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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER: 0-20981
DOCUMENT SCIENCES CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0485994
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
6339 PASEO DEL LAGO, CARLSBAD, CALIFORNIA 92009
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (760) 602-1400
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 28, 2000, there were 10,919,051 shares of the Registrant's
common stock outstanding and the aggregate market value of such shares held by
non-affiliates of the Registrant (based upon the closing sale price of such
shares on the Nasdaq National Market on March 28, 2000) was approximately
$18,692,700. Shares of common stock held by each executive officer and director
and by each entity that owns 5% or more of the outstanding common stock have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
Certain sections of the Registrant's definitive Proxy Statement for the
2000 Annual Meeting of Stockholders to be held on June 7, 2000 are incorporated
by reference in Part III of this Form 10-K to the extent stated herein.
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PART I
ITEM 1. BUSINESS
This item contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results could differ materially from those projected in the
forward-looking statements as a result of the factors set forth in
"Business -- Risk Factors" below, the section of Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations
entitled "Factors Affecting Future Results" and elsewhere in this Report.
Document Sciences Corporation develops, markets and supports a family of
document automation software used in high volume electronic publishing
applications. Document automation has become increasingly important as more
companies realize the benefits of automating the high volume production of
individually customized documents that require the precise layout of information
such as financial data, marketing text and graphs. Our document automation
software, the Document Sciences Autograph family of products, enables
personalized and customized publishing solutions for many industries including
insurance, managed healthcare, financial services, commercial print services,
government, telecommunications and manufacturing. Our products facilitate an
important form of communication between organizations and customers by employing
enterprise database assets to produce high-quality documents that are ready to
print on demand and distribute in high volume. Additionally, our core technology
is being applied to provide electronic document automation solutions for the
Internet by leveraging the capabilities of Adobe's widespread PDF technology.
Document Sciences Autograph is licensed to more than 680 customers worldwide who
are collectively producing an estimated one billion customized pages per month.
Our highly portable Document Sciences Autograph software platform enables
cost-effective, just-in-time, on demand, high volume publishing that is fully
automated, capable of quality document composition and flexible for end-user
customization. Our products are used in a wide array of computing environments
from client/server to large computer systems.
PRODUCTS
The Document Sciences Autograph family of products currently addresses
three major functional areas within the enterprise document automation arena:
Document Composition and Assembly, Variable Content Management and Electronic
Document Viewing, as described below. All of our software products can be
complemented by our professional services organization.
Historically, we have licensed our products for one year, for an initial
license fee, after which an annual renewal fee, usually 15% of the initial
license fee, is required for continued use. We have augmented this approach with
new licensing models whereby we offer perpetual licenses for our products, as
well as three-year term licenses, after which the license may be renewed for
additional three-year terms, or converted for perpetual use. We also provide
three-year maintenance agreements that are usually in an amount equal to 15%,
per year, of the initial license fee. The list price for a three-year license
fee for CompuSet, our core product, is currently $80,000 for a mainframe
installation and ranges down to $40,000 for a PC NT server installation. Options
currently range from $3,000 to $50,000. A typical new account sale through the
direct channel is currently about $100,000 for software licenses and
approximately $75,000 for professional services.
Document Composition and Assembly
Composition and Assembly. CompuSet automates document composition and
assembly using data and content stored in corporate databases. CompuSet software
consists of a rule-based language and a composition engine that provides
high-speed composition and assembly of complex documents with high typographic
and aesthetic levels of quality. Variable content is marked with CompuSet tags
which, in turn, are defined in logically separate style specifications. The
CompuSet tags are conceptually and syntactically similar to HTML or XML, the
current web standards for content tagging, and the style specification is
conceptually similar to CSS, the current web standard for style definition.
Without requiring any real-time user interaction, CompuSet transforms the tagged
data and variable content into finished electronic documents. These can be
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composed and assembled at rates in excess of 50 pages per second, depending on
computing configuration and complexity of the document. Document composition and
construction features are rich and extensive, including the generation of
multi-dimensional dynamic data driven graphics, and the support of full color
text and images. CompuSet operates on a wide range of popular computers and
operating systems including mainframes, Unix platforms and PC NT servers.
Data and Content Capture. Data and content capture products include the
Data Preparation Tool, or DPT, as well as a number of content Importers. These
prepare data and content for subsequent composition and assembly by CompuSet.
DPT is an optional product that enables users to capture and tag raw data and
variable content from a variety of sources, including corporate databases, for
subsequent processing by CompuSet. It provides an easy-to-use Graphical User
Interface, or GUI, that describes the existing data environment and the related
data processing and tagging instructions for CompuSet. It then automatically
generates a data preparation program in COBOL that is compatible with mainframe
COBOL compilers and Acucorp's AcuCobol runtime products. Content Importers
accept externally generated document objects, including text, static graphics
and scanned images, and converts them into formats that are compatible with
CompuSet. The content Importers currently supported include Xerox Metacode,
Adobe PostScript and the TIFF standard for scanned images. This part of the
architecture is extensible and new content Importers can be developed as
required. Additional content Importers for the support of certain popular web
formats are planned for introduction during 2000.
Document Output and Merge. Emitters transform the output of CompuSet into a
number of popular Page Description Languages, or PDLs, for subsequent printing
and/or viewing. The PDLs provide device-specific instructions for rendering
text, forms, images and graphics into finished documents. The Emitters also
condition the PDLs for transport over a variety of high-speed printing
interfaces and for support of various finishing devices. The PDL formats
currently supported are Xerox Metacode, IBM AFPDS, HP PCL and Adobe PostScript.
This part of the architecture is extensible and new Emitters can be developed as
required. Additional Emitter features and enhancements, including inline Output
Processing functionality, are planned for introduction during 2000.
Rapid Application Development Tools. Visual CompuSet application
development tools run on Microsoft Windows(R) and simplify variable document
application design and prototyping. Visual CompuSet incorporates support for the
optional DPT product, for a variety of Importer, Merge and Emitter tools, as
well as for the CompuSeries II design environment and JetForm(R) Corporation's
JetForm Design tool. Visual CompuSet uses a PC Windows version of CompuSet,
combined with an editor to manipulate the tagged document data and content.
Visual CompuSet supports all of the dynamic functions and features of the
CompuSet production engine.
Visual CompuSet Professional Edition. The recent introduction of Visual
CompuSet Professional Edition, or VCPro, significantly augments the capabilities
of the Visual CompuSet product. A new DPT Document Designer component is tightly
integrated with the graphical DPT user interface. Users can define their
existing data environment with DPT and directly associate their variable data
and content elements with CompuSet style objects such as sections, paragraphs,
tabular elements, images, photographs and 2 and 3-D data-driven graphics. The
DPT Document Designer GUI interactions feature WYSIWYG and Drag-and-Drop
operability. The feature set is rich and general-purpose and the design
centerline is the generation of complex high-value investment statement that
feature rich use of cross-marketing elements including full-color graphics.
Existing Visual CompuSet users can upgrade to the new Professional Edition
product. VCPro enhancements, including web application support, are planned for
introduction during 2000.
Variable Content Management
Variable Content Management products provide client/server solutions for
the creation, revision and management of document components used in several
types of document automation solutions. They consist of the Document Library
Service, or DLS, Server and Client products. DLS manages the document component
creation process required by complex variable and text-intensive documents, such
as contracts and policies. In addition to component creation, DLS also supports
the definition of complex assembly rules
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required for interactive or fully automated document composition and assembly
using Microsoft Word(R) and/or CompuSet. DLS uses a client/server architecture
for accessing data and files on a mainframe or NT network server. The DLS Client
product manages text objects created with Microsoft Word(R). The DLS text
objects are tracked and managed in a multi-authoring environment that supports
access security, revision control and approval workflow. DLS also provides a
criteria-based document text object selection capability for customized or
personalized documents. These criteria are then used by DLS to select the text
objects and generate a Microsoft Word(R) document or a CompuSet-ready tagged
file, based on application volume requirements. The customized or personalized
document assembly can be directed to occur in a high volume fashion on the
server or in a just-in-time, on-demand fashion on the local DLS Client PC.
DLS Web Express. The recent introduction of DLS Web Express significantly
augments the flexibility of our DLS product line by incorporating Internet
support. DLS Web Express enables the dynamic creation of web-ready documents
using HTML and/or Adobe PDF. These documents can be created on-demand through
Advanced Server Page (ASP), or other web-compatible, applications. Dynamic web
browser form input is routed to the DLS Web Express Server to automatically
assemble and generate a customized web-ready document for local browser viewing
or printing. Target applications include insurance agent and sales proposal
automation. Existing DLS users can upgrade to the new DLS Web Express product.
Additional features and enhancements to DLS Web Express are planned for 2000.
Electronic Document Viewing
Electronic Document Viewing enables on-line viewing and archiving of
electronic documents produced by CompuSet document automation applications. It
consists of the CCF Formatter and CompuView, as well as the PDF Formatter for
supporting Adobe's popular Portable Document Format. The CCF Formatter is
available for a variety of mainframe, Unix platforms and PC NT servers. The
electronic document files are generated in the Composite Container Format, or
CCF, which is optimized for fast, memory-efficient viewing, transport and
storage. CCF container files can then be viewed by CompuView. CCF files consist
of three major components: an internal rendition of the pages for WYSIWYG
viewing, various indices for locating documents and reusable document elements.
The view of the document is virtually identical to the printed document. CCF
files can be distributed, archived or printed through document distribution and
archiving systems offered by third party software developers that integrate CCF
and CompuView. The PDF Formatter can also be used to support archiving and
viewing with third party products. Lastly, indexed support of IBM's AFPDS
document format is provided for compatibility with IBM's On-Demand offering.
We are developing a variety of Internet extensions, as well as considering
additional possible future extensions, some of which are not currently under
active development. We believe that our core technology can be extended to the
Internet and we are continuing our development activities in this area, although
there can be no assurance that such development activities will result in
commercially successful products. See "Business -- Research and Development".
PROFESSIONAL SERVICES
In addition to our software products, we provide a comprehensive suite of
professional services that can assist customers in the implementation of
mission-critical document automation applications. Professional services include
on-site software installation, customer training programs, telephone support
programs and consulting services. Consulting services is currently focused on
assisting in the sale of high margin initial software licenses by providing
project management, requirements analysis, application design and application
development services. In addition to consulting services, we currently provide
introductory-level customer education with CompuSet, DLS, DPT and VCPro initial
licenses. Additional and advanced classes are available for additional fees at
our headquarters in San Diego, our offices in Milwaukee and at customer sites.
We believe that the use of our professional services enables customers to deploy
our document automation products more rapidly and effectively. The professional
services and support organizations employed a staff of 43 as of December 31,
1999.
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SALES AND MARKETING
Our sales and marketing organization targets vertical industry markets that
require document automation and high volume, high quality document
customization. We currently license our products using a combination of direct
sales and alternate channels. In the United States, we market our products
primarily through a direct sales force that manages our existing base of
corporate accounts, as well as targets new accounts in select market segments.
Our sales account executives are grouped into industry focused teams and are
provided with pre-sales technical support by qualified solution analysts.
Account executives and solution analysts are located throughout the United
States to provide optimal coverage. We also distribute our software products
through value added resellers, or VARs, such as Xerox Canada, Ltd. in Canada,
Fuji Xerox Co., Ltd. in Australia and Xerox Brazil, Ltd. in Brazil. Our
subsidiary, Document Sciences Europe, markets our products in Europe, Africa and
the Middle East by providing VAR channel management and support and by defining
European market and product requirements. Our European VARs are principally
Xerox Europe affiliates who re-market our products. Our revenues from export
transactions with Xerox affiliates were $2.9 million, $4.1 million and $4.6
million in 1997, 1998 and 1999, respectively. The sales and marketing
organization employed a staff of 37 as of December 31, 1999.
We intend to expand our sales and marketing organization to provide
incremental direct sales coverage in the US as well as incremental indirect
channel coverage throughout the world, including the US. Such planned expansion
will occur by first addressing the unique product requirements of a region or
market segment, followed by the development of suitable VARs, to sell in that
region or market segment. The VAR expansion will be facilitated by our newly
improved worldwide VAR program. As we are able to increase our market presence,
we may choose to augment our alternate channels with a direct sales capability.
In some cases, we also plan on providing our software through OEM channels where
specific coverage would not be provided by either direct or alternate channels.
In addition, we also intend to increase both our product offerings and
markets through joint marketing, sales and distribution and development
relationships with other major companies. Current relationships include formal
and informal marketing and sales alliances with Xerox, IBM, BMC, RSD, JetForm
Corporation, Systemware and Anacomp. These relationships provide sales leads for
our products and extend our sales coverage and networking capabilities.
RESEARCH AND DEVELOPMENT
With the release of DLS Web Express in 1999 and the continuing sales of our
PDF Formatter during the year, Document Sciences has continued to enhance its
World Wide Web functionality. Early in 1999, we engaged several customers in a
formal requirements analysis looking ahead three years. We used the Quality
Function Deployment (QFD) process, which is a formal procedure for interviewing
customers, identifying their needs and prioritizing specific product features.
As a result, we have identified a number of requirements related to regulated,
electronic documents of the future. Our major product initiatives in 2000 are
addressing several of the key requirements from the QFD exercise.
