...................... 104 52
Accumulated deficit......................................... (27,668) (19,105)
--------- ---------
Total stockholders' equity............................... 102,181 116,813
========= =========
$ 153,678 $ 160,649
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
DOCUMENTUM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
License................................................. $ 19,503 $ 21,562 $ 46,589 $ 57,329
Service................................................. 14,273 12,321 40,422 30,063
-------- -------- -------- --------
Total revenue.......................................... 33,776 33,883 87,011 87,392
-------- -------- -------- --------
Cost of revenue:
License................................................. 1,317 944 3,864 2,851
Service................................................. 7,765 7,272 23,300 18,278
-------- -------- -------- --------
Total cost of revenue.................................. 9,082 8,216 27,164 21,129
-------- -------- -------- --------
Gross profit............................................... 24,694 25,667 59,847 66,263
-------- -------- -------- --------
Operating expenses:
Sales and marketing..................................... 15,787 13,823 43,054 36,239
Research and development................................ 6,212 5,391 18,765 12,764
General and administrative.............................. 5,613 2,635 13,944 7,355
Acquisition and related costs........................... - - - 2,171
Purchased in process research and development........... - 34,622 - 34,622
-------- -------- -------- --------
Total operating expenses............................... 27,612 56,471 75,763 93,151
-------- -------- -------- --------
Loss from operations....................................... (2,918) (30,804) (15,916) (26,888)
-------- -------- -------- --------
Interest and other income, net............................. 809 1,112 2,942 3,256
-------- -------- -------- --------
Loss before income tax provision (benefit)................. (2,109) (29,692) (12,974) (23,632)
Provision for (benefit from) income taxes.................. (717) 1,676 (4,411) 4,075
======== ======== ======== ========
Net loss................................................... $ (1,392) $ (31,368) $ (8,563) $ (27,707)
======== ======== ======== ========
Basic and diluted loss per share........................... $ (0.08) $ (1.90) $ (0.51) $ (1.72)
======== ======== ======== ========
Shares used to compute basic and diluted loss per share.... 16,512 16,500 16,718 16,072
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
DOCUMENTUM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (8,563) $(27,707)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciaition and amortization.......................... 6,089 3,931
Provision for doubtful accounts......................... (71) 687
Gain on sale of fixed assets............................ (143) -
In process research and development write-off........... - 34,622
Changes in assets and liabilities:
Accounts receivable................................... (1,807) (6,283)
Other current assets and other assets................. (614) (8,833)
Accounts payable...................................... 1,902 1,977
Accrued liabilities................................... (2,732) 5,021
Deferred revenue...................................... 8,199 4,616
-------- --------
Net cash provided by operating activities........... 2,260 8,031
-------- --------
Cash flow from investing activities:
Purchase of short-term investments........................ (73,556) (74,716)
Sales of investments...................................... 91,384 72,753
Purchases of property and equipment....................... (18,424) (6,575)
Other..................................................... - (1,451)
-------- --------
Net cash used in investing activities............... (596) (9,989)
-------- --------
Cash flows from financing activities:
Issuance of common stock.................................. 3,941 4,205
Repurchase of common stock................................ (10,062) -
Repayment on loan......................................... - (330)
Proceeds from debt........................................ 292 -
-------- --------
Net cash provided by (used in) financing
activities......................................... (5,829) 3,875
-------- --------
Effect of exchange rate on changes in cash.................. 52 138
-------- --------
Net increase (decrease) in cash and cash equialents......... (4,113) 2,055
Cash and cash equivalents at beginning of period............ 16,240 14,236
-------- --------
Cash and cash equivalents at end of period.................. 12,127 16,291
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
DOCUMENTUM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of presentation
The unaudited condensed consolidated financial statements of Documentum
included herein reflect all adjustments, consisting only of normal recurring
adjustments, which in the opinion of management are necessary to present fairly
the Company's consolidated financial position, results of operations and cash
flows for the periods presented. These financial statements should be read in
conjunction with the Company's audited consolidated financial statements
included in the Company's 1998 Annual Report on Form 10-K. The consolidated
results of operations for the period ended September 30, 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.
Reclassifications
Certain prior period balances have been reclassified to conform to current
year presentation.
Comprehensive net income
Comprehensive income is comprised of net income (loss) and other
comprehensive earnings such as foreign currency translation gain/loss and
unrealized gains or losses on available-for-sale marketable securities. The
Company's unrealized gains and losses on available-for-sale marketable
securities have been insignificant for all periods presented. Documentum's total
comprehensive losses were as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss........................... $(1,392) $(31,368) $(8,563) $(27,707)
Other comprehensive income.........
Foreign translation adjustment... 347 109 52 138
------- -------- ------- --------
Comprehensive net loss......... (1,045) (31,259) (8,511) (27,569)
======= ======== ======= ========
</TABLE>
Revenue recognition
The Company's revenue is derived from the sale of perpetual licenses for its
content management and web application software and related services which
include maintenance and support, consulting and training services. Revenue from
license arrangements are recognized upon shipment of the product if collection
of the resulting receivable is probable. If a vendor obligation exists under the
license arrangement, revenue is deferred based on vendor-specific objective
evidence of the undelivered element. If vendor-specific objective evidence does
not exist for all undelivered elements, all revenue is deferred until sufficient
evidence exists or all elements have been delivered. Allowances for estimated
future returns are provided upon shipment. Payments received in advance of
revenue recognition are recorded as deferred revenue. Revenue from annual
maintenance and support is deferred and recognized ratably over the term of the
contract. Revenue from consulting and training is deferred and recognized when
the services are performed and collectibility is deemed probable. During 1998,
the Company recognized revenue in accordance with Statement of Position No. 97-2
("SOP 97-2"), "Software Revenue Recognition". In December 1998, the American
Institute of Certified Public Accountants ("AICPA") issued Statement of Position
No. 98-9 ("SOP 98-9"), "Modification of SOP 97-2, Software Revenue Recognition,
with Respect to Certain Transactions." The provisions of SOP 98-9 have been
adopted for transactions entered into during the fiscal year beginning January
1, 1999. The adoption of SOP 98-9 did not have a material impact on revenue
recognized during the three and nine months ended September 30, 1999.
For the three months ended September 30, 1999, the Company had sales to a
single customer in the amount of $4.5 million representing 13% of total revenues
for the period. For the three months ended September 30, 1998, the
6
<PAGE>
DOCUMENTUM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Company had sales to another single customer in the amount of $3.7 million
representing 11% of total revenue for that period.
Net income (loss) per share
Basic net income (loss) per share is computed using the weighted average
number of shares of common stock. Diluted net income (loss) per share is
computed using the weighted average number of shares of common stock and common
equivalent shares outstanding during the period. Common equivalent shares
consist of stock options (using the treasury stock method). Common equivalent
shares are excluded from the computation if their effect is antidilutive.
