1% better than last year!!!!!!!
DOCUCORP INC (DOCC)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CERTAIN INFORMATION CONTAINED HEREIN MAY INCLUDE "FORWARD-LOOKING STATEMENTS"
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED,
AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. ALL
STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS INCLUDED IN THIS FORM
10-Q, ARE FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS ARE SUBJECT TO CERTAIN
RISKS AND UNCERTAINTIES, WHICH INCLUDE, BUT ARE NOT LIMITED TO, TECHNOLOGICAL
ADVANCES, DEPENDENCE UPON THE INSURANCE INDUSTRY, INTEGRATION OF OPERATING
SUBSIDIARIES, FLUCTUATIONS IN OPERATING RESULTS, AND THE OTHER RISK FACTORS
AND CAUTIONARY STATEMENTS LISTED FROM TIME TO TIME IN THE COMPANY'S PERIODIC
REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. ALL
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS FORM 10-Q AND ALL SUBSEQUENT ORAL
FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS ACTING ON
ITS BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THESE CAUTIONARY
STATEMENTS.
OVERVIEW
DocuCorp develops, markets, and supports a portfolio of open-architecture, enterprise-wide document automation software products that enable its customers to produce complex, high-volume, individualized documents. In addition, the Company provides document automation consulting, systems integration, and document processing and printing services through a 170-person service organization. Document processing and printing services utilize the Company's software to provide solutions for handling high-volume, complex print, finish, and mailing for customers who outsource this activity.
DocuCorp was formed in connection with the acquisition of FormMaker Software, Inc. ("FormMaker") by Image Sciences, Inc. ("Image Sciences") (the "Merger"). The Merger was treated as an acquisition of FormMaker by Image Sciences, and accordingly, the Merger transaction was recorded under the purchase method of accounting. The accompanying unaudited interim consolidated financial statements include the accounts of the Company and its subsidiaries. Consolidated results of FormMaker and its subsidiary are included from the effective date of the Merger, May 15, 1997.
In March 1998, the Company acquired all of the capital stock of EZPower Systems, Inc. ("EZPower") and Maitland Software, Inc. ("Maitland"). EZPower develops, markets, and supports flexible Internet and client/server solutions for document management, workflow, and web content management software products. Maitland has developed a data acquisition and transformation program which allows users the ability to more easily interface existing applications and databases with document printing and publishing software. Both of these acquisitions were recorded under the purchase method of accounting, and accordingly, the results of operations of EZPower and Maitland for all periods subsequent to the acquisition date are included in the accompanying unaudited interim consolidated financial statements.
The Company derives its revenues from license fees, recurring maintenance fees, and professional services fees related to its software products. License revenues are generally derived from perpetual and term licenses of software products. Maintenance and other recurring revenues consist primarily of recurring license fees and annual maintenance contracts. Professional services revenues include fees for consulting, implementation, print outsourcing, and education services.
HISTORICAL OPERATING RESULTS OF THE COMPANY
The following table sets forth selected unaudited interim consolidated statements of operations data of the Company expressed as a percentage of total revenues for the periods indicated:
Three months ended
October 31,
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1998 1997
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Revenues
Professional services 53% 62%
License 22 14
Maintenance and other recurring 25 24
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Total revenues 100 100
Expenses
Professional services 40 45
Product development and support 19 17
Selling, general and administrative 28 26
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Total expenses 87 88
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Operating income 13 12
Other income (expense), net 2 (1)
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Income before income taxes 15 11
Provision for income taxes 7 4
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Net income 8% 7%
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COMPARATIVE ANALYSIS OF QUARTERLY RESULTS FOR THE THREE MONTHS ENDED OCTOBER 31,
1998 AND 1997
REVENUES
Total revenues increased 13% mainly due to the 72% increase in license revenues. The increased license revenues are primarily the result of additional licenses in the insurance market. Maintenance revenues increased 20% due to an expanding customer base, as well as the one-time effect of reinstatement of several previously expired maintenance contracts. Professional services revenues decreased 4% as anticipated due to the termination of the Policy Management Systems Corporation ("PMSC") print outsourcing contract in May of 1998. The decrease in PMSC-based print outsourcing revenues was partially offset by an increase in more profitable services business.
Backlog for the Company's products and services of approximately $28.8 million as of October 31, 1998, of which approximately $17.0 million is scheduled to be satisfied within one year, is primarily comprised of recurring software license fees and maintenance revenues for ongoing maintenance and support, software implementation and consulting services, and print outsourcing services. Software agreements for recurring license fees generally have non-cancelable terms of up to five years. Annual maintenance contracts may generally be terminated upon 30 days notice; however, the Company has not historically experienced material cancellations of such contracts. Software implementation and consulting services backlog is principally performed under time and material agreements of which some have cancellation provisions. Print outsourcing services agreements generally provide that fees are charged on a per transaction basis. The estimated future revenues with respect to software implementation and print outsourcing services are based on management's estimate of revenues over the remaining life of the respective contracts.