In general, our product development strategy is based on delivering
document automation solutions for specific types of documents in single
industries. A cross-functional team that includes a representative from each
discipline in the company is responsible for delivering each focused offering.
We use a documented business planning and product delivery process to guide its
product development and delivery activities.
New product offerings build on Document Sciences' Autograph family of
products. These established products are maintained by teams that respond to
customer requests for defect corrections and feature enhancements. By building
on our existing products we maximize our reuse of existing software and
expertise and enable our customers to purchase new offerings as upgrades.
There can be no assurance that we will be successful in developing,
introducing and marketing new products on a timely and cost-effective basis, if
at all, or that new products will achieve market acceptance.
We expect to continue to enhance our existing products and to develop new
products, particularly as they relate to electronic document automation
applications. Research and development expenditures have grown
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substantially since our inception. Such expenditures, not including amounts
capitalized, were $3.3 million, $4.3 million and $4.7 million in 1997, 1998 and
1999. The development organization employed a staff of 39 as of December 31,
1999. We employ independent contractors as needed to supplement the permanent
development staff.
COMPETITION
The market for document automation products is intensely competitive,
subject to rapid change and significantly affected by new product introductions
and other market activities of industry participants. Our software products are
targeted at document intensive organizations that require the ability to produce
large quantities of customized and personalized documents in paper or electronic
form. We face direct and indirect competition from a broad range of competitors
who offer a variety of products and solutions to our current and potential
customers. Our principal competition currently comes from systems developed
in-house by the internal MIS departments of large organizations where there is a
reluctance to commit the time and effort necessary to convert their document
automation processes to our document automation software. We also face
competition from Docucorp, in the insurance industry, M&I Data Services, Inc. in
banking and financial services, Group 1 Software, Inc. in commercial direct
mailing and marketing as well as several other general purpose competitors.
Several of our competitors have longer operating histories, significantly
greater financial, technical and marketing resources, greater name recognition
and a larger installed base of customers.
It is also possible that we will face competition from new competitors.
These include large independent software companies offering personal
computer-based application software solutions, such as Microsoft Corporation and
Adobe Corporation, and from large corporations providing database management
software solutions, such as Oracle Corporation. In addition, Xerox, either
directly or through affiliated entities, could become a large competitor.
Moreover, as the market for document automation software develops, a number of
these or other companies with significantly greater resources than Document
Sciences could attempt to enter or increase their presence in the document
automation market by either acquiring or forming strategic alliances with our
competitors or by increasing their focus on the industry. In addition, current
and potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address the needs of our current and prospective customers. It
is possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. Increased competition may result in
price reductions, reduced gross margins and loss of market share, any of which
could have a material adverse effect on our business, operating results and
financial condition. There can be no assurance that we will be able to compete
successfully against current or future competitors or that competitive pressures
faced by us will not materially adversely affect our business, operating results
and financial condition.
We believe that the principal competitive factors affecting our market
include product performance and functionality, ease of use, scalability,
operating across multiple computer and operating system platforms, product and
company reputation, client service and support and price. Although we believe we
currently compete favorably with respect to such factors, there can be no
assurance that we will be able to maintain our competitive position against
current and future competitors, especially those with greater financial,
technical and marketing resources than us, or that we will be successful in the
face of increasing competition from new products, new solutions introduced by
existing competitors or by new companies entering the market.
PATENTS AND PROPRIETARY RIGHTS
Our success is dependent, in part, on the ability to protect our
proprietary technology. We rely primarily on a combination of copyright and
trademark laws, trade secrets, confidentiality procedures and contractual
provisions to protect our proprietary rights. We seek to protect our software,
documentation and other written materials under trade secret and copyright laws,
which afford only limited protection. We presently have no patents or patent
applications pending. 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.
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Policing unauthorized use of our products is difficult, and while we are
unable to determine the extent to which piracy of our software 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 to as great
an extent as do the laws of the United States. There can be no assurance that
our means of protecting our proprietary rights will be adequate or that our
competitors will not independently develop similar technology. We are not aware
that any of our products infringe upon the proprietary rights of third parties.
There can be no assurance, however, that third parties will not claim
infringement by us with respect to current or future products. We expect that
software product developers will increasingly be subject to infringement claims
as the number of products and competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time consuming, result in costly
litigation, cause product shipment delays or require us to enter into royalty or
licensing agreements. Such royalty or licensing agreements, if required, may not
be available on terms acceptable to us or at all, which could have a material
adverse effect upon our business, operating results and financial condition.
In addition, we also rely on certain software that we license from third
parties, including software that is integrated with internally developed
software and used in our products to perform key functions. There can be no
assurances that such firms will remain in business, that they will continue to
support their products or that their products will otherwise continue to be
available to us on commercially reasonable terms. The loss or inability to
maintain any of these software licenses could result in delays or reductions in
product shipments until equivalent software can be developed, identified,
licensed and integrated, which would adversely affect our business, operating
results and financial condition.
EMPLOYEES
As of December 31, 1999, we had 140 employees including 43 in professional
services, 37 in sales and marketing, 39 in research and development and 21 in
finance and administration. None of our employees are represented by a labor
union. We have experienced no work stoppages and believe our relationship with
our employees is good. Competition for qualified personnel in the industry in
which we compete is intense. We believe that our future success will depend in
part on our continued ability to attract, hire and retain qualified personnel.
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RISK FACTORS
The following is a discussion of certain factors which currently impact or
may impact our business, operating results and/or financial condition. Anyone
making an investment decision with respect to our common stock or other
securities is cautioned to carefully consider these factors.
If any of the following risks actually occur, our business, future
operating results and financial condition could be materially adversely
affected. In such case, the trading price of our common stock could decline and
you may lose all or part of your investment.
OUR QUARTERLY RESULTS FLUCTUATE SIGNIFICANTLY AND WE MAY NOT BE ABLE TO MAINTAIN
OUR EXISTING GROWTH RATES.
Our total revenues and operating results can vary, sometimes substantially,
from quarter to quarter and we expect them to vary significantly in the future.
Our revenues and operating results are difficult to forecast; and our future
results will depend upon many factors, including the following:
- the demand for our products;
- the level of product and price competition we face;
- the length of our sales cycle;
- the size and timing of individual license transactions;
- the delay or deferral of customer implementations;
- the budget cycles of our customers;
- our success in expanding our direct sales force or indirect distribution
channels;
- the timing of our new product introductions and enhancements, as well as
those of our competitors;
- our mix of products and services;
- our level of international sales;
- the activities of and acquisitions by our competitors;
- our timing of new hires;
- changes in foreign currency exchange rates;
- our ability to develop and market new products and to control costs; and
- general domestic and international economic conditions.
Our initial license fee revenue mainly depends on when orders are received
and shipped. However, because of our sales model, our customers' implementation
schedule and the complexity of the implementation process, revenue from some
software shipments may not be recognized in the same quarter as the shipment
occurs. Our operating expenses are primarily based on anticipated revenue
levels. Since a high percentage of those expenses are relatively fixed, a delay
in the recognition of revenue from license transactions could cause significant
variations in operating results from quarter to quarter and we may sustain
losses as a result. If such expenses precede increased revenues, our operating
results would be materially adversely affected.
As a result of these factors, results from operations 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 and you
should not rely upon them as an indication of our future performance.
Furthermore, our operating results in some future quarter may fall below the
expectations of public market analysts and investors. If this occurs, the price
of our common stock would likely be materially adversely affected.
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WE ARE SUBSTANTIALLY CONTROLLED BY XEROX.
Xerox owns approximately 62% of the outstanding shares of our common stock.
Consequently, Xerox controls Document Sciences, is able to elect our entire
board of directors and could have significant input into our operations. In
addition, Xerox is able to determine the outcome of all corporate actions
requiring stockholder approval, including potential mergers, acquisitions,
consolidations and sales of all or substantially all of our assets. Xerox's
voting power could delay or prevent a change in control of Document Sciences and
may prevent or discourage tender offers for our common stock at a premium price
by another person or entity. Xerox affiliates currently hold two of the five
seats on our board of directors.
OUR BUSINESS IS DEPENDENT ON MAINTAINING OUR RELATIONSHIPS WITH XEROX.
We currently have a variety of contractual and informal relationships with
Xerox and affiliates of Xerox, including a Cooperative Marketing Agreement, a
Transfer and License Agreement and various distribution agreements. We rely on
these relationships and agreements for a significant portion of our total
revenues.
- In 1999, revenues derived from relationships with Xerox and affiliates of
Xerox accounted for approximately $5.2 million, representing 21% of our
total revenues;
- In 1998, revenues derived from relationships with Xerox and affiliates of
Xerox accounted for approximately $5.4 million, representing 27% of our
total revenues; and
- In 1997, revenues derived from relationships with Xerox and affiliates of
Xerox accounted for approximately $4.6 million, representing 23% of our
total revenues.
Included above were commissions that we received from sales of Xerox
printers under our strategic marketing alliance with Xerox. These commissions
were:
- 1999: $287,000;
- 1998: $344,000; and
- 1997: $859,000.
These commissions have little or no associated costs and have contributed a
substantial portion of our income from operations for certain prior operating
periods. This commission arrangement was terminated as of September 30, 1999.
Furthermore, there can be no assurance that existing and potential
customers will continue to do business with us because of these relationships or
our historical ties with Xerox and its affiliates. Though we intend to continue
our existing relationships with Xerox, our strategy is to lessen our dependence
on Xerox. However, there can be no assurance that we will be able to do so and,
because of our current level of dependence on Xerox, there can be no assurance
that our move to become more independent will not adversely affect our business,
operating results and financial condition. Our failure to maintain these
relationships, particularly with Xerox and its affiliates, or to establish new
relationships in the future, could have a material adverse effect on our
business, operating results and financial condition.
Xerox has strategic alliances and other business relationships with other
companies who supply software and services used in high volume electronic
publishing applications and who now or in the future may be our competitors.
There can be no assurance that Xerox or one of its affiliated companies will not
engage in business that directly competes with us. In addition, Xerox has
ongoing internal development activities that could in the future lead to
products that compete with us. Xerox could in the future expand these
relationships or enter into additional ones, and as a result our business could
be materially adversely affected.
OUR GROWTH IS DEPENDENT UPON SUCCESSFULLY FOCUSING OUR DISTRIBUTION CHANNELS.
We intend to streamline our worldwide sales and distribution channels by
focusing on key target industry market segments where our current and planned
products enjoy a significant competitive advantage and a current, high market
demand. We also plan on leveraging our existing relationships with Xerox
Corporation,
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IBM Corporation and their channels and affiliates by launching targeted joint
marketing and value added reseller programs and by introducing new product
offerings that are optimized for selected target markets and marketing channels.
In addition, we intend to form additional partnerships with system integrators
and consultants in order to broaden our capacity to deliver complete document
automation solutions that incorporate significant services content, while also
maintaining our core domain expertise. We cannot assure you that we will be able
to successfully streamline and focus our worldwide channels, leverage our
existing relationships or form new alliances. If we fail to do so, it will have
a material adverse effect on our business, operating results and financial
condition.
CONTINUED EXPANSION OF OUR PROFESSIONAL SERVICES IS NECESSARY FOR OUR FUTURE
GROWTH.
We are increasing our focus on the consulting services component of our
professional services to assist customers in the planning and implementation of
enterprise-wide, mission-critical document automation applications. Our
increased focus is dependent on retaining and hiring professionals to perform
these consulting services. Should we be unable to maintain the necessary
services workforce, our business and financial condition could be materially
adversely affected.
OUR GROWTH DEPENDS ON MARKET ACCEPTANCE OF OUR EXISTING PRODUCTS AND OUR
INTRODUCTION OF NEW PRODUCTS AND ENHANCEMENTS TO EXISTING PRODUCTS.
Our future business, operating results and financial condition will depend
upon market acceptance of our existing products, as well as our ability to
develop new products that address the future needs of our target markets and to
respond to emerging industry standards and practices. Our Document Sciences
Autograph family of products has been applied mainly to document automation
applications producing paper-based documents. We believe that our core
technology can be extended to the Internet, intranets and commercial on-line
services, and we have begun initial development activity in this area. We cannot
assure you that we will be successful in developing, introducing and marketing
new products or product enhancements, including new products or the extension of
existing products for the Internet, intranets and commercial on-line services,
on a timely and cost effective basis, if at all. In addition, we cannot assure
you that our new products and product enhancements will adequately meet the
requirements of the marketplace or achieve market acceptance. Delays in our
commercial shipments of new products or enhancements may result in client
dissatisfaction and a delay or loss of product revenues.
If we are unable, for technological or other reasons, to develop and
introduce new products or enhancements of existing products in a timely manner
in response to changing market conditions or client requirements, then our
business, operating results and financial condition will be materially adversely
affected. In addition, we cannot assure you that our existing products, new
products or new versions of our existing products will achieve market
acceptance. In order to provide our customers with integrated product solutions,
our future success will also depend in part upon our ability to maintain and
enhance relationships with our technology partners.
A LONGER THAN EXPECTED SALES CYCLE MAY AFFECT OUR REVENUES AND OPERATING
RESULTS.
The licensing of our software products is often an enterprise-wide decision
by prospective customers and generally involves a sales cycle of three to twelve
months in order to educate them regarding the use and benefits of our products.