The following is a reconciliation of the computation for basic and diluted
loss per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss..................................... $ (1,392) $ (31,368) $ (8,563) $ (27,707)
-------- --------- -------- ---------
Shares calculation
Average basic shares outstanding........ 16,512 16,500 16,718 16,072
Effect of dilutive options.............. - - - -
-------- --------- -------- ---------
Total shares used to compute
diluted earnings per share........... 16,512 16,500 16,718 16,072
======== ========= ======== =========
Loss per basic and diluted share............. $ (0.08) $ (1.90) $ (0.51) $ (1.72)
======== ========= ======== =========
</TABLE>
Options to purchase 3,161,353 and 1,514,704 shares of common stock were
outstanding during the three months ended September 30, 1999 and September 30,
1998, respectively, and 3,485,766 and 1,328,786 shares of common stock were
outstanding during the nine months ended September 30 1999 and September 30
1998, respectively, but were not included in the computation of diluted loss per
share because either the option's exercise price was greater than the average
market price of the common shares during the period or inclusion of such options
would have been anti-dilutive.
Business acquisition
On January 5, 1998, the Company acquired all the outstanding shares of WMI,
a privately-held company, in exchange for 192,473 shares of the Company's common
stock valued on the transaction date at approximately $6.7 million. The
acquisition was accounted for as a pooling of interests on the date of
acquisition. WMI was a professional services firm with approximately 35
employees located in Oakland, California specializing in the design, development
and implementation of document management systems for the semiconductor
industry. As of December 31, 1997, WMI had $530,000 in total assets. The Company
believes that this acquisition is immaterial to the Company's prior financial
statements and as such the Company's prior financial statements have not been
restated. The acquisition of WMI is part of the Company's strategic plan to add
specific domain expertise in targeted vertical industries. The Company recorded
merger expenses of approximately $2.2 million in connection with the acquisition
in the first quarter of 1998. The $2.2 million primarily consisted of accounting
and legal fees and other related transactions costs.
7
<PAGE>
DOCUMENTUM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
On July 16, 1998, the Company acquired all the outstanding shares of Relevance
Technologies, Inc., (Relevance), a privately held company, in exchange for
consideration totaling approximately $36.5 million, including 578,488 shares of
the Company's common stock. The acquisition was accounted for using the purchase
method of accounting on the date of acquisition. Relevance was a development
stage software company with approximately 25 employees located in San Francisco,
California specializing in the development of content mining technology for
unstructured information. The acquisition of Relevance represents a new market
opportunity for Documentum to develop additional applications for the sharing
and applying of both corporate and Internet based knowledge. As of June 30,
1998, Relevance had no revenues and had gross assets of approximately $3.6
million. The company recorded $34.6 million as a charge related to the write-off
of purchased in process research and development.
Related Party Transactions
The Company has distribution agreements with Xerox and its affiliated
entities, which provide Xerox, or its affiliates with the non-exclusive rights
to sell the Company's products in specified territories. For the three and nine
months ended September 30, 1999 and 1998, the Company recognized license revenue
from Xerox and its affiliated entities in the amount of $118,000, $755,000,
$855,000 and $7,539,000, respectively. As of September 30, 1999 and December 31,
1998, the Company had accounts receivable due from Xerox and its affiliated
entities in the amounts of $676,000 and $2,485,000, respectively. As of December
31, 1998, Xerox owned approximately 10% of the Company's outstanding common
shares; however, on September 29, 1999 Xerox sold a majority of its holdings and
on October 6, 1999 Xerox completely divested all of their remaining holdings in
the Company.
Debt
In July 1999, the Company entered into a capital lease agreement, under a
sale-leaseback arrangement, for the rental of computer equipment in the amount
of $292,000. The lease agreement requires quarterly principle and interest
payments in the amount of $37,230. This lease has an interest rate of 1.66% and
a maturity date of July 2001. As of September 30, 1999, the Company has not made
any payments related to this capital lease and has recorded current and long-
term portions of debt in the amounts of $145,000 and $147,000, respectively.
Line of Credit
In June 1999, the Company terminated its existing line of credit. There were
no borrowings outstanding at the time of termination. In August 1999, the
Company entered into an unsecured revolving line of credit agreement with a new
bank. The agreement allows for borrowings of up to $20 million bearing interest
at the Company's option of: (1) the bank's prime rate or (2) the LIBOR rate plus
1.50%. This line of credit expires on July 30, 2001. The Company must comply
with certain financial covenants and conditions as described in the agreement.
The Company did not have any borrowings outstanding under this line of credit as
of September 30, 1999.
Stock Repurchase
On April 15, 1999 the Board of Directors approved the repurchase of up to $20
million of the Company's common stock on the open market or in private
transactions. During the second and third quarters of 1999, the Company
repurchased and retired 395,000 and 301,300 shares of common stock,
respectively, for approximately $5.6 million and $4.5 million, respectively.
Rights Plan
On February 3, 1999, the Company adopted a Share Purchase Plan ("Rights Plan")
under which all stockholders of record as of February 24, 1999 will receive
rights to purchase shares of a new series of preferred stock. The rights will be
exercisable only if a person or group acquires 20% or more of the Company's
common stock or announces a tender offer for 20% or more of the common stock. If
a person acquires 20% or more of the Company's common stock, all rightsholders
except the purchaser will be entitled to acquire the Company's common stock at a
50% discount. The Company's Board of Directors may redeem the rights prior to
the time a person acquires more than 20% of the Company's common stock.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
The following discussion contains forward-looking statements regarding the
Company, its business, prospects and results of operations that are subject to
certain risks and uncertainties posed by many factors and events that could
cause the Company's actual business, prospects and results of operations to
differ materially from those that may be anticipated by such forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed herein as well as those discussed under
the caption "Risk Factors". Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date of this
report. The Company undertakes no obligation to revise any forward-looking
statements in order to reflect events or circumstances that may subsequently
arise. Readers are urged to carefully review and consider the various
disclosures made by the Company in this report and in the Company's other
reports filed with the Securities and Exchange Commission that attempt to advise
interested parties of the risks and factors that may affect the Company's
business.
