Back to GetFilings.com
1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------------
FORM 10-K
------------------------------------
(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, 1997
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.)
6333 GREENWICH DRIVE, SUITE 200, SAN DIEGO, 92122
CALIFORNIA (zip code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (619) 625-2000
------------------------------------
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 27, 1998, there were 10,814,962 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 27, 1998) was approximately
$12,484,489. 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
1998 Annual Meeting of Stockholders to be held on April 28, 1998 are
incorporated by reference in Part III of this Form 10-K to the extent stated
herein.
================================================================================
2
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 "Certain
Additional Business Risks" 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 (the "Company") develops, markets and
supports a family of document automation software products and services 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.
The Company's document automation software, the Autograph family of products,
enables personalized and customized publishing solutions for many industries
including insurance, managed healthcare, financial services, telecommunications,
manufacturing/distribution, government and commercial print services. The
Company's 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, the Company's core technology is being applied to provide
electronic document automation solutions for the Internet, intranets and
commercial on-line services. Autograph is licensed to more than 670 customers
worldwide who are collectively producing an estimated one billion customized
pages per month. The highly portable 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 enduser
customization. The Company's products are used in a wide array of computing
environments from client/server to large computer systems.
PRODUCTS
The Company's Autograph family of products currently addresses three major
functional areas: Document Composition and Assembly, Document Management, and
Document Viewing, as described below. All of the Company's software products can
be complemented by the Company's Professional Services organization.
The list price for an initial license fee for CompuSet, the Company's core
product, is currently $75,000 for an initial mainframe installation and ranges
down to $35,000 for an initial single PC; options currently range from $3,000 to
$50,000. The Company licenses its products for one year, after which an annual
renewal fee, usually in an amount equal to 15% of the initial license fee, is
required for continued use. A typical new sale is currently about $85,000 for
software licenses and approximately $50,000 for professional services.
DOCUMENT COMPOSITION AND ASSEMBLY
Composition and Assembly. CompuSet, the Company's flagship product,
automates document composition and assembly using data and information in
corporate databases. It is the Company's core technology. CompuSet software
consists of a rulebased language and a composition engine that provide
high-speed composition and assembly of complex documents with high typographic
and aesthetic levels of quality. Information content is marked with CompuSet
tags which, in turn, are defined in logically separate style specifications.
Without requiring real-time user interaction, the composition engine then
transforms the tagged data and information into finished electronic documents
that can be composed and assembled at rates in excess of 50 pages per second,
depending on computing configuration and complexity of the document. Document
construction facilities are extensive, including the full support of dynamic
data driven graphics generation. CompuSet operates on a range of computers and
operating systems including mainframes, workstations, network servers and
personal computers.
Data Capture and Setup. Data capture and setup products include CompuPrep
and a number of Importers, and prepare data and information for subsequent
composition and assembly by CompuSet.
2
3
CompuPrep is an optional tool that enables users to capture and tag raw data and
information from a variety of sources, including corporate databases, for
subsequent processing by CompuSet. It is a high level language that describes
the data environment, related data processing and the tagging instructions for
CompuSet. Importers accept externally generated document objects, including
text, static graphics and scanned images, and convert them into formats
compatible with CompuSet. The Importers support Adobe PostScript, Xerox Metacode
and the TIFF standard for scanned images.
Document Output and Merge. Emitters transform CompuSet's output into a
number of popular Page Description Languages (PDLs) for printing and viewing.
The PDLs provide instructions for rendering text, forms, bitmaps, and graphics
into documents. The PDL formats currently supported are Xerox Metacode, IBM
AFPDS, and Adobe PostScript. This part of the architecture is extensible and new
Emitters can be provided as required.
Application Development Tools. CompuSeries application development tools
run on Microsoft Windows(R) and simplify document design and application
prototyping. CompuSeries currently consists of several modules. CompuSpec is a
tool for defining document formatting rules. Formatting specifications which are
selected from a menu are associated with tags which are referenced in the
document data. The results of the selected formatting specifications are
visually displayed in a preview window. CompuBuild uses a PC version of
CompuSet, combined with an editor to manipulate the tagged document data.