In addition, the implementation of our products by customers involves a
significant commitment of their resources over an extended period of time, and
is commonly associated with substantial customer business process reengineering
efforts. For these and other reasons, our sales and customer implementation
cycles are subject to a number of significant delays over which we have little
or no control. Any delay in the sale or customer implementation of a limited
number of license transactions could have a material adverse effect on our
business and financial condition and cause our operating results to vary
significantly from quarter to quarter.
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OUR OPERATING RESULTS ARE SUBSTANTIALLY DEPENDENT ON SALES OF A SMALL NUMBER OF
PRODUCTS IN HIGHLY CONCENTRATED INDUSTRIES.
We derived 75% of our initial license revenue from CompuSet and related
CompuSet option products in 1999. Our initial license fees from DLS and DVS
comprised 21% and 4%, respectively, in 1999. As a result, factors that may
adversely impact the pricing of or demand for CompuSet and related products,
such as competition from other products, negative publicity or obsolescence of
the hardware or software environments in which our products run, could have a
material adverse effect on our business, operating results and financial
condition. Our financial performance will continue to depend significantly on
the successful development, introduction and customer acceptance of new and
enhanced versions of our CompuSet software and related products. Our revenues
are derived from sales to a small number of industries as follows:
- Licenses to end users in the insurance and commercial print services
industries for 1999 accounted for 68% of initial license revenues;
- Licenses to end users in these industries for 1998 accounted for 44% of
initial license revenues; and
- Licenses to end users in these industries for 1997 accounted for 61% of
initial license revenues.
Our future success will depend on our ability to continue to successfully
market our products in these and other industries. We cannot assure you that we
will continue to be successful in developing and marketing CompuSet products and
related services. Our failure to do so would have a material adverse effect on
our business, operating results and financial condition.
WE MAY BE EXPOSED TO RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS.
Our revenues from export sales, including sales through our foreign
subsidiary, accounted for the following:
- 25% of our total revenues in 1999;
- 31% of our total revenues in 1998; and
- 28% of our total revenues in 1997.
Our wholly owned subsidiary, Document Sciences Europe, markets and supports
our products in Europe. We license our products in Europe through value added
resellers and to a lesser extent, direct sales. Our VARs are principally Xerox
affiliates who re-market our products. Revenues generated by this subsidiary
were $4.4 million, $4.5 million and $3.7 million in 1997, 1998 and 1999,
respectively. In Canada, Australia and Brazil we distribute our products through
Xerox Canada, Ltd., Fuji Xerox Co., Ltd. and Xerox Brazil, Ltd., respectively.
Revenues generated by these Xerox affiliates were $1.0 million, $1.7 million and
$2.4 million in 1997, 1998 and 1999, respectively. In order to successfully
expand export sales, we must establish additional foreign operations, hire
additional personnel and develop relationships with additional international
resellers. If we are unable to do so in a timely manner, our growth in
international export sales could be limited, and our business, operating results
and financial condition could be materially adversely affected. In addition, we
cannot assure you that we will be able to maintain or increase international
market demand for our products.
Additional risks inherent in our international business activities include:
- currency fluctuations;
- unexpected changes in regulatory requirements;
- tariffs and other trade barriers;
- our limited experience in localizing products for foreign countries;
- lack of acceptance of our localized products in foreign countries;
- longer accounts receivable payment cycles;
- difficulties in managing our international operations;
- potentially adverse tax consequences including restrictions on the
repatriation of earnings; and
- the burdens of complying with a wide variety of foreign laws.
A portion of our business is conducted in currencies other than the U.S.
dollar, primarily the French franc. Although exchange rate fluctuations have not
had a significant impact on us, fluctuations in the value of
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the currencies in which we conduct our business relative to the U.S. dollar
could cause currency transaction gains and losses in future periods. We do not
currently engage in currency hedging transactions, and we cannot assure you that
fluctuations in currency exchange rates in the future will not have a material
adverse impact on our international revenues, business, operating results and
financial condition.
OUR BUSINESS IS DEPENDENT ON THE MARKET FOR DOCUMENT AUTOMATION SOFTWARE.
The market for document automation software is intensely competitive,
highly fragmented, underdeveloped and subject to rapid change. Marketing and
sales techniques in the document automation software marketplace, as well as the
bases for competition, are not well established. We cannot assure you that the
market for document automation software will develop or that, if it does
develop, organizations will adopt our products. We have spent, and intend to
continue to spend, significant resources educating potential customers about the
benefits of our products. However, we cannot assure you that such expenditures
will enable our products to achieve further market acceptance, and if the
document automation software market fails to develop or develops more slowly
than we currently anticipate, our business, operating results and financial
condition would be materially adversely affected.
In addition, the commercial market for document automation of electronic
documents designed for use with the Internet, intranets and commercial on-line
services has only recently begun to develop, and the success of our products
designed for this market will depend in part on their compatibility with such
services. It is difficult to predict whether the Internet, intranets and
commercial on-line services will be a viable commercial marketplace or whether
the demand for related products and services will increase or decrease in the
future. Since the increased commercial use of the Internet, intranets and
commercial on-line services could require substantial modification and
customization of certain of our products and services as well as the
introduction of new products and services, we cannot assure you that we will be
able to effectively or successfully compete in this market.
OUR ABILITY TO MANAGE OUR GROWTH WILL AFFECT OUR BUSINESS.
We have recently experienced a period of growth in total revenues. Our
ability to compete effectively and to manage future change will require us to
continue to improve our financial and management controls, reporting systems and
procedures on a timely basis and to expand, train and manage our work force. We
cannot assure you that we will be able to do so successfully. Our failure to do
so could have a material adverse effect on our business, operating results and
financial condition.
OUR EXECUTIVE OFFICERS AND CERTAIN KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS,
AND THESE OFFICERS AND KEY PERSONNEL MAY NOT REMAIN WITH US IN THE FUTURE.
Our future performance depends in significant part upon the continued
service of our key technical, sales and senior management personnel, none of
whom had signed employment agreements with us as of December 31, 1999. The loss
of the services of one or more of our executive officers could 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 product development, sales and management personnel.
Competition for such personnel is intense, and there can be no assurance that we
will be able to retain our key employees or that we will be able to attract,
assimilate or retain other highly qualified product development, sales and
managerial personnel in the future.
OUR FAILURE TO ADEQUATELY LIMIT OUR EXPOSURE TO PRODUCT LIABILITY CLAIMS MAY
ADVERSELY AFFECT US.
Our license agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability claims. However,
it is possible that the limitation of liability provisions contained in our
license agreements may not be effective under the laws of certain jurisdictions.
Although we have not experienced any product liability claims to date, sale and
support of our products may entail the risk of such
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claims in the future. A successful product liability claim brought against us or
a claim arising as a result of our professional services could have a material
adverse effect upon our business, operating results and financial condition.
OUR PRODUCTS MAY SUFFER FROM DEFECTS OR ERRORS.
Software products as complex as those we offer, particularly our new Visual
CompuSet Professional Edition product, may contain undetected defects or errors
when first introduced or as new versions are released. As a result, we could in
the future lose or delay recognition of revenues as a result of software errors
or defects. In addition, 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 have a greater sensitivity to
product defects than the general market for software products. Although our
business has not been adversely affected by any such errors to date, we cannot
assure you that, despite our testing and testing by current and potential
customers, errors will not be found in our new products or releases. If these
errors are discovered after the commencement of commercial shipments, it could
result in any of the following:
- loss of revenue or delay in market acceptance;
- diversion of our development resources;
- damage to our reputation; or
- increased service and warranty costs.
If any of these factors occur, it would have a material adverse effect upon
our business, operating results and financial condition.
WE MAY FACE RISKS FROM THE EURO.
In January 1999, a new currency called the "Euro" was introduced in certain
Economic and Monetary Union, or EMU, countries. During 2002, all EMU countries
are expected to be operating with the Euro as their single currency. Uncertainty
exists as to the effects the Euro will have on the marketplace. Additionally,
all of the final rules and regulations have not yet been defined and finalized
by the European Commission with regard to the Euro. We are still assessing the
impact the EMU formation will have on our internal systems and the sale of our
products. We expect to take appropriate actions based on the results of such
assessment. We have not yet determined any potential costs.
ITEM 2. PROPERTIES
Our principal administrative, sales, marketing, training and research and
development facilities occupy approximately 21,300 square feet in Carlsbad,
California, pursuant to a lease expiring on February 28, 2005. Our subsidiary in
France occupies approximately 2,200 square feet of office space with a renewable
lease expiring on April 15, 2004. In addition, our regional office in Milwaukee,
Wisconsin occupies approximately 7,500 square feet of office space pursuant to a
lease expiring on March 31, 2003. Sales representatives and field technical
support personnel operate from their homes.
ITEM 3. LEGAL PROCEEDINGS
We are not a party, nor is our property subject, to any material pending
legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal year 1999.
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Executive Officers of Document Sciences
The executive officers of Document Sciences and their ages, as of March 31,
2000, are as follows:
NAME AGE POSITION
---- --- --------
Barton L. Faber........... 51 President and Chief Executive Officer
John L. McGannon.......... 39 Vice President, Chief Financial Officer and Secretary
Peter L. Bradshaw......... 44 Vice President, Development
Daniel J. Fregeau......... 43 Vice President, Worldwide Sales and Business Development
Ann Kana.................. 40 Vice President, Professional Services
John H. Wilson............ 55 Vice President, Finance
Barton L. Faber has served as President and Chief Executive Officer since
June 1999. He has been a member of the Board of Directors since 1996. From 1996
to 1998, Mr. Faber served as Chairman of the Board of Directors and Chief
Executive Officer of Metromail. From April 1985 to June 1996, he held various
positions with R.R. Donnelly. Prior to joining R.R. Donnelley, he held various
positions with Mobil Oil Corporation and Ramada Europe. Mr. Faber currently
serves as a member of the Board of Directors of Dataware Technologies, Inc.,
GeoSystems Global Corporation and Xeikon N.V.
John L. McGannon has served as Vice President, Chief Financial Officer and
Secretary since December 1999. He has also served as Vice President, Chief
Administrative Officer and Controller since joining Document Sciences in
September 1998. From June 1997 through August 1998, Mr. McGannon served as the
Manager of Financial Analysis and Planning for Simulation Sciences, Inc., a
California-based software developer for the oil and chemical engineering
industries. Mr. McGannon worked for Chevron Corporation from 1988 to 1997 in a
variety of finance and accounting positions.
Peter L. Bradshaw has served as Vice President of Development since March
1994. Prior to joining Document Sciences, Mr. Bradshaw was manager of the
Application Software Team at Xerox from 1989 to 1994, where he was responsible
for integrating high volume printers with application software. From 1982 to
1989, Mr. Bradshaw worked in Xerox' Workstation Business Unit where he managed
the development team responsible for the graphical user interface for the 6085
Workstation. From 1977 to 1980, Mr. Bradshaw was at Bell Telephone Laboratories
in system development.
Daniel J. Fregeau has served as Vice President of Worldwide Sales and
Business Development since 1998. From 1997 to 1998, he served as Vice President,
Business Development, from 1994 to 1997, he served as Vice President, Marketing
and from 1992 to 1994, he served as Vice President, Sales. Prior to joining
Document Sciences, Mr. Fregeau was Marketing Manager for the Networking Division
of Sears Business Centers, San Diego, from 1990 to 1992. Mr. Fregeau was a
founder and principal of MicroAge in San Diego from 1988 to 1990. From 1982 to
1988, Mr. Fregeau held several positions with Xerox Corporation's Electronic
Publishing Business Unit including Manager of Systems Engineering and
Integration, Technical Program Manager and Project Manager. While at Xerox, Mr.
Fregeau designed and directed the development of several publishing products and
was a key contributor to the launch of the XICS (now CompuSet) product in the
U.S. and Canada.
Ann Kana has served as Vice President of Professional Services since July
1999. She joined Document Sciences in May 1997 and previously served as Director
of Project Management in Professional Services. From 1990 to 1997, Ms. Kana held
various management positions in business planning, product development,
marketing and finance at SABRE Travel Information Network, a division of The
SABRE Group. Ms. Kana's past positions include seven years with Andersen
Consulting, serving as a manager in their Financial and Commercial Services
Division from 1987 to 1989. Ms. Kana holds a B.A. degree in Managerial Studies
from Rice University and a M.S. in Accounting from Texas A&M University.
John H. Wilson has served as Vice President of Finance since August 1999.
Between 1988 and 1999, Mr. Wilson served as an interim senior financial officer
for several software and electronic industry companies in San Diego, California,
including Document Sciences from May 1998 to August 1999. Mr. Wilson's previous
experience includes senior financial and general management positions in the
retail and healthcare
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industries and service with Price Waterhouse Coopers, LLP. Mr. Wilson is a
Certified Public Accountant in California and holds a Master's Degree in
Business from Woodbury University in Los Angeles.
Executive officers are appointed by the Board of Directors and serve at the
discretion of the Board. There are no family relationships among any directors
or executive officers of Document Sciences.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol
"DOCX". The following table sets forth the range of high and low closing prices
on the National Market of the common stock for the periods indicated, as
reported by Nasdaq. Such quotations represent inter-dealer prices without retail
markup, markdown or commission and may not necessarily represent actual
transactions.