9
<PAGE>
Results of Operations
The following table sets forth certain items from the Company's condensed
consolidated statements of operations as a percentage of total revenue for the
periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
License................................................. 57.7% 63.6% 53.5% 65.6%
Service................................................. 42.3% 36.4% 46.5% 34.4%
----- ----- ----- -----
Total revenue.......................................... 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
Cost of revenue:
License................................................. 3.9% 2.8% 4.4% 3.3%
Service................................................. 23.0% 21.5% 26.8% 20.9%
----- ----- ----- -----
Total cost of revenue.................................. 26.9% 24.3% 31.2% 24.2%
----- ----- ----- -----
Gross profit............................................... 73.1% 75.7% 68.8% 75.8%
----- ----- ----- -----
Operating expenses:
Sales and marketing..................................... 46.7% 40.8% 49.5% 41.5%
Research and development................................ 18.4% 15.9% 21.6% 14.6%
General and administrative.............................. 16.6% 7.8% 16.0% 8.4%
Acquisition and related costs........................... 0.0% 0.0% 0.0% 2.5%
Purchased in-process research and development........... 0.0% 102.2% 0.0% 39.6%
----- ----- ----- -----
Total operating expenses............................... 81.7% 166.7% 87.1% 106.6%
----- ----- ----- -----
Loss from operations....................................... (8.6%) (91.0%) (18.3%) (30.8%)
----- ----- ----- -----
Interest and other income, net............................. 2.4% 3.3% 3.4% 3.7%
----- ----- ----- -----
Loss before income tax provision (benefit)................. (6.2%) (87.7%) (14.9%) (27.1%)
Provision for (benefit from) income taxes.................. (2.1%) 4.9% (5.1%) 4.7%
===== ===== ===== =====
Net loss................................................... (4.1%) (92.6%) (9.8%) (31.8%)
===== ===== ===== =====
As a Percentage of Related Revenue:
Cost of license revenue.................................... 6.8% 4.4% 8.3% 5.0%
Cost of service revenue.................................... 54.4% 59.0% 57.6% 60.8%
</TABLE>
Revenue
The Company's revenue is derived from the sale of perpetual licenses for its
content management and web application software and related services, which
include maintenance and support, consulting and training services. Revenue from
license arrangements is recognized upon shipment of the product if collection of
the resulting receivable is probable. If a vendor obligation exists under the
license arrangement, revenue is deferred based on vendor-specific objective
evidence of the undelivered element. If vendor-specific objective evidence does
not exist for all undelivered elements, all revenue is deferred until sufficient
evidence exists or all elements have been delivered. Allowances for estimated
future returns are provided upon shipment. Payments received in advance of
revenue recognition are recorded as deferred revenue. Revenue from annual
maintenance and support are deferred and recognized ratably over the term of the
contract. Revenue from consulting and training is deferred and recognized when
the services are performed and collectibility is deemed probable. During 1998,
the Company recognized revenue in accordance with Statement of Position No. 97-2
("SOP 97-2"), "Software Revenue Recognition." In December 1998, the American
Institute of Certified Public Accountants ("AICPA") issued Statement of Position
No. 98-9 ("SOP 98-9"), "Modification of SOP 97-2, Software Revenue Recognition,
with
10
<PAGE>
Respect to Certain Transactions." The provisions of SOP 98-9 have been adopted
for transactions entered into during the fiscal year beginning January 1, 1999.
The adoption of SOP 98-9 did not have a material impact on revenue recognized
during the three and nine months ended September 30, 1999.
License revenue decreased by 10% or $2.1 million for the three months ended
September 30, 1999 from $21.6 million for the three months ended September 30,
1998, and decreased 19% or $10.7 million for the nine months ended September 30,
1999 from $57.3 million for the nine months ended September 30, 1998. License
revenue was adversely impacted by a general industry slowdown in customer
license sales for enterprise software applications. The Company experienced a
weakness in customer demand and difficulty in closing large license contracts
with customers during the first nine months of 1999. In the three and nine
months ended September 30, 1999, the Company recorded three and seven license
deals over $1.0 million, respectively. In the corresponding periods of 1998, the
Company recorded six and thirteen license deals over $1.0 million, respectively.
For the three months ended September 30, 1999 and 1998, the Company had sales to
a single customer accounting for $4.5 million and $3.7 million, respectively, or
23% and 17% of total license revenue, respectively. For the three and nine
months ended September 30, 1999 and 1998, license revenue from Xerox and certain
Xerox affiliates, as systems integrators, accounted for 1%, 4%, 2% and 13% of
total license revenue, respectively. The loss of a major customer or any
reduction or delay in orders by such customers would have a material adverse
effect on the Company's business, operating results and financial condition.
Also, the Company's strategy to provide customers with whole solutions could
result in software licenses being bundled with services. Therefore, with certain
future transactions, the delivery of services may delay recognition of license
revenue. Although the Company experienced significant revenue growth from 1992
to 1998, the Company does not believe that license revenue will increase in 1999
nor that historical growth rates are sustainable in the future.
Service revenue increased by 16% to $14.3 million for the three months ended
September 30, 1999 from $12.3 million, for the three months ended September 30,
1998, and increased 34% to $40.4 million for the nine months ended September 30,
1999 from $30.1 million for the nine months ended September 30, 1998,
representing 42%, 36%, 47%, and 34% of total revenue in the respective periods.
The increase in dollars was attributable to a larger installed base of customers
receiving ongoing maintenance, training and support services and increases in
the Company's professional services staff in conjunction with the Company's
focus to expand solution offerings to customers. The increase in service revenue
as a percent of total revenue was mainly due to a decrease in total license
revenue.
The Company markets its products through its direct sales force and its
indirect channel partners. While historically, the Company has generated the
majority of its revenue from its direct sales force, the Company has also
focused on complementing its direct sales channel with indirect channels,
consisting of systems integrators and distributors. Revenue from all indirect
channel partners comprised 28% and 29% of license revenue for the three months
ended September 30, 1999 and 1998, respectively, and 30% and 32% for the nine
months ended September 30, 1999 and 1998, respectively. Revenue from indirect
partners for any period is subject to significant variations. As a result, the
Company believes that period to period comparisons of indirect revenue is not
necessarily meaningful and should not be relied upon as indications of future
performance.
International revenue represented 53% and 24% of license revenue for the three
months ended September 30, 1999 and 1998, respectively, and 48% and 30% for the
nine months ended September 30, 1999 and 1998, respectively. The increase in
international revenue as a percent of license revenue was primarily due to an
enterprise wide sale to a single global customer in the amount of $4.5 million
in Europe, as well as a decrease in overall license revenue. In addition, sales
in Asia continue to grow as a result of growth in the sales force, resulting in
increased revenue from Asia as a percentage of total international revenue. The
Company classifies license revenue as domestic or international based upon the
billing location of the customer. In many instances, especially with large
purchases from multinational companies, the customer has the right to deploy the
licenses anywhere in the world. Thus, the percentages discussed herein represent
where licenses were sold, and may or may not represent where the products are
used. As a result, the Company believes that period to period comparisons of
international revenue is not necessarily meaningful and should not be relied
upon as indications of future performance.
Cost of revenue
Cost of license revenue consists primarily of the royalties paid to third-
party vendors, packaging, documentation, production and freight costs.
Royalties, which are paid to third-parties for selected products, include
11
<PAGE>
both fixed fees and variable fees. Cost of license revenue increased by 40% to
$1.3 million for the three months ended September 30, 1999 from $0.9 million for
the three months ended September 30, 1998, and increased by 36% to $3.9 million
for the nine months ended September 30, 1999 from $2.9 million for the nine
months ended September 30, 1998, representing 7% and 4% of the related license
revenue for the three months ended September 30, 1999 and 1998, respectively,
and 8% and 5% of the related license revenue for the nine months ended September
30, 1999 and 1998, respectively. The increase in cost of license revenue was
related to a shift in the mix of products being sold. The Company currently
carries more third party products and is selling a greater number of those
products than it had in the same periods in the prior year. Thus, royalty
expenses associated with the increase in sales of third party products have
increased over the comparable periods in 1998. The Company expects the cost of
license revenue to fluctuate in dollar amount as the related license revenue
fluctuates.
Cost of services revenue consists primarily of personnel-related costs
incurred in providing consulting services, training to customers, and
maintenance services, which includes telephone support. Cost of services revenue
increased by 7% to $7.8 million for the three months ended September 30, 1999
from $7.3 million for the three months ended September 30, 1998, and increased
27% to $23.3 million for the nine months ended September 30, 1999 from $18.3
million for the nine months ended September 30, 1998, representing 54% and 59%
of the related services revenue for the three months ended September 30, 1999
and 1998, respectively, and 58% and 61% of the related service revenue for the
nine months ended September 30, 1999 and 1998, respectively. The increase in
cost of services revenue in dollar amount was a result of increased personnel-
related costs as the Company expanded its consulting, training, and maintenance
operations to support its larger installed customer base, as well as an increase
in solutions offered to customers. The Company expects the cost of services
revenue to increase in dollar amount as the related services revenue increases.