FormMaker, which was acquired by the Company in connection with the Merger, historically distributed its line of DAP software products to the insurance industry in North America through an exclusive marketing agreement with PMSC. Revenues from PMSC under this agreement for the three months ended October 31, 1997 were approximately $1.8 million. In September 1998, both parties agreed to terminate the marketing agreement and enter into a new non-exclusive marketing agreement. The new marketing agreement between DocuCorp and PMSC allows PMSC to market all of the Company's software products to insurance and financial services companies worldwide. As of October 31, 1998, the Company has not received any material revenues under the new agreement.
In addition, PMSC terminated its print outsourcing agreement effective May 1998. Revenues from PMSC under this agreement for the three months ended October 31, 1997 were approximately $1.7 million. Print outsourcing revenues have declined from fiscal year 1998 levels while the Company replaces these revenues with new business.
PROFESSIONAL SERVICES EXPENSE
Professional services expense is composed primarily of personnel expenses related to both consulting and print outsourcing services. Postage and supplies expense associated with the print outsourcing business decreased approximately $850,000 due to the decrease in print outsourcing revenues. This decrease in expense was offset by increased personnel costs as the professional services department expanded. For the three months ended October 31, 1998 and 1997, professional services expense represented 76% and 72% of professional services revenues, respectively. The increase in cost as a percentage of professional services revenues is mainly due to higher profit margins earned under a short-term print outsourcing agreement in the three months ended October 31, 1997 and increased costs related to the Company's services expansion internationally in the three months ended October 31, 1998. The Company expects professional services expenses to increase in order to meet additional resource requirements as professional services activities increase domestically and internationally.
PRODUCT DEVELOPMENT AND SUPPORT EXPENSE
Product development and support expense consists primarily of research and development efforts, amortization of capitalized software development costs, customer support, and other product support costs. For the three months ended October 31, 1998, product development and support expense increased 22%. The majority of the increase is related to additional personnel expenses associated with the acquisitions of EZPower and Maitland in March of 1998. The Company anticipates continued acceleration of development efforts, including Internet applications, integration of its newly acquired document management and workflow solutions with its existing offerings, further development of systems for use in industries such as utilities and financial services, development of new software products utilizing object-oriented technology, and continued support of its existing product lines. Accordingly, expenditures in this area are expected to increase in relation to the anticipated growth in revenues.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense increased 25% largely due to third-party selling costs due PMSC associated with one significant contract during the three months ended October 31, 1998, as well as increased sales commissions as a result of the 72% increase in license revenues. In addition, goodwill amortization increased as a result of the acquisitions of EZPower and Maitland in March of 1998.
OTHER INCOME (EXPENSE), NET
The 228% increase in other income (expense), net was due to a significant amount of interest income in the three months ended October 31, 1998, compared with interest expense in the comparable period of the prior year. As a result of the receipt of approximately $18.5 million of Initial Public Offering ("IPO") proceeds in April 1998, interest income increased in the first quarter and is expected to continue to increase as compared to corresponding periods of fiscal 1997 due to significant cash and cash equivalent balances maintained by the Company. With the IPO proceeds, the Company repaid the Company's debt in April of 1998 leaving minimal interest expense which is solely related to capital lease obligations.
PROVISION FOR INCOME TAXES
The effective tax rates for the three months ended October 31, 1998 and 1997 were approximately 44% and 40%, respectively. Goodwill amortization related to the recent acquisitions is non-deductible, which increased the effective tax rate for the three months ended October 31, 1998. The majority of goodwill amortization related to the Merger is also non-deductible. The Company used a portion of its net operating loss carryforwards and outstanding tax credits to offset its current tax liability for the three months ended October 31, 1998 and 1997.
NET INCOME
Net income increased 42% for the three months ended October 31, 1998. This is due to increased revenue and increased interest income, partially offset by additional expenses needed to meet the revenue levels.
YEAR 2000
The Year 2000 computer issue is primarily the result of Information Technology (IT) or non-IT systems and programs with date sensitive devices, such as embedded chips or code using a two digit format, as opposed to four digits, to indicate the year. Such systems and programs may be unable to correctly interpret dates beyond the year 1999, which could cause a system failure or other errors, with the resultant disruption in the operation of such systems. The Company has assembled an internally staffed team to address and manage the Year 2000 project related to the Company's products and services offerings, as well as any IT and non-IT internal systems supporting the Company's operations.
With respect to the Company's product line and services offerings, current versions of the Company's products are designed to be "Year 2000" compliant. The Company is currently in the process of testing and upgrading, if necessary, its product offerings. Customers using pre-Year 2000 compliant versions of the Company's software products are entitled to receive upgraded Year 2000 compliant software as part of their software support agreements with the Company, as long as the customer support agreement remains in force. The Company is currently in the process of assessing the extent to which its services implementations are Year 2000 compliant. To the extent the Company is directly involved in resolving any non-compliant services implementations, generally the customer will be responsible for the fees associated with such services. Accordingly, the Company does not currently believe that the effects of any Year 2000 non-compliance in the Company's installed base of products or services offerings will result in any material adverse impact on the Company's business or financial condition.