HIGH LOW
----- -----
FISCAL 1998
First quarter ended March 31, 1998.......................... $4.88 $2.94
Second quarter ended June 30, 1998.......................... $4.25 $2.69
Third quarter ended September 30, 1998...................... $3.00 $1.69
Fourth quarter ended December 31, 1998...................... $2.50 $1.38
FISCAL 1999
First quarter ended March 31, 1999.......................... $2.69 $1.63
Second quarter ended June 30, 1999.......................... $2.13 $1.25
Third quarter ended September 30, 1999...................... $2.13 $1.69
Fourth quarter ended December 31, 1999...................... $3.38 $1.45
We had 115 record holders as of December 31, 1999. There were no sales of
unregistered stock in 1999.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data of Document Sciences
Corporation. This historical data should be read in conjunction with the
Consolidated Financial Statements and the related notes thereto in Item 8 and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7.
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF INCOME
Net revenues............................ $10,512 $15,319 $19,740 $ 20,107 $24,305
Income (loss) from operations........... 1,685 1,665 (58) (10,361) 1,366
Net income (loss)....................... 1,052 1,361 838 (9,154) 2,111
Net income (loss) per share............. .12 .14 .08 (.86) .20
Shares used in per share calculations... 8,563 9,615 11,013 10,690 10,817
BALANCE SHEET
Working capital......................... $ 1,353 $25,807 $23,896 $ 14,883 $16,611
Total assets............................ 6,289 32,022 34,229 30,989 30,423
Capital lease obligations, less current
portion............................... 99 116 52 13 1
Stockholders' equity.................... 856 26,910 27,691 18,410 20,280
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to historical information, this Form 10-K contains
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those discussed herein. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed herein as well as those discussed in "Business -- Risk Factors" on
pages 8 through 13. Readers are cautioned not to place undue reliance on these
forward-looking statements, and we undertake no obligation to publicly release
the results of any revision to these forward-looking statements which may be
made to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
OVERVIEW
Document Sciences Corporation develops, markets and supports a family of
document automation software used in high volume electronic publishing
applications. We were incorporated in Delaware in October 1991 as a wholly owned
subsidiary of Xerox Corporation. Following our initial public offering of stock
in September 1996, Xerox ownership was reduced to approximately 62%.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
Revenues
Total revenues were $19.7 million, $20.1 million and $24.3 million in 1997,
1998 and 1999, respectively, representing increases of 2% from 1997 to 1998 and
21% from 1998 to 1999. Our revenues are divided into three categories based upon
the sources from which they are derived: initial license fees, annual renewal
license and support fees, and services and other revenues. Initial license fees
are comprised of license fees for the first year of use of our products. Annual
renewal license and support fees are comprised of license fees for the continued
use and support of our licensed products. Services and other revenues are
comprised of fees for consulting, application development and training services
performed by us as well as fees received from Xerox in connection with the sale
of certain Xerox printer products. We recognize revenue in accordance with AICPA
Statement of Position (SOP) 97-2, Software Revenue Recognition. Initial license
fees are recognized when a contract exists, the fee is fixed or determinable,
software delivery has occurred and collection of the receivable is deemed
probable. The portion of the initial license fee representing the software
support for the first year is deferred and recognized ratably over the contract
period. Annual renewal license and support fees are recognized ratably over the
contract period. Revenues from commissions paid by Xerox in connection with the
sale of Xerox printer products are recognized upon installation of the printer
products. Revenues generated from consulting services are recognized as the
related services are performed. However, when such consulting services are
deemed to be essential to the functionality of the delivered software product,
revenue from the entire arrangement is recognized in accordance with SOP 81-1,
Accounting for Performance of Construction-Type and Certain Production-Type
Contracts, and Accounting Research Bulletin (ARB) No. 45, Long-Term
Construction-Type Contracts.
We sell our products principally through our direct sales force
domestically, and internationally through distributors and value added
resellers, or VARs. Revenues from export sales and sales through our foreign
subsidiary were $5.5 million, $6.2 million and $6.1 million in 1997, 1998 and
1999, respectively, representing an increase of 13% from 1997 to 1998 and a
decrease of 2% from 1998 to 1999. Revenue from export sales were 28%, 31% and
25% of total revenues in 1997, 1998 and 1999, respectively. The decrease from
1998 to 1999 is primarily the result of decreased activity associated with an
internal realignment of our foreign subsidiary.
Until September 30, 1999, we had a strategic marketing alliance with Xerox
under which both parties agreed to pay each other fees on referrals that lead to
the successful sale or licensing of each other's products. Our revenues from
this strategic marketing alliance were $859,000, $344,000 and $287,000 in 1997,
1998 and 1999, respectively. These commissions were 4%, 2% and 1% of total
revenues in 1997, 1998 and 1999, respectively. Commissions paid relating to
referrals from Xerox were $121,000, $0 and $0 in 1997, 1998 and 1999,
respectively.
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We have entered into distributorship agreements with various Xerox foreign
affiliates to remarket our products internationally. Our revenues from these
agreements were $2.9 million, $4.1 million and $4.6 million in 1997, 1998 and
1999, respectively.
Initial license fees. Initial license fees were $8.8 million, $7.2 million
and $10.4 million in 1997, 1998 and 1999, respectively, representing a decrease
of 18% from 1997 to 1998 and an increase of 44% from 1998 to 1999. The increase
in 1999 was mainly due to increased sales by our direct sales force in the
United States. The decrease in 1998 was caused by greater dependence on solution
sales and the adoption of SOP 97-2, Software Revenue Recognition. This SOP
requires deferring recognition of some revenues, depending on the nature and
complexity of certain transactions. Initial license revenues were 44%, 36% and
43% of total revenues in 1997, 1998 and 1999, respectively.
Annual renewal license and support fees. Annual renewal license fees were
$4.6 million, $5.9 million and $7.6 million in 1997, 1998 and 1999,
respectively, representing increases of 28% from 1997 to 1998 and 29% from 1998
to 1999. These increases were principally due to an increase in the installed
base of users of our software products. Annual license fees were 23%, 29% and
31% of total revenues in 1997, 1998 and 1999, respectively.
Services and other. Revenues from services and other were $6.4 million,
$7.0 million and $6.3 million in 1997, 1998 and 1999, respectively, representing
an increase of 9% from 1997 to 1998 and a decrease of 10% from 1998 to 1999. The
decrease in 1999 was principally due to our latest software versions not needing
as much consulting services in order to be used. The increase in 1998 was
principally due to the increased number of new customer licenses generating
increased demand for services as well as the increasing scope of professional
services offered. Revenues from services and other were 32%, 35% and 26% of
total revenues in 1997, 1998 and 1999, respectively.
Cost of Revenues and Operating Expenses
Cost of initial license fees. Costs of initial license fees were $677,000,
$1.4 million and $1.4 million in 1997, 1998 and 1999, respectively, representing
8%, 19% and 13% of initial license fees in 1997, 1998 and 1999, respectively.
Cost of initial license fees includes documentation, reproduction costs, product
packaging, packaging design, product media, employment costs for installation
and distribution personnel, the cost of third party software and amortization of
previously capitalized software development costs. The decrease as a percentage
of revenue in 1999 from 1998 was primarily due to savings realized from our
restructuring. The increase as a percentage of revenue in 1998 from 1997 was
primarily the result of increased payments for third party software integrated
into our Visual CompuSet products and an increase in the amount of capitalized
software resulting from the 3rd quarter 1998 release of Visual CompuSet and DPT.
Cost of annual renewal license and support fees. Costs of annual renewal
license fees consist principally of the employment-related costs for our
technical support staff. Costs of annual license fees were $750,000, $862,000
and $947,000 in 1997, 1998 and 1999, respectively, representing 16%, 15% and 13%
of annual license fees in 1997, 1998 and 1999, respectively. While the relative
costs of servicing our customer base are decreasing, the increase in absolute
dollars is attributable to additional technical support personnel necessary to
support our increasing customer base.
Cost of services and other. Costs of services and other were $3.1 million,
$4.3 million and $3.6 million in 1997, 1998 and 1999, respectively, representing
48%, 62% and 58% of services and other revenue in 1997, 1998 and 1999,
respectively. Costs of services and other consist principally of the
employment-related costs of our consulting and training staff. The decrease in
1999 was primarily due to savings realized from our restructuring. The increase
in 1998 was mainly due to the addition of new staff to perform our professional
services.
Research and development. Research and development expenses were $3.3
million, $4.3 million and $4.7 million in 1997, 1998 and 1999, respectively,
representing increases of 30% from 1997 to 1998 and 9% from 1998 to 1999.
Research and development expenses consist primarily of the employment-related
costs of personnel associated with developing new products, enhancing existing
products, testing software products and
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developing product documentation. As a percentage of total revenue, research and
development expenses were 17%, 22% and 19% in 1997, 1998 and 1999, respectively.
We anticipate that we will continue to direct significant resources to the
development and enhancement of our products.
We expense all costs for research and development of new products until
technological feasibility has been assured. Thereafter, costs of software
development are capitalized until general release of the product. The
capitalized costs of software development are amortized using the greater of the
amount computed using the ratio of current product revenues to estimated total
product revenues or the straight-line method over the remaining estimated
economic life of the product. We capitalized software development costs of
$831,000, $644,000 and $643,000 in 1997, 1998 and 1999, respectively. The amount
of software development costs to be capitalized in the future may change if the
time between the establishment of technological feasibility of a product and its
general release changes.
Selling and marketing. Selling and marketing expenses were $9.1 million,
$11.4 million and $7.7 million in 1997, 1998 and 1999, respectively,
representing increases of 25% from 1997 to 1998 and a decrease of 32% from 1998
to 1999. Selling and marketing expenses consist primarily of salaries,
commissions, marketing programs and related costs for pre- and post-sales
activity. The decrease in 1999 was primarily the result of savings realized from
our restructuring and the aligning of our commission structure with our
recognition of revenue. The increase in 1998 was the result of personnel added
in 1998 to increase the geographic coverage of our selling organization. Selling
and marketing expenses were 46%, 56% and 32% of total revenues in 1997, 1998 and
1999, respectively.
General and administrative. General and administrative expenses consist of
employment-related costs for finance, administration and human resources and
general corporate management expenses. General and administrative expenses were
$2.9 million, $6.2 million and $4.6 million in 1997, 1998 and 1999,
respectively, representing 15%, 31% and 19% of total revenues in 1997, 1998 and
1999, respectively. The decrease in 1999 was the result of savings realized from
our restructuring. The increase in 1998 was the result of increased provisions
for bad debts, a one-time charge for severance and recruiting costs, increased
costs of outside consultants and professional fees as well as planned growth in
the finance and administrative functions.
Restructuring charges. In connection with a restructuring plan adopted in
the fourth quarter of fiscal 1998, we recorded a $2.0 million restructuring
charge associated with our actions to reduce our overall cost structure that had
become inconsistent with our revenue base. This charge included the termination
of 46 employees, the write off of impaired assets and a reduction in our leased
facilities.
Interest, net. Interest, net is composed of interest income from cash and
cash equivalents and short-term investments offset by finance charges related to
equipment leases. Interest, net was $1.1 million, $901,000 and $745,000 in 1997,
1998 and 1999, respectively. The decrease in 1999 is from lower cash balances
due to payments made toward the restructuring charges. The decrease in 1998 was
due to declining cash balances as a result of operating losses.
Provision for income taxes. Effective tax rates were approximately 22%, 3%
and 0% in 1997, 1998 and 1999, respectively. The 1998 and 1999 rates differs
from the federal statutory rate primarily due to valuation allowances offsetting
deferred tax assets.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Our total revenues and operating results can vary, sometimes substantially,
from quarter to quarter and are expected to vary significantly in the future.
Our revenues and operating results are difficult to forecast. Future results
will depend upon many factors, including the 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, the budget cycles of our customers, our success in expanding
our direct sales force and indirect distribution channels, the timing of new
product introductions and product enhancements by us and our competitors, 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,
controlling costs and general domestic and international
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economic conditions. In addition, our sales generally reflect a relatively high
amount of revenue per order, and, therefore, the loss or delay of individual
orders could have a significant impact on our revenues and quarterly operating
results. In addition, a significant amount of our revenues occur predominantly
in the third month of each fiscal quarter and tend to be concentrated in the
latter half of that third month.
Our software products generally are shipped as orders are received. As a
result, initial license fees in any quarter are substantially dependent on
orders booked and shipped in that quarter. The timing of receipt of initial
license fees is difficult to predict because of the length of our sales cycle,
typically three to twelve months from the initial contact. Because our operating
expenses are based on anticipated revenue trends and because a high percentage
of our expenses are relatively fixed, a delay in the recognition of revenue from
a limited number of initial license transactions could cause significant
variations in operating results from quarter to quarter and could result in
losses. To the extent such expenses precede, or are not subsequently followed
by, increased revenues, our operating results could be materially adversely
affected.
Due to the foregoing factors, revenues and operating results for any
quarter are subject to significant variation, and we believe that
period-to-period comparisons are not necessarily meaningful and should not be
relied upon as indications of future performance.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1999, we had $17.3 million in cash, cash equivalents and
short-term investments. This is a decrease of $2.6 million from December 31,
1998. This decrease was mainly caused by capital investments in equipment and
software and a decrease in liabilities due to the paying of expenses that
resulted from our 1998 restructuring.