Operating expenses
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, benefits, sales commissions and other expenses related to the direct
sales force, various marketing expenses and costs of other market development
programs. Sales and marketing expenses increased by 14% to $15.8 million for the
three months ended September 30, 1999 from $13.8 million for the three months
ended September 30, 1998 and increased 19% to $43.1 million for the nine months
ended September 30, 1999 from $36.2 million for the nine months ended September
30 1998, representing 47% and 41% of total revenue for the three months ended
September 30, 1999 and 1998, respectively, and 50% and 42% of total revenue for
the nine months ended September 30, 1999 and 1998, respectively. The increase in
dollar amount was the result of the Company's strategy to continue to invest in
its sales and marketing infrastructure, including an increase in the number of
sales teams and the number of marketing programs over the comparable period of
1998. Additionally, in the third quarter of 1999, costs were incurred in an
effort to rebrand the Company. These costs included the design and development
of the Company's logo and website. These costs contributed to the increase in
costs over the same periods last year. The increase in sales and marketing
expenses as a percentage of total revenue was primarily due to a decrease in
total license revenue. The Company expects that sales and marketing expense will
continue to increase in dollar amount.
Research and development. Research and development expenses consist primarily
of salaries and benefits for software developers, contracted development efforts
and related facilities costs. Research and development expenses increased by 15%
to $6.2 million for the three months ended September 30, 1999 from $5.4 for the
three months ended September 30, 1998, and increased by 47% to $18.8 million for
the nine months ended September 30, 1999 from $12.8 million for the nine months
ended September 30, 1998, representing 18% and 16% of total revenue for the
three months ended September 30, 1999 and 1998, respectively, and 22% and 15% of
total revenue for the nine months ended September 30, 1999, respectively. The
increase in dollar amount reflects the expansion of the Company's engineering
staff and related costs required to support the development of new products,
including Documentum 4i, which was introduced in the second quarter of 1999, and
enhancements to existing products. The increase in research and development
expenses as a percentage of total revenue was primarily due to a decrease in
total license revenue. Based on the Company's research and development process,
costs incurred between the establishment of technological feasibility and
general release have not been material and therefore have been expensed as
incurred. The Company expects research and development costs will continue to
increase in dollar amount in order to support increased development efforts to
both existing products and new products.
General and administrative. General and administrative expenses consist
primarily of personnel costs for finance, information technology, legal, human
resources and general management as well as outside professional
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services. General and administrative expenses increased by 113% to $5.6 million
for the three months ended September 30, 1999 from $2.6 million for the three
months ended September 30, 1998, and increased by 90% to $13.9 million for the
nine months ended September 30, 1999 from $7.4 million for the nine months ended
September 30, 1998, representing 17% and 8% of total revenue for the three
months ended September 30, 1999 and 1998, respectively, and 16% and 8% of total
revenue for the nine months ended September 30, 1999 and 1998, respectively. The
increase in dollar amount is primarily due to increased staffing and
professional fees necessary to manage and support the Company's growth, as well
as consulting costs associated with changes to the Company's information
systems. The increase in general and administrative expenses as a percentage of
total revenue was primarily due to a decrease in total license revenue. The
Company expects general and administrative expenses to increase in dollar amount
in order to support the growing needs of the Company.
Acquisition and related costs. In connection with the 1998 acquisition of
WMI, the Company incurred charges of $2.2 million primarily consisting of
accounting and legal fees and other transaction related costs. Approximately,
$489,000 of the costs incurred in connection with the acquisition is included in
accrued liabilities at September 30, 1999.
Purchased in process research and development. In connection with the 1998
acquisition of Relevance, the Company recorded a $34.6 million write-off related
to purchased in process research and development.
Interest and other income, net
Interest and other income, net, consists primarily of interest income earned
on the Company's cash and cash equivalents and short term investments, and other
items including foreign exchange gains and losses, the gain on sale of fixed
assets, and interest expense. Interest and other income, net, decreased $0.3
million for the three and nine months ended September 30, 1999 to $0.8 million
and $2.9 million, respectively, from $1.1 million for the three months ended
September 30, 1998 and $3.3 million for the nine months ended September 30,
1999. The decrease was related to lower cash and investment balances. To date,
the Company's international sales have been generally denominated in U.S.
dollars and the Company has not engaged in hedging activities as the exposure to
currency fluctuations has been insignificant. In the future, as the Company
expands its international operations, the Company expects to have an increased
amount of non-U.S. dollar denominated contracts. Unexpected changes in the
exchange rates for these foreign currencies could result in significant
fluctuation in the foreign currency translation gains and losses in future
periods.
Income taxes
Income tax provision (benefit) for the interim periods are based on estimated
annual income tax rates. The Company's effective tax rate is 34%. For the three
and nine months ended September 30, 1999, the Company recorded a tax benefit of
$0.7 million and $4.4 million, respectively, which it believes is fully
recoverable for income tax purposes based on carryback potential against taxes
previously paid. The estimated effective tax rate for the three and nine months
ended September 30, 1998, excludes the effects of the non-deductible write-off
of in-process research and development as a result of the acquisition of
Relevance, and the non-deductible items related to the acquisition of WMI.
Liquidity and Capital Resources
The Company's cash, cash equivalents and short-term investments totaled $78.5
million at September 30, 1999 representing 51% of total assets. The Company has
invested the Company's cash in excess of current operating requirements in
investment grade securities. The investments have variable and fixed interest
rates and primarily short-term maturities. In accordance with SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities" such
investments are classified as "available-for-sale."
Net cash provided by operating activities was $2.3 million and $8.0 million
for the nine months ended September 30, 1999 and 1998, respectively. For the
nine months ended September 30, 1999, the cash generated by operations was
primarily attributable to an increase in accounts payable of $1.9 million,
depreciation and amortization of $6.1 million, and deferred revenue of
approximately $8.2 million offset by a increase in accounts receivable of $1.8
million and other assets of $0.6 million, a decrease in accrued liabilities of
$2.7 million and a net loss of $8.6 million. For the nine months ended September
30, 1998, the cash generated by operations was primarily
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attributable to net loss of $27.7 million adjusted for noncash charges of $39.2
million, an increase in accounts payable of $2.0 million, accrued liabilities of
$5.0 million, and deferred revenue of $4.6 million, offset by the increase in
accounts receivable of $6.3 million and other assets of $8.8 million, consisting
primarily of $2.5 million for prepaid rent related to a new lease, $2.2 million
prepaid third party royalties and $1.0 million in deferred tax assets. For the
nine months ended September 30, 1999 and 1998, capital expenditures, net of
dispositions, were $18.4 million and $6.6 million, respectively. Capital
expenditures for the nine months ended September 30, 1999, were primarily for
computer equipment, office furniture and leasehold improvements related to the
new office facility described below.