With respect to the Company's internal IT and non-IT software systems and hardware, the Company has identified non-compliant hardware and software systems and is currently in the remediation phase. The Company believes there is no significant exposure to the Company related to non-compliant internal IT and non-IT software systems and hardware and that the majority of identified non-compliant systems are planned to be upgraded as part of its normal upgrade process within the next 12 months.
Although the Company is undertaking efforts to ensure that all its systems and programs are Year 2000 compliant, the Company has no control over services, functions, and data provided by third-party vendors and others which may result in the inability to provide services. The Company is contacting and working with its material customers and vendors to verify their Year 2000 compliance. The Company has no control over third-parties and if they will be Year 2000 compliant. Further, the Company is unable to predict the impact, if any, on the Company's revenues as a result of its customers being distracted from their document automation needs as their attention is re-directed, or customer resources are diverted, to becoming Year 2000 compliant. The extent to which third-party customers and vendors do not become Year 2000 compliant on a timely basis or may be indirectly impacted by the Year 2000 issue may have a material adverse effect on the Company.
The Company is in the early phase of developing contingency plans and determining the extent of such plans.
No assurance can be given that the Company will not be exposed to potential claims resulting from system problems associated with the century change. However, the Company believes its Year 2000 compliance project will be substantially completed by the end of fiscal year 1999 and will not have a material adverse effect on the Company.
LIQUIDITY AND CAPITAL RESOURCES
At October 31, 1998, the Company's principal sources of liquidity consisted of cash and cash equivalents of $13.6 million. The Company completed an IPO in the form of a rights offering to Safeguard Scientifics, Inc. stockholders in April 1998. Net proceeds to the Company from this offering, after deduction of the underwriting discount and IPO expenses, were approximately $18.5 million.
Cash and cash equivalents for the three months ended October 31, 1998 decreased $863,000 due to cash used by various investing and financing activities, and was partially offset by cash provided by operating activities. Cash flows provided by operating activities were $3.0 million as the result of profitable operations and various other cash operating activities. Cash flows used in investing activities of $2.8 million was the result of the purchase of short-term investments, development of capitalized software, and purchase of fixed assets. Cash flows from financing activities used $1.1 million primarily as the result of the repurchase of treasury stock under the Company's stock repurchase program. As of October 31, 1998, the Company had repurchased 360,314 shares at an average per share cost of $3.47.
Working capital was $16.4 million at October 31, 1998, compared with $16.0 million at July 31, 1998.
In connection with the Merger, the Company assumed a $10.0 million revolving credit facility from FormMaker. This credit facility was renegotiated in September 1997. In September 1998, the Company allowed $6.5 million of the credit facility to expire under its normal terms. The remaining $3.5 million bears interest at the bank's prime rate less 0.25%, or 7.75%, as of October 31, 1998 and is due and payable in March 1999. Under the credit facility, the Company is required to maintain certain financial covenants. As of October 31, 1998 there were no borrowings under this credit facility.
The Company's liquidity needs are expected to arise primarily from funding the continued development, enhancement, and support of its software offerings, and the selling and marketing costs associated principally with continued entry into new vertical and international markets.
The Company currently anticipates that amounts available from the IPO proceeds, its existing credit facility, and cash generated from operations will be sufficient to satisfy its operating cash needs for the foreseeable future.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") and No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), were issued. SFAS 130 establishes standards for reporting comprehensive income and its components with the same prominence as other financial statements. The Company adopted SFAS 130 on August 1, 1998; however, the Company does not have any items of comprehensive income in the periods presented. SFAS 131 establishes standards for reporting information about operating segments in annual and interim financial statements, although this statement need not be applied to interim financial statements in the initial year of its application. SFAS 131 is effective for fiscal years beginning after December 15, 1997, and therefore the Company will adopt its requirements in connection with its annual reporting for the year ending July 31, 1999.
Also, effective August 1, 1998, the Company adopted Statement of Position No. 97-2 , "Software Revenue Recognition" ("SOP 97-2") issued by the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants, which supersedes Statement of Position No. 91-1 "Software Revenue Recognition". The adoption of SOP 97-2 did not have a material effect on the Company's financial position or results of operations for the first three months of fiscal 1999 and the Company does not anticipate it will have a material impact in the future.
In March 1998, the Accounting Standards Executive Committee issued Statement of Position No. 98-1, "Accounting for Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1").
SOP 98-1 requires costs related to internal use software that are incurred in the preliminary project stage to be expensed as incurred. SOP 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998. Accordingly, the Company will adopt SOP 98-1 for the year ending July 31, 2000. The Company does not believe the adoption of SOP 98-1 will have a material effect on the Company's financial position or results of operations. |