We believe that our existing cash balances and anticipated cash flows from
operations will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures at least through the next twelve months. A
portion of our cash could be used to acquire or invest in complementary
businesses or products or obtain the right to use complementary technologies. We
are currently evaluating, in our ordinary course of business, potential
investments such as businesses, products or technologies. We have no current
understandings, commitments or agreements with respect to any acquisition of
other businesses, products or technologies.
RECENTLY ENACTED ACCOUNTING STANDARDS
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-1, Accounting for Costs of Computer
Software Developed or Obtained for Internal Use. This standard requires
companies to capitalize qualifying software costs that are incurred during the
application development stage and amortize them over the software's estimated
useful life. We adopted SOP 98-1 effective January 1, 1999 with no material
effect on the financial statements.
In June 1998, the Financial Accounting Standards Board, or FASB, issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
which establishes accounting and reporting standards for derivative instruments
and hedging activities. The Statement will require the recognition of all
derivatives on our balance sheet at fair value. The FASB has subsequently
delayed implementation of the standard for the financial years beginning after
June 15, 2000. We expect to adopt the new Statement effective January 1, 2001.
The impact on our financial statements is not expected to be material.
In December 1999, the Securities and Exchange Commission Staff released
Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements. The adoption of SAB No. 101 did not have any impact on our revenue
recognition.
YEAR 2000 COMPLIANCE
We completed all Year 2000 compliance work by December 31, 1999 and have
experienced no significant problems in 2000. The costs incurred to complete this
work were immaterial. We see no continued exposure to the Year 2000 problem.
19
20
EURO CONVERSION
In January 1999, a new currency called the "Euro" was introduced in certain
Economic and Monetary Union, or EMU, countries. During 2002, all EMU countries
are expected to be operating with the Euro as their single currency. Uncertainty
exists as to the effects the Euro will have on the marketplace. Additionally,
all of the final rules and regulations have not yet been defined and finalized
by the European Commission with regard to the Euro. We are still assessing the
impact the EMU formation will have on our internal systems and the sale of our
products. We expect to take appropriate actions based on the results of such
assessment. We have not yet determined any potential costs.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY EXCHANGE RISK
Our earnings and cash flows are subject to fluctuations due to changes in
foreign currency exchange rates. To a certain extent, foreign currency exchange
rate movements also affect our competitive position, as exchange rate changes
may affect business practices and/or pricing strategies on non-U.S. based
competitors. The primary foreign currency risk exposure is related to U.S.
Dollar to French Franc and U.S. Dollar to Euro conversions. Considering both the
anticipated cash flows from firm sales commitments and anticipated sales for the
next quarter and the foreign currency derivative instruments in place at year
end, a hypothetical 10% weakening of the U.S. Dollar relative to all other
currencies would not materially adversely affect expected first quarter 2000
earnings or cash flows. This analysis is dependent on actual export sales during
the next quarter occurring within 90% of budgeted forecasts. The effect of the
hypothetical change in exchange rates ignores the affect this movement may have
on other variables including competitive risk. If it were possible to quantify
this competitive impact, the results could well be different than the
sensitivity effects described above. In addition, it is unlikely that all
currencies would uniformly strengthen or weaken relative to the U.S. Dollar. In
reality, some currencies may weaken while others may strengthen. Each month we
review our position for expected currency exchange rate movements.
INTEREST RATE RISK
We are exposed to changes in interest rates primarily from our short-term
available-for-sale investments. Under our current policies, we do not use
interest rate derivative instruments to manage exposure to interest rate
changes. A hypothetical 100 basis point adverse move in interest rates along the
entire interest rate yield curve would not materially affect the fair value of
our interest sensitive financial instruments at December 31, 1999. Declines in
interest rates over time will, however, reduce our interest income.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is in Item 14 of Part IV of this
Report and is incorporated into this item by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
20
21
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information required by this item concerning our directors is
incorporated by reference to the information set forth in the section entitled
"Election of Directors -- Nominees" in our Proxy Statement for the 2000 Annual
Meeting of Stockholders to be filed with the Commission within 120 days after
the end of our fiscal year ended December 31, 1999. The information required by
this item concerning our executive officers is incorporated by reference to the
information set forth in the section entitled "Executive Officers of the
Company" at the end of Part I of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item regarding executive compensation is
incorporated by reference to the information set forth in the section entitled
"Executive Officer Compensation" in our Proxy Statement for the 2000 Annual
Meeting of Stockholders to be filed with the Commission within 120 days after
the end of our fiscal year ended December 31, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item regarding security ownership of
certain beneficial owners and management is incorporated by reference to the
information set forth in the section entitled "Security Ownership of Management
and Certain Beneficial Owners" in our Proxy Statement for the 2000 Annual
Meeting of Stockholders to be filed with the Commission within 120 days after
the end of our fiscal year ended December 31, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item regarding certain relationships and
related transactions is incorporated by reference to the information set forth
in the section entitled "Certain Transactions" in our Proxy Statement for the
2000 Annual Meeting of Stockholders to be filed with the Commission within 120
days after the end of our fiscal year ended December 31, 1999.
21
22
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form 10-K:
1. Financial Statements. The following consolidated financial
statements, related notes thereto and the Report of Independent Auditors
are included in Part IV of this Report on the pages indicated by the Index
to Financial Statements as presented on page 24 of this Report.
Report of Ernst & Young LLP, Independent Auditors
Consolidated Balance Sheets -- December 31, 1998 and 1999
Consolidated Statements of Operations -- Fiscal Years Ended December 31,
1997, 1998 and 1999
Consolidated Statements of Stockholders' Equity -- Fiscal Years Ended
December 31, 1997, 1998 and 1999
Consolidated Statements of Cash Flows -- Fiscal Years Ended December 31,
1997, 1998 and 1999
Notes to Consolidated Financial Statements
2. Financial Statement Schedule. The following financial statement
schedule for the fiscal years ended December 31, 1997, 1998 and 1999 is
filed as part of this Form 10-K and should be read in conjunction with our
consolidated financial statements and related notes thereto.
Schedule II Valuation and Qualifying Accounts............... S-1
Schedules other than those listed above have been omitted since they are
either not required, not applicable or the information is otherwise
included.
3. Exhibits: See Item 14(c) below.
(b) Reports on Form 8-K. No reports on Form 8-K were filed by us during the
fiscal quarter ended December 31, 1999.
(c) Exhibits. The exhibits listed on the accompanying index to exhibits
immediately following the financial statement schedules are filed as part of, or
incorporated by reference into, this Form 10-K.
(d) Financial Statement Schedules. See Item 14(a) above.
22
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed
on its behalf by the undersigned, thereunto duly authorized on this 28th day of
March 2000.
DOCUMENT SCIENCES CORPORATION
By: /s/ BARTON L. FABER
------------------------------------
Barton L. Faber
President and Chief Executive
Officer
Dated: March 28, 2000
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Barton L. Faber his attorneys-in-fact,
each with full power of substitution, for him or her in any and all capacities,
to sign any and all amendments to this Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each said attorneys-in-fact or his or her substitute or substitutes, may do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Form 10-K has been signed below by the following persons on behalf of the
Registrant and in the capacities and on March 28, 2000 in the capacities
indicated:
SIGNATURES TITLE
---------- -----
/s/ BARTON L. FABER President and Chief Executive Officer
- --------------------------------------------- (principal executive officer)
Barton L. Faber
/s/ JOHN L. MCGANNON Vice President, Chief Financial Officer and
- --------------------------------------------- Secretary
John L. McGannon (principal financial and accounting officer)
/s/ THOMAS L. RINGER Chairman of the Board of Directors
- ---------------------------------------------
Thomas L. Ringer
/s/ BARTON L. FABER Director
- ---------------------------------------------
Barton L. Faber
/s/ CHARLES P. HOLT Director
- ---------------------------------------------
Charles P. Holt
/s/ COLIN J. O'BRIEN Director
- ---------------------------------------------
Colin J. O'Brien
/s/ BRIAN E. STERN Director
- ---------------------------------------------
Brian E. Stern
23
24
DOCUMENT SCIENCES CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors........... F-1
Consolidated Balance Sheets................................. F-2
Consolidated Statements of Operations....................... F-3
Consolidated Statements of Stockholders' Equity............. F-4
Consolidated Statements of Cash Flows....................... F-5
Notes to Consolidated Financial Statements.................. F-6
24
25
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Document Sciences Corporation
We have audited the accompanying consolidated balance sheets of Document
Sciences Corporation as of December 31, 1998 and 1999, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1999. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Document
Sciences Corporation at December 31, 1998 and 1999, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
San Diego, California
January 14, 2000
F-1
26
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
---------------------------
1998 1999
------------ -----------
Current assets:
Cash and cash equivalents................................. $ 6,694,420 $ 3,746,357
Short-term investments.................................... 13,220,581 13,528,662
Accounts receivable, less allowance for doubtful accounts
of $725,561 and $765,873 in 1998 and 1999,
respectively........................................... 4,721,466 6,063,873
Due from affiliates....................................... 1,122,343 1,878,114
Unbilled revenue.......................................... 391,601 308,063
Income tax receivable..................................... 331,337 --
Other current assets...................................... 519,479 913,453
----------- -----------
Total current assets........................................ 27,001,227 26,438,522
Property and equipment, net................................. 1,668,855 1,787,245
Computer software costs, net of accumulated amortization of
$853,509 and $1,547,871 in 1998 and 1999, respectively.... 1,383,590 1,332,048
Goodwill, net of accumulated amortization of $116,874 and
$186,998 in 1998 and 1999, respectively................... 934,987 864,863
----------- -----------
$30,988,659 $30,422,678
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,065,986 $ 605,038
Accrued compensation...................................... 1,874,044 1,876,813
Other accrued liabilities................................. 1,773,716 695,754
Deferred revenue.......................................... 7,362,838 6,638,681
Current portion of obligations under capital leases....... 41,568 11,376
----------- -----------
Total current liabilities................................... 12,118,152 9,827,662
Obligations under capital leases............................ 12,618 1,244
Deferred revenue............................................ 448,099 313,669
Commitments
Stockholders' equity:
Common stock, $.001 par value; Authorized
shares -- 30,000,000; Issued and outstanding
shares -- 10,857,958 in 1998 and 10,919,051 in 1999.... 10,858 10,919
Deferred compensation..................................... (67,326) (10,794)
Treasury stock............................................ (686,989) (609,983)
Additional paid-in capital................................ 25,409,399 25,425,809
Accumulated comprehensive income (loss)................... 204,071 (186,500)
Retained earnings (deficit)............................... (6,460,223) (4,349,348)
----------- -----------
Total stockholders' equity........................ 18,409,790 20,280,103
----------- -----------
$30,988,659 $30,422,678
=========== ===========
See accompanying notes.
F-2
27
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
------------------------------------------
1997 1998 1999
----------- ------------ -----------
Revenues:
Initial license fees (including $1,765,000,
$2,987,600 and $3,138,700 from affiliates in
1997, 1998 and 1999, respectively)............ $ 8,758,364 $ 7,186,247 $10,405,839
Annual renewal license and support fees
(including $888,700, $1,234,300 and $1,604,600
from affiliates in 1997, 1998 and 1999,
respectively)................................. 4,622,810 5,889,410 7,607,077
Services and other (including $1,117,300,
$1,184,800 and $430,300 from affiliates in
1997, 1998 and 1999, respectively)............ 6,359,135 7,031,693 6,292,324
----------- ------------ -----------
Total revenues........................... 19,740,309 20,107,350 24,305,240
Cost of revenues:
Initial license fees............................. 677,324 1,367,939 1,375,892
Annual renewal license and support fees.......... 750,069 862,058 947,445
Services and other............................... 3,096,362 4,344,896 3,628,909
----------- ------------ -----------
Total cost of revenues................... 4,523,755 6,574,893 5,952,246
----------- ------------ -----------
Gross profit....................................... 15,216,554 13,532,457 18,352,994
Operating expenses:
Research and development......................... 3,321,397 4,336,116 4,679,067
Selling and marketing (including $121,000, $0 and
$0 to affiliates in 1997, 1998 and 1999
respectively)................................. 9,088,486 11,353,604 7,680,764
General and administrative....................... 2,864,868 6,214,275 4,626,854
Restructuring charges............................ -- 1,988,983 --
----------- ------------ -----------
Total operating expenses................. 15,274,751 23,892,978 16,986,685
----------- ------------ -----------
Income (loss) from operations...................... (58,197) (10,360,521) 1,366,309
Interest, net...................................... 1,127,075 900,755 744,566
----------- ------------ -----------
Income (loss) before provision for income taxes.... 1,068,878 (9,459,766) 2,110,875
Provision for income taxes......................... 231,200 (306,168) --
----------- ------------ -----------
Net income (loss).................................. $ 837,678 $ (9,153,598) $ 2,110,875
=========== ============ ===========
Net income (loss) per share -- basic............... $ 0.08 $ (.86) $ .20
=========== ============ ===========
Weighted average shares used in basic
calculation...................................... 10,743,352 10,690,340 10,693,888
=========== ============ ===========
Net income (loss) per share -- diluted............. $ 0.08 $ (.86) $ .20
=========== ============ ===========
Weighted average shares used in diluted
calculation...................................... 11,012,635 10,690,340 10,816,948
=========== ============ ===========
See accompanying notes.