In June 1998, the Company signed and made a deposit of $2.5 million to lease
approximately 122,000 square feet and 63,000 square feet in Pleasanton,
California beginning in June 1999 and January 2000, respectively, and expiring
in May 2005 and December 2006, respectively. This space serves as the Company's
headquarters and contains the principal administrative, engineering,
manufacturing, marketing and sales facilities. The Company has made significant
capital purchases related to leasehold improvements and office furniture for the
new facilities. The Company currently has no other significant capital spending
or purchase commitments other than normal purchase commitments and commitments
under facilities and capital leases.
On April 15, 1999 the Board of Directors approved the repurchase of up to $20
million of the Company's common stock on the open market or in private
transactions. As of September 30, 1999, the Company repurchased and retired
696,300 shares of its common stock for approximately $10.1 million.
On January 15, 1998, the Company entered into an unsecured revolving credit
agreement (the "Facility"). The Facility allowed for borrowings of up to $10
million bearing interest at the Company's option of: (1) the bank's prime rate
minus 0.5%; (2) the LIBOR plus 1.0%; or (3) at the bank's competitive bid rate.
The Company terminated this line of credit effective in June 1999.
In August 1999, the Company entered into an unsecured revolving line of credit
agreement with a new bank. The agreement allows for borrowings of up to $20
million bearing interest at the Company's option of: (1) the bank's prime rate
or (2) the LIBOR rate plus 1.50%. This line of credit expires on July 30, 2001.
The Company must comply with certain financial covenants and conditions as
described in the Facility. The Company did not have any borrowings outstanding
under this line of credit as of September 30, 1999.
In July 1999, the Company entered into a capital lease agreement, under a
sale-leaseback arrangement, for the rental of computer equipment in the amount
of $292,000. The lease agreement requires quarterly principle and interest
payments in the amount of $37,230. This lease has an interest rate of 1.66% and
a maturity date of July 2001. As of September 30, 1999, the Company has not made
any payments related to this capital lease and has recorded current and long-
term portions of debt in the amount of $145,000 and $147,000, respectively.
The Company believes that its existing cash, cash equivalents and short-term
investment balances, its available bank financing and the cash flows generated
from operations, if any, will be sufficient to meet its anticipated cash needs
for working capital and capital expenditures for at least the next twelve
months. A portion of the Company's cash could be used to acquire or invest in
complementary businesses or products or obtain the right to use complementary
technologies. The Company periodically evaluates, in the ordinary course of
business, potential investments such as businesses, products or technologies.
See "Risk Factors - Risks Associated with Acquisitions".
Year 2000 Readiness Disclosure
The Company's State of Readiness
Throughout the coming year, most companies will face a potentially serious
information systems problem because many software application and operational
programs may not properly recognize calendar dates beginning in the year 2000.
This problem could force computers to either shut down or provide incorrect data
or information.
The Company has commenced a comprehensive Year 2000 project to identify the
risks associated with its information systems, products, operations and
infrastructure, suppliers and customers that are not Year 2000 compliant, and in
December 1998 established a Year 2000 Program Office to manage the Year 2000
project. The
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Year 2000 project consists of three phases: 1) identification of risks,
2) assessment of risks, and if necessary, 3) development, implementation, and
testing of remediation and contingency plans. All contingency planning is
targeted for completion in November 1999. The Year 2000 project is ongoing, and
its phases are not sequential. Instead, as risks are identified, the assessment
and remediation plans are begun. The Company is currently performing work in all
three phases of the project.
During 1998, the Company identified two date-processing issues in third-party
software that are embedded in its product line. Engineering efforts were made by
the Company to address those date-processing issues, and technical fixes were
made available. In October of 1998, the Company released the "EDMS 98" suite of
core products which included those fixes and which have been verified as Year
2000-compliant according to definitions posted on the Company's Web site. The
Company is currently working with its customers who are not utilizing or
implementing the EDMS 98 products to identify and remediate any problems
associated with the identified date processing issues. In September 1999, the
Company identified another issue in this third party software and "patches" were
made immediately available to all customers.
In addition, the Company has recently released its 4i application series and
has performed all appropriate Year 2000 testing on those products. The Company
will continue to make changes to those products if and when Year 2000 issues are
determined.
The Company has substantially completed its review of internal systems and
believes it has identified all mission-critical problems. During 1999, the
Company planned to modify or replace any non-compliant software, systems and
equipment as part of a comprehensive infrastructure upgrade that coincided with
the move of its headquarters facilities to a new location, which was completed
on schedule. Further remediation of desktop software is now targeted for
completion in November 1999.
Further, the Company is engaged in a comprehensive customer communications
initiative in 1999 to ensure that all relevant Year 2000 data is available to
customers for their Year 2000 planning. Finally, the Company intends to create
and manage detailed contingency plans for all third-party suppliers that have
not adequately responded to the vendor compliance surveys managed by the Y2K
Program Office, and for all mission-critical systems as part of its objective to
ensure business continuity at the turn of the century.
The Costs to address the Company's Year 2000 Issues
Although the Company will continue to prioritize resources in product
engineering and internal business infrastructure groups to address Year 2000
issues, those resources are allocated within the normal software development and
infrastructure and facilities improvement processes of the Company. Therefore,
no complete estimate of the expected total cost of this effort can be made at
this time. Internally, the Company has budgeted $900,000 in 1999 for incremental
Year 2000 remediation to be performed preceding, during and in the months
following the move of its headquarters. The costs related to Year 2000 have been
immaterial to date.
The Company is also engaged in a thorough risk assessment of all license and
service agreements, and is in the process of contingency planning to address any
issues that may arise.
The Company has determined that a best estimate of unexpected costs is less
than $2 million for risks that are quantifiable at this time (services,
additional engineering, downtime for failure of local power grids or other
mission-critical systems, etc.).
The Risks of the Company's Year 2000 Issues
As the Year 2000 project continues, the Company may discover additional Year
2000 problems, may not be able to develop, implement or test remediation or
contingency plans, or may find that the costs of these activities exceed current
expectations, and become material. In many cases, the Company is relying on
assurances from third parties, including vendors and partners, that new and
upgraded information systems and other products will be Year 2000 compliant.
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Possible losses from claims of breach of contract or warranty due to Year 2000
non-compliance of earlier versions of the Company's software cannot be
reasonably estimated at this time; previous to the release of EDMS 98, date
processing problems were discovered in two (embedded OEM) third-party vendors'
software. A program is being initiated to address those problems for customers
who cannot, for legitimate business reasons, update to the compliant release,
according to definitions posted on the Company's website. In addition, that
program will also address custom applications and installations that have been
delivered by the Company's consulting services organization.
Even if the Company, in a timely manner, completes all of its assessments,
identifies and tests remediation plans believed to be adequate, and develops
contingency plans believed to be adequate, some problems may not be identified
or corrected in time to prevent material adverse consequences to the Company.
Additionally, no estimate can be made at this time of possible losses from
asserted and nonasserted claims of breach of contract or warranty due to Year
2000 noncompliance, nor can any assurance be given that the Year 2000 problem
will not have an adverse impact on the Company's operations, revenue, or
earnings.
Risk Factors
Uncertainty of Future Operating Results. Our future operating results may vary
significantly and are difficult to predict due to a number of factors, of which
many are beyond our control. These factors include:
. demand for our products;
. the level of product and price competition;
. the length of our sales cycle;
. the size and timing of individual license transactions;
. the delay or deferral of customer implementations;
. our success in expanding our customer support organization, direct sales
force and indirect distribution channels;
. the timing of new product introductions and product enhancements;
. changes in our pricing policy;
. the publication of opinions concerning us, our products or technology by
industry analysts;
. the mix of products and services sold;
. levels of international sales;
. activities of and acquisitions by competitors;
. the timing of new hires;
. changes in foreign currency exchange rates;
. our ability to develop and market new products and control costs; and
. domestic and international economic and political conditions.
One or more of the foregoing factors may cause our operating expenses to be
disproportionately high during any given period or may cause our net revenue and
operating results to fluctuate significantly. For example, during the first nine
months of fiscal year 1999, the Company's revenue was significantly lower than
expected. As a result of the relatively fixed nature of the Company's expenses,
the Company experienced a net loss for the period. Based on the preceding
factors, we may experience a shortfall in revenue or earnings or otherwise fail
to meet public market expectations, which could materially and adversely affect
our business, financial condition and the market price of our common stock.
Fluctuations in Quarterly Operating Results. Our net revenue and operating
results may vary drastically from quarter to quarter because of numerous factors
largely beyond our control, including the following:
. the potential delay in recognizing revenue from license transactions;
. the discretionary nature of our customers' budget and purchase cycles;
. variations in our customers' fiscal or quarterly cycles;
. the size and complexity of our license transactions;
. the timing of new product releases;
. seasonal variations in operating results; and
. the tendency to realize a substantial amount of revenue in the last weeks, or
even days, of each quarter.
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Each customer makes a discretionary decision to implement our products that is
subject to its resources and budget cycles. Additionally, our license sales
generally reflect a relatively high amount of revenue per order, and as a
result, the loss or delay of individual orders as happened in the first nine
months of 1999, could have a significant impact on quarterly operating results
and revenue. Furthermore, the timing of license revenue is difficult to predict
because of the length of our sales cycle, which typically ranges from six to 12
months from initial contact. Also, our strategy of providing customers with
complete content management solutions typically results in software licenses
being bundled with services. In these cases, the delivery of services may delay
recognition of license revenue. Because our operating expenses are based on
anticipated revenue trends and because a high percentage of these expenses is
relatively fixed, any shortfall from anticipated revenue or a delay in the
recognition of revenue from license transactions could cause significant
variations in operating results from quarter to quarter and could result in
operating losses. If these expenses precede, or are not followed by, increased
revenue, our operating results could be materially and adversely affected.
As a result of the foregoing and other factors, operating results for any
quarter are subject to significant variation, and we believe that period-to-
period comparisons of our results of operations are not necessarily meaningful
in terms of their relation to future performance. You should not rely upon these
comparisons as indications of future performance. Furthermore, it is likely that
our future quarterly operating results from time to time will not meet the
expectations of public market analysts or investors, in which case there would
likely be a material adverse effect on the price of our common stock.
Lengthy Sales and Implementation Cycles. The timing of the sales and
implementation of our products is lengthy and not predictable with any degree of
certainty. You should not rely on prior sales and implementation cycles as an
indication of future cycles.
The licensing of our software products is often an enterprise-wide decision by
prospective customers and generally requires us to engage in a lengthy sales
cycle (generally between six and 12 months) to provide a significant level of
education to prospective customers regarding the use and benefits of our
products. Additionally, the size and complexity of any particular transaction
can also cause delays in the sales cycle. The implementation of our products
involves a significant commitment of resources by customers over an extended
period of time and is commonly associated with substantial reengineering efforts
by the customer. For these and other reasons, the sales and customer
implementation cycles are subject to a number of significant delays over which
we have little or no control. A delay in the sale or customer implementation of
even a limited number of license transactions could have a material adverse
effect on our business, financial condition and operations and cause our
operating results to vary significantly from quarter to quarter.
Product Concentration. To date, substantially all of our revenue have been
attributable to sales of licenses of the Documentum EDMS and Documentum 4i
family of products and related services. We expect such products and related
services to continue to account for a substantial majority of our future
revenue. As a result, factors adversely affecting the pricing of or demand for
such products, such as competition or technological change, could have a
material adverse effect on our business, financial condition and results of
operations.
New Versions, New Products and Rapid Technological Change. The content
management software and services market in which we compete is characterized by
(1) rapid technological change, (2) frequent introduction of new products and
enhancements, (3) changing customer needs, and (4) evolving industry standards.
The introduction of products embodying new technologies and the emergence of new
industry standards can render existing products obsolete and unmarketable.
Accordingly, the life cycles of our products are difficult to estimate. To keep
pace with technological developments, evolving industry standards and changing
customer needs, we must support existing products and develop new products. Our
future success also depends in part on our abilities to execute on our strategy
of developing web applications in certain target vertical industries and to
maintain and enhance relations with technology partners, including RDBMS
vendors, in order to provide our customers with integrated product solutions.
We may not be successful in maintaining and enhancing the aforementioned
relationships or in developing, marketing and releasing new products or new
versions of our products that respond to technological developments,
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evolving industry standards or changing customer requirements. We may also
experience difficulties that could delay or prevent the successful development,
introduction and sale of these enhancements. In addition, these enhancements may
not adequately meet the requirements of the marketplace and may not achieve any
significant degree of market acceptance. If we fail to successfully maintain or
enhance relationships with our technology partners or to execute on our
integrated product solution strategy, or if release dates of any future products
or enhancements are delayed, or if these products or enhancements fail to
achieve market acceptance when released, our business, operating results and
financial condition could be materially and adversely affected. We have in the
past experienced delays in the release dates of enhancements to our products.
While the delays we have experienced to date have been minor (not exceeding six
months), there can be no assurance that we will not experience significant
future delays in product introduction.
Dependence on Emerging Markets. The market for content management software
and services is intensely competitive, highly fragmented and rapidly changing.
Our future financial performance will depend primarily on the continued growth
of the market for content management software and services and the adoption of
our products by organizations in this market. If the content management software
and services market fails to grow or grows more slowly than we currently
anticipate, our business, financial condition and operating results would be
materially and adversely effected.
Intense Competition. Our products target the emerging market for Web-based
and client/server software solutions. This market is intensely competitive,
rapidly changing and significantly affected by new product introductions and
other market activities of industry participants. We encounter direct
competition from a number of public and private companies that offer a variety
of products and services addressing this market. These companies include FileNet
and OpenText. Additionally, several other enterprise software vendors, such as
Microsoft, Oracle and Lotus (a division of IBM) are potential competitors in the
future. As the Company develops and sells more web-based solutions, companies
such as Interwoven, Vignette and Open Market/FutureTense may become competitors
in the future. Many of these current and potential competitors have longer
operating histories, significantly greater financial, technical, marketing and
other resources, significantly greater name recognition and a larger installed
base of customers than we do. In addition, several of these companies, including
Microsoft, Oracle, Lotus and others, have well-established relationships with
our current and potential customers and strategic partners, as well as extensive
resources and knowledge of the enterprise software industry that may enable them
to more easily offer a single-vendor solution. As a result, these competitors
may be able to respond more quickly to new or emerging technologies and changes
in customer requirements, or to devote greater resources to the development,
promotion and sale of their products, than we can.