F-3
28
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK TREASURY STOCK ADDITIONAL ACCUMULATED RETAINED
-------------------- ------------------- PAID-IN DEFERRED COMPREHENSIVE EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION INCOME (LOSS) (DEFICIT)
---------- ------- ------- --------- ----------- ------------ ------------- -----------
Balance at December 31,
1996.................... 10,722,168 $10,722 -- $ -- $25,382,203 $(351,473) $ 13,222 $ 1,855,697
Issuance of common stock
upon exercise of
options................. 81,201 81 -- -- 16,694 -- -- --
Purchase of treasury
stock................... -- -- 75,000 (285,000) -- -- -- --
Sale of treasury stock.... -- -- (14,928) 44,485 -- -- -- --
Amortization of deferred
compensation............ -- -- -- -- -- 110,004 -- --
Comprehensive income
(loss):
Unrealized gain on
short-term
investments........... -- -- -- -- -- -- 56,284 --
Net income.............. -- -- -- -- -- -- -- 837,678
Comprehensive income....
---------- ------- ------- --------- ----------- --------- --------- -----------
Balance at December 31,
1997.................... 10,803,369 10,803 60,072 (240,515) 25,398,897 (241,469) 69,506 2,693,375
Issuance of common stock
upon exercise of
options................. 54,589 55 -- -- 10,502 -- -- --
Purchase of treasury
stock................... -- -- 212,800 (543,618) -- -- -- --
Sale of treasury stock.... -- -- (49,714) 97,144 -- -- -- --
Amortization of deferred
compensation............ -- -- -- -- -- 174,143 -- --
Comprehensive income
(loss):
Unrealized loss on
short-term
investments........... -- -- -- -- -- -- (22,337) --
Foreign currency
translation
adjustment............ -- -- -- -- -- -- 156,902 --
Net loss................ -- -- -- -- -- -- -- (9,153,598)
Comprehensive loss......
---------- ------- ------- --------- ----------- --------- --------- -----------
Balance at December 31,
1998.................... 10,857,958 10,858 223,158 (686,989) 25,409,399 (67,326) 204,071 (6,460,223)
Issuance of common stock
upon exercise of
options................. 61,093 61 -- -- 16,410 -- -- --
Sale of treasury stock.... -- -- (48,276) 77,006 -- -- -- --
Amortization of deferred
compensation............ -- -- -- -- -- 56,532 -- --
Comprehensive income
(loss):
Unrealized loss on
short-term
investments........... -- -- -- -- -- -- (271,098) --
Foreign currency
translation
adjustment............ -- -- -- -- -- -- (119,473) --
Net income.............. -- -- -- -- -- -- -- 2,110,875
Comprehensive income....
---------- ------- ------- --------- ----------- --------- --------- -----------
Balance at December 31,
1999.................... 10,919,051 $10,919 174,882 $(609,983) $25,425,809 $ (10,794) $(186,500) $(4,349,348)
========== ======= ======= ========= =========== ========= ========= ===========
TOTAL
STOCKHOLDERS'
EQUITY
-------------
Balance at December 31,
1996.................... $26,910,371
Issuance of common stock
upon exercise of
options................. 16,775
Purchase of treasury
stock................... (285,000)
Sale of treasury stock.... 44,485
Amortization of deferred
compensation............ 110,004
Comprehensive income
(loss):
Unrealized gain on
short-term
investments........... 56,284
Net income.............. 837,678
-----------
Comprehensive income.... 893,962
-----------
Balance at December 31,
1997.................... 27,690,597
Issuance of common stock
upon exercise of
options................. 10,557
Purchase of treasury
stock................... (543,618)
Sale of treasury stock.... 97,144
Amortization of deferred
compensation............ 174,143
Comprehensive income
(loss):
Unrealized loss on
short-term
investments........... (22,337)
Foreign currency
translation
adjustment............ 156,902
Net loss................ (9,153,598)
-----------
Comprehensive loss...... (9,019,033)
-----------
Balance at December 31,
1998.................... 18,409,790
Issuance of common stock
upon exercise of
options................. 16,471
Sale of treasury stock.... 77,006
Amortization of deferred
compensation............ 56,532
Comprehensive income
(loss):
Unrealized loss on
short-term
investments........... (271,098)
Foreign currency
translation
adjustment............ (119,473)
Net income.............. 2,110,875
-----------
Comprehensive income.... 1,720,304
-----------
Balance at December 31,
1999.................... $20,280,103
===========
See accompanying notes.
F-4
29
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
--------------------------------------------
1997 1998 1999
------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss)................................ $ 837,678 $ (9,153,598) $ 2,110,875
Adjustments to reconcile net income (loss) to net
cash (used in) operating activities:
Depreciation and amortization.................. 455,663 614,099 529,188
Amortization of goodwill....................... 46,749 70,125 70,124
Loss on disposal of fixed assets............... -- 610,159 25,881
Amortization of computer software costs........ 91,340 377,384 694,362
Amortization of deferred compensation.......... 110,004 174,143 56,532
Current income tax expense payable to
affiliates.................................. 76,443 (387,443) --
Deferred income taxes.......................... 99,200 (85,000) --
Provision for doubtful accounts................ 432,451 507,283 44,510
Changes in operating assets and liabilities,
net of effects of acquired business:
Accounts receivable......................... (3,336,203) 398,369 (1,885,316)
Due from affiliates......................... 658,958 679,251 (283,754)
Unbilled revenue............................ (288,932) (102,669) 83,538
Income tax receivable....................... -- (331,337) 331,337
Other current assets........................ (47,584) (239,162) (395,671)
Accounts payable............................ (25,054) 391,675 (456,309)
Accrued compensation........................ (44,030) 1,080,978 7,935
Accrued liabilities......................... (108,933) 1,374,169 (1,075,860)
Deferred revenue............................ 404,780 3,990,648 (844,986)
------------ ------------ ------------
Net cash (used in) operating activities.......... (637,470) (30,926) (987,614)
INVESTING ACTIVITIES
Purchases of short-term investments.............. (16,905,885) (16,196,630) (16,027,127)
Sales of short-term investments.................. 19,220,812 18,194,575 12,784,046
Maturities of short-term investments............. 2,599,431 3,010,000 2,935,000
Purchases of property and equipment, net......... (1,593,389) (752,194) (709,568)
Proceeds from disposal of assets................. -- -- 29,640
Unrealized losses on securities.................. -- (22,337) (271,098)
Cash paid for acquired business.................. (507,000) -- --
Additions to computer software costs............. (831,317) (643,655) (642,820)
------------ ------------ ------------
Net cash provided by (used in) investing
activities..................................... 1,982,652 3,589,759 (1,901,927)
FINANCING ACTIVITIES
Principal payments under capital lease
obligations.................................... (60,835) (63,158) (41,566)
Purchase of treasury stock....................... (285,000) (543,618) --
Sale of treasury stock........................... 44,485 97,144 77,006
Proceeds from issuance of common stock........... 16,775 10,557 16,471
------------ ------------ ------------
Net cash provided by (used in) financing
activities..................................... (284,575) (499,075) 51,911
------------ ------------ ------------
Increase (decrease) in cash and cash
equivalents.................................... 1,060,607 3,059,758 (2,837,630)
Foreign currency translation adjustment.......... -- 108,361 (110,433)
Cash and cash equivalents at beginning of year... 2,465,694 3,526,301 6,694,420
------------ ------------ ------------
Cash and cash equivalents at end of year......... $ 3,526,301 $ 6,694,420 $ 3,746,357
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid.................................... $ 17,777 $ 11,135 $ 3,108
============ ============ ============
See accompanying notes.
F-5
30
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Document Sciences Corporation was incorporated on October 18, 1991 in
Delaware as a subsidiary of Xerox Corporation ("Xerox"). We develop, market and
support a family of document automation software products and services used in
high volume electronic publishing applications. Autograph, our document
automation software architecture, enables personalized publishing solutions for
many industries including insurance, managed healthcare, financial services,
commercial print services, government, telecommunications and manufacturing.
We currently derive substantially all of our license revenues from licenses
of CompuSet, Autograph's flagship product, and related products and from fees
for services related to the CompuSet software. Our financial performance will
continue to depend, in significant part, on the successful development,
introduction and customer acceptance of new and enhanced versions of the
CompuSet software and related products. There can be no assurance that we will
continue to be successful in developing and marketing CompuSet products and
related services.
We currently have a variety of contractual and informal relationships with
Xerox and affiliates of Xerox, including a cooperative marketing alliance
agreement, a transfer and license agreement and various distribution agreements.
There can be no assurance that Xerox or its affiliates will continue these
relationships. Our failure to maintain these relationships with Xerox and its
affiliates could have a material adverse effect on our financial statements.
BASIS OF PRESENTATION
In 1994, we established a wholly owned subsidiary, Document Sciences
Europe, in France, in order to market and support our products to the European
community. The accompanying consolidated financial statements include the
accounts of all our operations. Significant intercompany accounts and
transactions have been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the financial statements, as well as
the disclosure of contingent assets and liabilities at the date of the financial
statements. Actual results could differ from those estimates.
FOREIGN OPERATIONS
The functional currency of our French subsidiary is the French Franc. The
balance sheet accounts of our subsidiary are translated into U.S. Dollars at
exchange rates prevailing at the balance sheet dates. Revenues and expenses are
translated into U.S. Dollars at the average rates of exchange during the period.
For the years ended December 31, 1998 and 1999, foreign currency translation
gains are recorded as a separate component of stockholders' equity. Foreign
currency translation gains and losses were not material in 1997. Foreign
currency transaction gains and losses are included in general and administrative
expenses in the consolidated statements of operations and were not material
during the years ended December 31, 1997, 1998 and 1999.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash and cash equivalents consist of cash and highly liquid investments
which include debt securities with remaining maturities when acquired of three
months or less and are stated at market. We evaluate the
F-6
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
financial strength of institutions at which significant investments are made and
believe the related credit risk is limited to an acceptable level.
We have adopted Statement of Financial Accounting Standards (SFAS) No. 115,
Accounting for Certain Investments in Debt and Equity Securities, and classify
our investments as available-for-sale in accordance with that standard.
Available-for-sale securities are carried at fair value. Unrealized gains and
losses, net of tax, are reported in stockholders' equity. Realized gains and
losses and declines in value judged to be other-than-temporary, if any, on
available-for-sale securities will be included in investment income. The cost of
securities sold is based on the specific identification method.
CONCENTRATION OF CREDIT RISK
We sell our products primarily to large, multinational customers in the
United States, Europe, Brazil, Canada and Australia. We derived 28%, 31% and 25%
of our total revenues from customers outside the United States for the years
ended December 31, 1997, 1998 and 1999, respectively. A significant
concentration of our customers is in the insurance and commercial print service
industries. Xerox was the only customer that accounted for more than 10% of our
revenue in any one year. They accounted for 23%, 27% and 21% for the years ended
December 31, 1997, 1998 and 1999, respectively.
Credit is extended based on an evaluation of the customer's financial
condition and a cash deposit is generally not required. We estimate our
potential losses on trade receivables on an ongoing basis and provide for
anticipated losses in the period in which the revenues are recognized.
IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of, we record
impairment losses on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the asset's carrying amount. SFAS No. 121 also
addresses the accounting for long-lived assets that are expected to be disposed
of. To date, no such impairments have been identified.
COMPUTER SOFTWARE COSTS
In accordance with SFAS No. 86, Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed, costs incurred in the
research and development of new software products and significant enhancements
to existing software products are expensed as incurred until the technological
feasibility of the product has been established. After technological feasibility
has been established, direct production costs, including programming and
testing, are capitalized until general release of the product.
Capitalized costs of software to be sold, licensed or otherwise marketed
are amortized using the greater of the amount computed using the ratio of
current period product revenues to estimated total product revenues or the
straight-line method over the remaining estimated economic lives of the
products. It is possible that estimated total product revenues, the estimated
economic life of the product, or both, will be reduced in the future. As a
result, the carrying amount of capitalized software costs may be reduced in the
future, which could result in charges to our operating results in future
periods.
DEPRECIATION AND AMORTIZATION
Depreciation is provided on a straight-line method over the estimated
useful lives of the assets (generally five to seven years). Amortization of
leasehold improvements is provided over the lesser of the remaining lease term
or the estimated useful life of the improvements. Amortization of goodwill is
provided over an estimated life of 15 years.
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
REVENUE RECOGNITION
We recognize revenue in accordance with AICPA Statement of Position (SOP)
97-2, Software Revenue Recognition. Initial license fees are recognized when a
contract exists, the fee is fixed or determinable, software delivery has
occurred and collection of the receivable is deemed probable. The portion of the
initial license fee representing the software support for the first year is
deferred and recognized ratably over the contract period. Annual renewal license
and support fees are recognized ratably over the contract period. Revenues from
commissions paid by Xerox in connection with the sale of Xerox printer products
are recognized upon installation of the printer products. Revenues generated
from consulting services are recognized as the related services are performed.
However, when such consulting services are deemed to be essential to the
functionality of the delivered software product, revenue from the entire
arrangement is recognized in accordance with SOP 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts, and
Accounting Research Bulletin (ARB) No. 45, Long-Term Construction-Type
Contracts.