We also face indirect competition from systems integrators. We rely on a
number of systems consulting and systems integration firms for implementation
and other customer support services, as well as for recommendations of our
products during the evaluation stage of the purchase process. Although we seek
to maintain close relationships with these service providers, many of them have
similar, and often more established, relationships with our competitors. If we
are unable to develop and maintain effective, long-term relationships with these
third parties, our competitive position would be materially and adversely
affected. Further, many of these third parties possess industry-specific
expertise and have significantly greater resources than we do, and may market
software products that compete with us in the future.
There are many factors that may increase competition in the market for Web-
based and client/server software solutions, including (1) entry of new
competitors, (2) alliances among existing competitors and (3) consolidation in
the software industry. Increased competition may result in price reductions,
reduced gross margins and loss of market share, any of which could materially
and adversely affect our business, financial condition and operating results. If
we cannot compete successfully against current and future competitors or
overcome competitive pressures, our business, operating results and financial
condition may be adversely affected.
End-User Customer and Industry Concentration. Our success depends on
maintaining relationships with our existing customers. A relatively small number
of customers have accounted for a significant percentage of our revenue. For the
three months ended September 30, 1999 and 1998, sales to our five largest
customers accounted for 42% and 45% of license revenue, respectively, and 23%
and 24% of license revenue for the nine months ended September 30, 1999 and
1998, respectively. Additionally, our customers are somewhat concentrated in the
process
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and discrete manufacturing, pharmaceutical and architectural engineering and
construction industries. We expect that sales of our products to a limited
number of customers and industry segments will continue to account for a
significant percentage of revenue for the foreseeable future. The loss of a
small number of customers or any reduction or delay in orders by any such
customer, or our failure to market successfully our products to new customers
and new industry segments could have a material adverse effect on our business,
financial condition and operating results.
Reliance on Certain Relationships. We have established strategic
relationships with a number of organizations that we believe are important to
our sales, marketing and support activities and the implementation of our
products. We believe that our relationships with these organizations, including
indirect channel partners and other consultants, provide marketing and sales
opportunities for our direct sales force, expand the distribution of our
products and broaden our product offerings through product bundling. These
relationships allow us to keep pace with the technological and marketing
developments of major software vendors and provide us with technical assistance
for our product development efforts. Our failure to maintain these
relationships, or to establish new relationships in the future, could have a
material adverse effect on our business, financial condition and results of
operations.
Management of Growth. Our business grew rapidly through 1998. This growth has
placed a significant strain on our management systems and resources.
To manage future growth we must continue to (1) improve and maintain our
financial and management controls, reporting systems and procedures on a timely
basis and (2) expand, train and manage our employee work force. If we fail to
manage our growth effectively, our business, financial condition and results of
operations could be materially and adversely affected.
Dependence on Key Personnel. Our future performance depends in significant
part on the continued service of our key technical, sales and senior management
personnel, none of whom is bound by an employment agreement with us. The loss of
services of one or more of our executive officers or key technical personnel
would have a material adverse effect on our business, operating results and
financial condition.
Our future success also depends on our continuing ability to attract and
retain highly qualified technical, sales and managerial personnel. Competition
for such personnel is intense, and there can be no assurance that we can retain
key employees or that we can attract, assimilate or retain other highly
qualified personnel in the future.
International Operations. Our revenue is primarily derived from large multi-
national companies. To service the needs of these companies, we must provide
worldwide product support services. The Company has offices in London, Paris,
Munich, Tokyo, Melbourne and Seoul. The Company operates its international
technical support operations in the London, Munich and Melbourne offices. We
have expanded, and intend to continue expanding, our international operations
and enter additional international markets. This will require significant
management attention and financial resources that could adversely affect our
operating margins and earnings. We may not be able to maintain or increase
international market demand for our products. If we do not, our international
sales will be limited, and our business, operating results and financial
condition could be materially and adversely affected.
Our international operations are subject to a variety of risks, including (1)
foreign currency fluctuations, (2) economic or political instability, (3)
shipping delays, (4) various trade restrictions, (5) our limited experience in,
and the costs of, localizing products for foreign countries, (6) longer accounts
receivable payment cycles and (7) difficulties in managing international
operations, including, among other things, the burden of complying with a wide
variety of foreign laws.
Dependence on Proprietary Technology and Risks of Infringement. We rely
primarily on a combination of copyright, trademark and trade secret laws,
confidentiality procedures and contractual provisions to protect our proprietary
rights. We also believe that factors such as the technological and creative
skills of our personnel, new product developments, frequent product
enhancements, name recognition and reliable product maintenance are essential to
establishing and maintaining a technology leadership position. We seek to
protect our software, documentation and other written materials under trade
secret and copyright laws, which afford only limited protection.
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Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult, and while we are unable to determine the extent to which piracy of
our products exists, software piracy can be expected to be a persistent problem.
In addition, the laws of some foreign countries do not protect our proprietary
rights as fully as do the laws of the United States. Our means of protecting our
proprietary rights in the United States or abroad may not be adequate.
Additionally, our competition may independently develop similar technology.
Although we do not believe that we are infringing any proprietary rights of
others, third parties may claim that we have infringed their intellectual
property rights. Furthermore, former employers of our former, current or future
employees may assert claims that such employees have improperly disclosed to us
the confidential or proprietary information of such former employers. Any such
claims, with or without merit, could (1) be time-consuming to defend, (2) result
in costly litigation, (3) divert management's attention and resources, (4) cause
product shipment delays, and (5) require us to pay money damages or enter into
royalty or licensing agreements. A successful claim of intellectual property
infringement against us and our failure or inability to license or create a
workaround for such infringed or similar technology may materially and adversely
affect our business, operating results and financial condition.
We license certain software from third parties, including software that is
integrated with internally developed software and used in our products to
perform key functions. These third-party software licenses may not continue to
be available to us on acceptable terms. The loss of, or inability to maintain,
any of these software licenses could result in shipment delays or reductions.
This could materially and adversely affect our business, operating results and
financial condition.
Product Liability. Our license agreements with our customers typically
contain provisions designed to limit our exposure to potential product liability
claims. It is possible, however, that the limitation of liability provisions
contained in our license agreements may not be effective under the laws of
certain jurisdictions. A successful product liability claim brought against us
could have a material adverse effect upon our business, financial condition and
results of operations.
Uncertainty of the Effects of the Year 2000 on Computer Programs and Systems.
Many currently installed computer systems and software programs use only two-
digit date code fields to identify the year, e.g., 85=1985. These date code
fields will need to accept four-digit entries to distinguish 21st century dates
from 20th century dates. Until the date fields are updated, the systems and
programs could fail or give erroneous results when referencing dates following
December 31, 1999. Such failures or errors could occur prior to the actual
change in century.
We have designed and tested the most current versions of our products to be
Year 2000 compliant and are currently engaged in a comprehensive Year 2000
project to further identify date-processing risks associated with our
information systems, products, operations and infrastructure, suppliers and
customers. We have notified all of our customers of Year 2000 related date
processing problems associated with older versions of our products and
encouraged them to upgrade to a Year 2000 compliant version. As a number of our
customers will continue to run product versions that are not Year 2000
compliant, the Company may incur increased expenses and additional liabilities
relating to these date-processing issues. Given the unprecedented nature of this
problem, we cannot reasonably estimate potential losses from claims of breach of
contract or warranty arising from these issues at this time, and we cannot
reliably measure the effect that any potential losses will have on our financial
condition and operations. In addition, there can be no assurances that the
Company's current product versions do not contain undetected errors or defects
associated with Year 2000 date-processing issues that may result in additional
material costs to the Company.
In addition, many companies are expending 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 that we offer. The efforts and resources expended to address Year
2000 issues may affect the purchasing patterns of our customers and potential
customers. We also believe that many potential customers may defer purchasing
Year 2000 compliant products until it is absolutely necessary, accelerate
purchasing Year
20
<PAGE>
2000 compliant products, switch to other systems or suppliers, or purchase our
products only as an interim solution. If any of the above were to happen, our
business, operating results or financial condition could be materially and
adversely affected.
We are currently evaluating our information technology and non-information
technology infrastructure for Year 2000 compliance to determine what actions are
required to make all internal systems Year 2000 compliant and what actions are
needed to mitigate vulnerability to problems related to enterprises with which
we interact. We also utilize third-party vendor network equipment,
telecommunication products and other products and services, including utilities,
that may or may not be Year 2000 compliant. However, if all Year 2000 issues are
not properly identified, or assessment, remediation and testing are not effected
timely with respect to Year 2000 problems that are identified, there can be no
assurance that the Year 2000 issue will not materially and adversely impact our
results of operations or adversely affect our relationships with customers,
vendors, or others. In addition, there can be no assurance that we will not be
affected by Year 2000 disruption in the operation of the enterprises with which
we interact. Accordingly, Year 2000 problems could have a material adverse
effect upon our business.
Although we have expended and will continue to expend resources and time to
address potential Year 2000 problems, there can be no assurance that we will be
successful in our efforts to identify and address all Year 2000 issues.
Additionally, there can be no assurance that we will not be affected by Year
2000 disruptions in the operations of the enterprises with which we interact.
Accordingly, Year 2000 problems could have a material adverse effect upon our
business.
Risk of Product Defects. Software products frequently contain errors or
failures, especially when first introduced or when new versions are released.
Also, new products or enhancements may contain undetected errors, or "bugs," or
performance problems that, despite testing, are discovered only after a product
has been installed and used by customers. Errors or performance problems could
cause delays in product introduction and shipments or require design
modifications, either of which could lead to a loss in or delay in recognition
of revenue.
Our products are typically intended for use in applications that may be
critical to a customer's business. As a result, we expect that our customers and
potential customers will have a greater sensitivity to product defects than the
market for software products generally. Despite extensive testing by us and by
current and potential customers, errors may be found in new products or releases
after commencement of commercial shipments, resulting in loss of revenue or
delay in market acceptance, damage to our reputation, diversion of development
resources, the payment of monetary damages or increased service or warranty
costs, any of which could have a material adverse effect upon our business,
operating results and financial condition.
Risks Associated with Acquisitions. As part of our business strategy, we
frequently evaluate strategic opportunities available to us and expect to make
acquisitions of, or significant investments in, businesses that offer
complementary products and technologies. For example, the Company acquired WMI
in January, 1998 and Relevance Technologies in July 1998. Such acquisitions
will, and any future acquisitions or investments would, expose us to the risks
commonly encountered in acquisitions of businesses. Future acquisitions of
complementary technologies, products or businesses will result in the diversion
of management's attention from the day-to-day operations of our business and the
potential disruption of our ongoing business. Additionally, such acquisitions
may include numerous other risks, including difficulties in the integration of
the operations, products and personnel of the acquired companies. Future
acquisitions may also result in dilutive issuances of equity securities, the
incurrence of debt and amortization expenses related to goodwill and other
intangible assets. Our failure to successfully manage future acquisitions may
have a material adverse effect on our business and financial results.
Possible Volatility of Stock Price. The trading price of our common stock is
subject to significant fluctuations in response to variations in quarterly
operating results, the gain or loss of significant orders, changes in earning
estimates by analysts, announcements of technological innovations or new
products by us or our competitors, general conditions in the software and
computer industries and other events or factors. In addition, the stock market
in general has experienced extreme price and volume fluctuations which have
affected the market price for many companies in industries similar or related to
ours and which have been unrelated to the operating performance of these
companies. These market fluctuations may adversely affect the market price of
our common stock.
21
<PAGE>
Effects of Certain Charter Document Provisions that may Prevent Certain
Corporate Actions. Our Board of Directors is authorized to issue up to
5,000,000 shares of preferred stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further approval by our stockholders. The preferred stock
could be issued with voting, liquidation, dividend and other rights superior to
those of the common stock. The rights of the holders of common stock will be
subject to, and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could make it more difficult for a
third party to acquire a majority of our outstanding voting stock. We have
instituted a classified Board of Directors in our Amended and Restated
Certificate of Incorporation. We have also implemented a Share Purchase Plan (or
"Rights Plan") under which all stockholders of record as of February 24, 1999
received rights to purchase shares of a new series of preferred stock. The
rights are exercisable only if a person or group acquires 20% or more of our
common stock or announces a tender offer for 20% or more of the common stock.
These provisions and certain other provisions of our Amended and Restated
Certificate of Incorporation and certain provisions of our Amended and Restated
Bylaws and of Delaware law, could delay or make more difficult a merger, tender
offer or proxy contest.
Item 3. Quantitative and Qualitative Disclosure About Market Risk - Interest
Rate Risk
As of September 30, 1999, the Company's investment portfolio includes $45.7
million of short-term corporate and municipal bonds which are subject to no
interest rate risk when held to maturity but may increase or decrease in value
if interest rates change prior to maturity. The Company maintains sufficient
cash and cash equivalent balances to typically hold its investments to maturity.
The remaining $20.7 million of short-term investments are held in short-term
securities bearing stated interest rates and are therefore subject to no
interest rate risk. An immediate 10% change in interest rates would be
immaterial to the Company's financial condition or results of operations.
22
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
27.1 Financial Data Schedule
(b)
(1) Current report on Form 8-K filed October 1, 1999, relating
to the resignation of PricewaterhouseCoopers LLP as
independent public accountants for the Company and the
announcement of a strategic global alliance formed with
PricewaterhouseCoopers LLP.
23
<PAGE>
SIGNATURE
Pursuant to the requirements of Securities Exchange Act of 1934, the registrant
has duly caused this report on Form 10-Q to be signed on its behalf by the
undersigned, thereunto duly authorized.
DOCUMENTUM, INC.
(Registrant)
Date: November 12, 1999 By: /s/ Mark S. Garrett
----------------------
Mark S. Garrett
Vice President, and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN
ITS ENTIRETY B REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-START> JUL-01-1999 JAN-01-1999
<PERIOD-END> SEP-30-1999 SEP-30-1999
<CASH> 12,127 0
<SECURITIES> 66,375 0
<RECEIVABLES> 37,048 0
<ALLOWANCES> 2,425 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 121,606 0
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<DEPRECIATION> 16,073 0
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0 0
0 0
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<INTEREST-EXPENSE> 1 62
<INCOME-PRETAX> (2,109) (12,974)
<INCOME-TAX> (717) (4,411)
<INCOME-CONTINUING> (1,392) (8,563)
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