COMPUTATION OF NET INCOME PER SHARE
In accordance with SFAS No. 128, Earnings per Share, "Basic EPS" includes
no dilution and is based on weighted-average common shares outstanding for the
period. SFAS No. 128 also requires companies with complex capital structures to
present "Diluted EPS" that reflects the potential dilution of securities such as
employee stock options.
In 1997 and 1999, the difference between weighted-average shares used in
determining Basic EPS versus Diluted EPS related to dilutive common stock
options totaled 269,288 and 123,060 shares, respectively. Common stock options
to purchase 248,182, 867,234 and 1,523,619 shares were excluded from the
calculation of weighted-average shares used in determining Diluted EPS for 1997,
1998 and 1999, respectively, as their effect would have been antidilutive.
STOCK OPTIONS
As permitted by SFAS No. 123, Accounting for Stock-based Compensation, we
have elected to follow Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations in
accounting for its employee stock options. Under APB Opinion No. 25, when the
exercise price of our employee stock options is not less than the market price
of the underlying stock on the date of grant, no compensation expense is
recognized.
INCOME TAXES
We follow the liability method of accounting for income taxes, as set forth
in SFAS No. 109, Accounting for Income Taxes. Through September 19, 1996, we
were included in the consolidated tax returns of Xerox, and our share of Xerox
consolidated income tax liability was determined on a separate company basis
computed under Internal Revenue Code guidelines. Subsequent to our initial
public offering on September 19, 1996, we have filed separate federal and state
tax returns and are only included in certain consolidated state tax returns with
Xerox.
COMPREHENSIVE INCOME
In 1998, we adopted SFAS No. 130, Reporting Comprehensive Income. SFAS 130
requires that all components of comprehensive income, including net income, be
reported in the financial statements in the period they are recognized.
Comprehensive income is defined as the change in equity during a period from
transactions and other events and circumstances from non-owner sources. Net
income and other comprehensive income, including foreign currency translation
adjustments and unrealized gains and losses on invest-
F-8
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
ments, shall be reported, net of their related tax effect, to arrive at
comprehensive income. We have disclosed comprehensive income in our financial
statements accordingly.
SEGMENT INFORMATION
In 1998, we adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS No. 131 amends the requirements for
public enterprises to report financial and descriptive information about their
reportable operating segments. Operating segments, as defined in SFAS No. 131,
are components of an enterprise for which separate financial information is
available and is evaluated regularly by a company in deciding how to allocate
resources and in assessing performance. This financial information is required
to be reported on the basis that is used internally for evaluating the segment
performance. We evaluate our operations in two segments, United States and
Europe operations.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-1, Accounting for Costs of Computer
Software Developed or Obtained for Internal Use. This standard requires
companies to capitalize qualifying software costs that are incurred during the
application development stage and amortize them over the software's estimated
useful life. We adopted SOP 98-1 effective January 1, 1999 with no material
effect on the financial statements.
RECLASSIFICATIONS
Certain reclassifications, none of which affect net income (loss), have
been made to prior years' amounts in order to conform to the current year's
presentation.
2. FINANCIAL STATEMENT INFORMATION
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and consist of the following at
December 31:
1998 1999
----------- -----------
Computer equipment........................................ $ 1,763,942 $ 1,908,711
Office equipment.......................................... 243,857 243,100
Office furniture and fixtures............................. 449,444 323,281
Leasehold improvements.................................... 242,155 681,004
----------- -----------
2,699,398 3,156,096
Less accumulated depreciation and amortization............ (1,030,543) (1,368,851)
----------- -----------
$ 1,668,855 $ 1,787,245
=========== ===========
The cost of equipment acquired under capital leases totaled $217,071 at
December 31, 1998 and 1999, respectively, with accumulated depreciation of
$131,958 and $168,614 at December 31, 1998 and 1999, respectively.
F-9
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
INVESTMENTS
We have classified all of our investment securities as available-for-sale.
The following table summarizes available-for-sale securities at December 31,
1998 and 1999:
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ---------- ---------- -----------
DECEMBER 31, 1998
U.S. treasury securities........... $ 5,048,469 $ 5,723 $ 7,081 $ 5,047,111
U.S. government agency
obligations...................... 3,046,330 25,018 -- 3,071,348
Obligations of states, territories
and political subdivisions....... 1,353,893 -- -- 1,353,893
U.S. corporate securities.......... 3,724,720 23,509 -- 3,748,229
----------- ------- -------- -----------
$13,173,412 $54,250 $ 7,081 $13,220,581
=========== ======= ======== ===========
DECEMBER 31, 1999
U.S. treasury securities........... $ 4,173,981 $ -- $102,917 $ 4,071,064
U.S. government agency
obligations...................... 3,356,996 -- 23,372 3,333,624
U.S. corporate securities.......... 6,221,613 482 98,121 6,123,974
----------- ------- -------- -----------
$13,752,590 $ 482 $224,410 $13,528,662
=========== ======= ======== ===========
The amortized cost and estimated fair value of available-for-sale
securities at December 31, 1999, by contractual maturity, are shown below:
COST ESTIMATED FAIR VALUE
----------- --------------------
Due in one year or less.............................. $ 4,480,147 $ 4,471,482
Due after one year through ten years................. 9,272,443 9,057,180
----------- -----------
$13,752,590 $13,528,662
=========== ===========
3. SEGMENT INFORMATION
The tables below summarize our operations in the United States and by those
of our subsidiary, Document Sciences Europe:
UNITED STATES EUROPE ELIMINATIONS TOTALS
------------- ---------- ------------ ------------
YEAR ENDED DECEMBER 31, 1997
Sales to unaffiliated
customers.................... $ 13,423,889 $2,545,303 $ -- $ 15,969,192
Sales to affiliates............ 1,871,136 1,899,981 -- 3,771,117
------------ ---------- -------- ------------
Revenues....................... $ 15,295,025 $4,445,284 $ -- $ 19,740,309
------------ ---------- -------- ------------
Operating income (loss)........ $ (267,503) $ 209,306 $ -- $ (58,197)
------------ ---------- -------- ------------
Identifiable assets............ $ 32,185,873 $2,059,769 $(16,666) $ 34,228,976
============ ========== ======== ============
UNITED STATES EUROPE ELIMINATIONS TOTALS
------------- ---------- ------------ ------------
YEAR ENDED DECEMBER 31, 1998
Sales to unaffiliated
customers.................... $ 13,581,446 $2,081,749 $ -- $ 15,663,195
Sales to affiliates............ 2,019,548 2,424,607 -- 4,444,155
------------ ---------- -------- ------------
Revenues....................... $ 15,600,994 $4,506,356 $ -- $ 20,107,350
------------ ---------- -------- ------------
Operating income (loss)........ $(10,404,611) $ 44,090 $ -- $(10,360,521)
------------ ---------- -------- ------------
Identifiable assets............ $ 29,811,491 $1,193,834 $(16,666) $ 30,988,659
============ ========== ======== ============
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UNITED
STATES EUROPE ELIMINATIONS TOTALS
------------ ---------- ------------ ------------
YEAR ENDED DECEMBER 31, 1999
Sales to unaffiliated customers..... $ 17,904,917 $2,200,623 $ -- $ 20,105,540
Sales to affiliates................. 2,709,352 1,490,348 -- 4,199,700
------------ ---------- -------- ------------
Revenues............................ $ 20,614,269 $3,690,971 $ -- $ 24,305,240
------------ ---------- -------- ------------
Operating income (loss)............. $ 1,549,879 $ (183,570) $ -- $ 1,366,309
------------ ---------- -------- ------------
Identifiable assets................. $ 30,106,425 $ 332,919 $(16,666) $ 30,422,678
============ ========== ======== ============
In 1998, we adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. Sales attributable to the United States were
made to customers located in North America, South America and Australia. Sales
attributable to Europe are based on those sales generated by our French
subsidiary. These sales were made to customers located in Europe, the Middle
East and Africa.
4. LEASES
We lease our headquarters in Carlsbad, California under an operating lease
expiring on February 28, 2005. Under the terms of the lease, effective March 1,
1999, monthly rental payments will be increased annually by 4%. The lease
provides us with an option to extend the lease term for an additional five years
at the base rent in effect for the last year of the initial lease term plus 4%.
Our offices in France and Milwaukee, Wisconsin are under operating leases
expiring on April 15, 2004 and March 31, 2003, respectively. We also lease
certain equipment under capital leases. Annual future minimum lease payments as
of December 31, 1999 are as follows:
OPERATING CAPITAL
YEARS ENDING DECEMBER 31, LEASES LEASES
------------------------- ---------- -------
2000................................................... $ 407,129 $12,346
2001................................................... 420,089 1,260
2002................................................... 433,416 --
2003................................................... 304,932 --
2004................................................... 268,815 --
Thereafter............................................. 45,092 --
---------- -------
1,879,473 13,606
Less amount representing interest....................................... (986)
-------
Present value of net minimum lease payments............................. 12,620
Less current portion.................................................... (11,376)
-------
Long-term portion of capital lease obligations.......................... $ 1,244
=======
Rent expense for the years ended December 31, 1997, 1998 and 1999 was
$522,694, $576,417 and $451,871, respectively.
5. STOCKHOLDERS' EQUITY
STOCK
As of December 31, 1999, authorized capital stock consisted of 30,000,000
shares of common stock and 2,000,000 shares of preferred stock.
F-11
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
STOCK INCENTIVE PLANS
Our Stock Incentive Plans provide for the issuance of incentive and
nonstatutory options to purchase Common Shares to eligible employees, officers,
directors of and consultants to Document Sciences. Our 1993 Stock Incentive Plan
(the "1993 Plan") provided for the issuance of up to 1,500,000 shares. In
October 1995, the Board of Directors approved the 1995 Stock Incentive Plan (the
"1995 Plan"), which provided for the issuance of an additional 779,250 shares
which included 29,250 shares previously reserved for issuance under the 1993
Plan. In 1998, this plan was amended to provide for the issuance of an
additional 750,000 shares. In 1999, this plan was amended to provide for the
issuance of an additional 350,000 shares. The 1995 Plan replaced the 1993 Plan.
All outstanding options under the 1993 Plan remain exercisable in accordance
with their original terms. Terms of stock purchase or stock option agreements,
including vesting requirements, are determined by the Board of Directors,
subject to the provisions of the 1995 Plan. The maximum term of the options
granted under the 1995 Plan is ten years. The exercise price of incentive stock
options must equal at least the fair market value on the date of grant. The
exercise price of nonstatutory stock options and stock issued under purchase
rights must equal at least 85% of the fair market value on the date of grant or
time of issuance.
The following table summarizes stock option activity under the stock
incentive plans:
WEIGHTED
NUMBER OPTION PRICE AVERAGE PRICE
OF SHARES PER SHARE PER SHARE
--------- -------------- -------------
Balance at December 31, 1997................ 517,470 $ .03 - $15.00 $3.57
Granted................................... 567,038 $1.75 - $ 3.38 $2.47
Exercised................................. (54,589) $ .17 - $ .67 $ .19
Canceled.................................. (162,685) $ .17 - $15.00 $4.13
---------
Balance at December 31, 1998................ 867,234 $ .03 - $10.00 $2.64
Granted................................... 1,297,850 $1.50 - $ 2.00 $1.90
Exercised................................. (61,093) $ .03 - $ .67 $ .27
Canceled.................................. (457,312) $ .03 - $10.00 $2.70
---------
Balance at December 31, 1999................ 1,646,679 $ .03 - $10.00 $2.10
=========
As of December 31, 1999, 330,733 of the options were vested and exercisable
and 142,456 were available for future grant. Following is a breakdown of the
options outstanding as of December 31, 1999:
WEIGHTED WEIGHTED
AVERAGE AVERAGE
WEIGHTED EXERCISE EXERCISE
RANGE OF AVERAGE PRICE OF PRICE OF
EXERCISE OPTIONS REMAINING OPTIONS OPTIONS OPTIONS
PRICES OUTSTANDING LIFE IN YEARS OUTSTANDING EXERCISABLE EXERCISABLE
- ------------ ----------- ------------- ----------- ----------- -----------
$ .03 - $ .67.. 96,449 4.34 $ 0.24 95,311 $ 0.24
$1.70 - $4.75.. 1,524,208 9.44 $ 2.08 213,198 $ 2.51
$10.00...... 26,022 6.53 $10.00 22,224 $10.00
--------- -------
1,646,679 9.10 $ 2.10 330,733 $ 2.36
========= =======
In 1996, we recorded $440,000 of deferred compensation for options granted
to employees prior to our initial public offering, which closed September 19,
1996. The amount recorded represents the difference between the option grant
price and the deemed fair market value of the related shares. We are amortizing
such amount ratably over the 48-month vesting period of the options.
On March 17, 1998, 68,403 options with exercise prices between $5.00 and
$15.00 per share were repriced to $4.75 per share, the fair market value of the
stock at such date.
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Adjusted pro forma information regarding net income (loss) is required by
SFAS No. 123, and has been determined as if we had accounted for our employee
stock options under the fair value method of that Statement. For options granted
in the period prior to September 19, 1996, the fair value for options was
estimated at the date of grant using the "minimum value" method for option
pricing with the following weighted-average assumptions: risk-free interest
rates of 5.5% - 6%, dividend yields of 0% and a weighted-average expected life
of the option of four to seven years. For options granted from September 19,
1996 to December 31, 1999, the fair value of options was estimated at the date
of grant using the "Black-Scholes" method for option pricing with the following
weighted-average assumptions: risk-free interest rates of 5.5% - 6%, dividend
yields of 0%, expected volatility of .69 to 1.43 and a weighted-average expected
life of the option of seven years.
For purposes of adjusted pro forma disclosures, the estimated fair value of
the options is amortized to expense over the option's vesting period. The effect
of applying SFAS No. 123 for purposes of providing pro forma disclosures is not
likely to be representative of the effects on reported net income (loss) for
future years because changes in the subjective input assumptions can materially
affect future value estimates. Our pro forma information is as follows:
YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1998 1999
-------- ----------- ----------
Adjusted pro forma basic net income (loss)..... $592,538 $(9,704,706) $1,466,003
Adjusted pro forma basic net income (loss) per
share........................................ $ .05 $ (.91) $ .14
Adjusted pro forma diluted net income (loss)
per
share........................................ $ .05 $ (.91) $ .14
Our 1997 Employee Stock Purchase Plan provides for the issuance of shares
of our common stock, up to a total of 350,000 shares, to eligible employees. The
price of the common shares purchased under the Plan is equal to 85% of the fair
market value of the common shares on the first or last day of the offering
period, whichever is lower.
6. INCOME TAXES
For financial reporting purposes, income (loss) before income taxes
includes the following components:
1997 1998 1999
---------- ----------- ----------
United States................................. $ 778,573 $(9,660,080) $2,294,445
Foreign....................................... 290,305 200,314 (183,570)
---------- ----------- ----------
$1,068,878 $(9,459,766) $2,110,875
========== =========== ==========
F-13
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The provision for income taxes (benefit) is as follows:
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1998 1999
-------- --------- ----
Current:
Federal............................................. $ 3,500 $(331,337) $--
State............................................... 19,900 -- --
Foreign............................................. 108,600 110,169 --
-------- --------- --
132,000 (221,168) --
Deferred (credit):
Federal............................................. 122,100 (104,000) --
State............................................... (22,900) 19,000 --
Foreign............................................. -- -- --
-------- --------- --
99,200 (85,000) --
-------- --------- --
$231,200 $(306,168) $--
======== ========= ==
Deferred income taxes reflect the net effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the deferred tax assets and liabilities are as follows:
DECEMBER 31,
-------------------------------------
1997 1998 1999
--------- ---------- ----------
Deferred tax liabilities:
Computer software costs...................... $(411,500) $ (509,100) $ (490,200)
Fixed assets................................. -- (127,900) (149,600)
--------- ---------- ----------
Total deferred tax liabilities....... (411,500) (637,000) (639,800)
--------- ---------- ----------
Deferred tax assets:
Operating loss carryforwards................. -- 2,496,000 2,362,700
Accrued vacation............................. 125,100 132,000 157,600
Provision for doubtful accounts.............. 76,600 262,400 255,400
Research and development credits............. 118,000 205,900 231,900
Restructuring charges........................ -- 728,800 --
State taxes.................................. 6,800 -- --
--------- ---------- ----------
Total deferred tax assets............ 326,500 3,825,100 3,007,600
Valuation allowance............................ -- 3,188,100 2,367,800
--------- ---------- ----------
Net deferred tax assets.............. 326,500 637,000 639,800
--------- ---------- ----------
Net deferred tax asset (liability)... $ (85,000) $ 0 $ 0
========= ========== ==========
A valuation allowance has been recognized to offset deferred tax assets as
of December 31, 1998 and 1999 as realization of such assets is uncertain.
As of December 31, 1999, we have Federal and California research and
development tax credit carryforwards of approximately $172,400 and $59,500,
respectively, which will begin to expire in 2012 unless previously utilized.
F-14
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The differences between our income tax provision and the amounts computed
by applying the statutory Federal income tax rate of 35% in 1997, 1998 and 1999
to income before income taxes are as follows:
DECEMBER 31,
-------------------------------------
1997 1998 1999
--------- ----------- ---------
Provision at statutory rate............................ $ 374,107 $(3,310,918) $ 738,806
Benefit for graduated rates............................ (10,689) 94,596 (21,109)
State income taxes, net of Federal benefit............. (1,950) -- --
Increase (decrease) in valuation allowance............. -- 3,188,100 (820,300)
Benefit of research credits............................ (118,004) -- --
Permanent differences and other........................ (12,264) (277,946) (102,603)
--------- ----------- ---------
Provision for income taxes............................. $ 231,200 $ (306,168) $ --
========= =========== =========
7. TRANSACTIONS WITH AFFILIATES
Until September 30, 1999, we had a strategic marketing alliance with Xerox
under which both parties agreed to pay each other fees on referrals that led to
the successful sale or licensing of each other's products. Included in services
and other revenues in the accompanying statements of operations are commissions
earned from Xerox totaling $859,000, $344,000 and $287,000 in 1997, 1998 and
1999, respectively. These commissions were 4%, 2% and 1% of total revenues in
1997, 1998 and 1999, respectively. Commissions paid relating to referrals from
Xerox, included in selling and marketing expense in the accompanying statements
of operations, were $121,000, $0 and $0 in 1997, 1998 and 1999, respectively.
We have distribution agreements with affiliates providing the non-exclusive
right to sub-license our software in Canada, Australia and Brazil. The terms of
the distributor agreements provide that the affiliates receive a discount from
the list price of our licensed products and annual license fees. Revenues from
the affiliates under these agreements, net of discounts, were $1.0 million, $1.7
million and $2.4 million in 1997, 1998 and 1999, respectively. Included in
accounts receivable are $333,900, $473,800 and $900,500 from these revenues at
December 31, 1997, 1998 and 1999, respectively.
We have distribution agreements with affiliates providing the non-exclusive
right to sub-license our software in Europe. Revenues under these agreements
were $1.9 million, $2.4 million and $2.2 million in 1997, 1998 and 1999,
respectively. Related accounts receivable are $414,500, $181,600 and $663,300 at
December 31, 1997, 1998 and 1999, respectively. We also license software to
Xerox and affiliates of Xerox in the United States. These revenues were
$864,100, $962,600 and $263,600 in 1997, 1998 and 1999, respectively. Related
accounts receivable are $419,200, $379,000 and $221,400 at December 31, 1997,
1998 and 1999, respectively.
8. SALES COMMITMENTS
In 1999, we began licensing software for non-cancelable three-year terms.
Where we provide extended payment terms to customers (allowing them to make
payments on a quarterly or annual basis), we recognize license revenue when
invoices come due, as SOP 97-2 precludes us from recognizing the portion of
these licenses that is not currently due from the customer. Amounts not
currently due from customers on these agreements are not reflected on our
Balance Sheet and are identified below.
We also began signing customers to non-cancelable three-year maintenance
agreements, which we recognize ratably over the service period. As we invoice
these agreements, the amounts are recorded initially to Deferred Revenue.
Amounts to be invoiced are not reflected on our Balance Sheet and are identified
below.
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DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes these multi-year license and maintenance
agreement activities for 1999, showing ending balances not reflected on our
Balance Sheet at December 31, 1999:
UNRECOGNIZED REVENUE BACKLOG
-----------------------------------------
MAINTENANCE
LICENSES AGREEMENTS TOTALS
----------- ----------- -----------
Balances at December 31, 1998................ $ -0- $ -0- $ -0-
1999 additions............................... 2,905,033 3,876,105 6,791,237
1999 revenue recognized...................... (2,064,003) (289,463) (2,353,466)
Invoiced and included in Deferred Revenue.... -0- (661,125) (661,125)
----------- ---------- -----------
Balances at December 31, 1999................ $ 841,030 $2,925,517 $ 3,766,547
=========== ========== ===========
All revenue from the unrecognized revenue backlog will have been recognized
by the end of the fourth quarter of 2002.
9. EMPLOYEE RETIREMENT PLAN
401(K) PLAN
Document Sciences has an employee savings and retirement plan (the "401(k)
Plan") that is intended to be tax-qualified covering substantially all
employees. Under the terms of the 401(k) Plan, employees may elect to contribute
up to 15% of their compensation, or the statutory prescribed limit, if less, to
the 401(k) Plan as a savings contribution. We may, in our discretion, match
employee contributions, at such rate as we determine, up to a maximum of $3,000
or 10% of the employee's compensation. The 401(k) Plan has a profit sharing
element whereby we can contribute annually an amount determined by the Board of
Directors. An employee's interest in matching contributions and profit sharing
contributions generally vest over four years from the date of employment. For
the years ended December 31, 1998 and 1999, we made discretionary contributions
of $443,000 and $346,200, respectively.
10. RESTRUCTURING CHARGES
In December 1998, our Board of Directors approved a plan of restructuring
and we recorded a charge of approximately $2.0 million. At December 31, 1998,
our restructuring reserve totaled $1.5 million. This amount was paid in 1999 and
there was no reserve remaining at December 31, 1999.
F-16
41
SCHEDULE II
DOCUMENT SCIENCES CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END
OF YEAR EXPENSES DEDUCTIONS OF YEAR
---------- ---------- ---------- ----------
Year Ended December 31, 1997
Allowance for doubtful accounts and returns... $227,112 $ 432,451 $441,285 $218,278
Year Ended December 31, 1998
Allowance for doubtful accounts and returns... 218,278 1,199,425 692,142 725,561
Year Ended December 31, 1999
Allowance for doubtful accounts and returns... 725,561 219,482 179,170 765,873
S-1
42
DOCUMENT SCIENCES CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 1999
INDEX TO EXHIBITS
EXHIBIT SEQUENTIAL
NUMBER EXHIBIT DESCRIPTION PAGE NUMBER
- ----------- ------------------- -----------
3.1(1) Restated Certificate of Incorporation of the Registrant
filed May 1, 1992.
3.2(1) Form of Amended and Restated Certificate of Incorporation of
the Registrant.
3.3(1) Amended and Restated Bylaws of the Registrant.
3.4(1) Form of Certificate of Amendment of Certificate of
Incorporation of the Registrant.
4.1(1) Specimen Stock Certificate.
10.1(1)(3) Form of Indemnity Agreement Between the Registrant and each
of its Officers and Directors.
10.2(1)(3) 1993 Stock Option Plan and Form of Agreement.
10.3(5) 1995 Stock Incentive Plan and Form of Agreement, as amended.
10.4(1)(3) Stockholder Rights Agreement Dated September 1996 Between
the Registrant and Xerox Corporation.
10.5(1) Tax Sharing Agreement Dated August 1996 Between the
Registrant and Xerox Corporation.
10.6(1) Transfer and License Agreement Dated July 1, 1992, as
Amended in September 1994, Between the Registrant and Xerox
Corporation.
10.7(1) Strategic Marketing Alliance Agreement Dated September 1,
1993, Between the Registrant and Xerox Corporation.
10.8(1) Value Added Remarketer Agreement Between Xerox Canada
Limited and the Registrant.
10.9(1) Value Added Reseller Agreement Between N.V. Rank Xerox S.A.
and the Registrant.
10.10(1) Form of Professional Services Agreement.
10.11(1) Form of Domestic Value Added Remarketer Agreement.
10.12(1) Form of International Value Added Reseller Agreement.
10.13(1) Form of Software License and Software Support Agreement.
10.14(2) Lease for Registrant's Principal Facilities, as Amended and
Assignment of Lease.
10.15(1)(3) Letter Agreement Between Tony Domit and the Registrant.
10.16(1)(3) Letter Agreement Between Thomas Anthony and the Registrant.
10.17(1)(3) Letter Agreement Between Judith A. O'Reilly and the
Registrant.
10.18(1)(3) Letter Agreement Between Daniel Fregeau and the Registrant.
10.19(1)(3) Letter Agreement Between Alfred G. Altomare and the
Registrant.
10.20(1) Value Added Reseller Agreement Between Geneva Digital Ltd.
and the Registrant.
10.21(1) Value Added Remarketer Agreement Between Business and
Business and the Registrant.
10.22(5) 1997 Employee Stock Purchase Plan, as amended.
10.23(4) Tony N. Domit Agreement.
10.24(4) Xerox Cooperative Marketing Agreement.
10.25(4) Xerox Canada Cooperative Marketing and Customer Support
Agreement.
10.26(5) International Business Machines Marketing Agreement.
43
EXHIBIT SEQUENTIAL
NUMBER EXHIBIT DESCRIPTION PAGE NUMBER
- ----------- ------------------- -----------
10.27(5) Lease for Company's new Principal Facilities, as Amended,
and Assignment of Lease.
10.28(5) Thomas J. Anthony Agreement.
10.29(5) Robert J. Pryor Agreement.
10.30(5) John H. Wilson Consulting Agreement.
21.1(1) List of Subsidiaries.
23.1(6) Consent of Ernst & Young LLP, Independent Auditors.
24.1(6) Power of Attorney (See page 23)
27(6) Financial Data Schedule.
- ---------------
(1) Previously filed as exhibits to Registration Statement on Form S-1
Registration Number 333-06344.
(2) Previously filed as exhibits to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996.
(3) Indicates management compensatory plan, contract or arrangement.
(4) Previously filed as exhibits to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997.
(5) Previously filed as exhibits to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998.
(6) Filed herewith.