CompuBuild supports all the dynamic functions and features of the CompuSet
production engine. CompuMerge is a tool used to specify the placement of
variable data into fixed document components such as in form-fill applications.
CompuView Proof is a document proofing tool used to preview the document layout
on the computer screen prior to printing. These tools were integrated into a
single Windows application, called CompuSeries II. The Company is in Beta
Testing to OEM JetForm(R) Corporation's JetForm Design product as well as the
JetForm production print drivers for Metacode, Postscript and AFP printers, and
will integrate it with CompuSeries II.
DOCUMENT MANAGEMENT
Document Management tools provide client/server solutions for the creation,
revision and management of document components used in the Company's document
automation solutions. They consist of the Document Library Service (DLS) and
Desktop Document Manager (DDM). DLS manages the document component creation
process required by complex variable documents. In addition, DLS can be used to
define complex assembly rules required for interactive or fully automated
document composition and assembly with CompuSet. DLS uses a client/server
architecture for accessing data and files on a mainframe or network server. DDM
is the client component of DLS and manages text objects created with Microsoft
Word(R). Text objects are tracked and managed in a multi-author environment by
providing access security, revision control and approval levels. DDM also
provides a criteria-based document object selection capability for customized or
personalized documents. These criteria are then used by DLS to generate a
CompuSet-ready tagged data file. 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 DDM PC.
DOCUMENT VIEWING
Document Viewing enables on-line viewing and archiving of electronic
documents produced by document automation applications. It consists of Document
Viewing Service (DVS) and CompuView. DVS uses a client/server architecture for
the creation and access of electronic document files. DVS is available for a
variety of mainframe, Unix and PC platforms. The electronic document files are
generated in a format called composite container format (CCF), which is
optimized for fast, memory-efficient viewing, transport and storage. CCF files
can then be viewed by CompuView. CCF files consist of three major components: a
page description language (PDL) rendition of the pages for WYSIWYG viewing;
various indices for locating documents; and reusable document elements. CCF
files can also be distributed, archived or printed through document distribution
and archiving systems offered by third party software developers that have
integrated CompuView. CompuView is a Windows application for viewing CCF files.
The view of the document is virtually identical to the printed document.
CompuView may also be integrated with third party document
3
4
retrieval systems. The Company introduced DVS in October 1995 and entered into
several OEM agreements in 1997 to have the program incorporated into archiving
software distributed by other major vendors.
The Company is considering possible future Internet extensions, some of
which are not currently under active development. The Company believes that its
core technology can be extended to the Internet, intranets and commercial online
services and has recently begun initial development activity in this area,
although there can be no assurance that such development activity will result in
commercially successful products. See "Business -- Research and Development".
PROFESSIONAL SERVICES
In addition to its software products, the Company provides a comprehensive
suite of services which can assist customers in the implementation of
enterprise-wide and mission-critical document automation applications.
Professional Services include on-site software installation, customer training
programs, telephone support programs and consulting services. Consulting
services are currently focusing on assisting in the sale of high margin initial
software licenses by providing project management and application development.
Eventually, the Company intends to expand Professional Services to include
document design, systems design and integration. In addition to consulting
services, the Company currently offers introductory-level customer education,
which is included with CompuSet initial licenses. Additional and advanced
classes are provided for additional fees at the Company's headquarters in San
Diego and at customer sites. The Company offers advanced and specialized
customer education in response to the unique needs of certain customers. The
Company believes that expanded Professional Services enables customers to deploy
the Company's document automation products more rapidly and effectively, and
assist the Company in the development of new products and provide recurring
revenue. The Professional Services and support organizations employed a staff of
56 as of December 31, 1997.
SALES AND MARKETING
The Company's sales and marketing organization targets vertical industry
markets that require document automation and high volume document
personalization and customization. The Company currently licenses its products
using a combination of direct sales and alternate channels. In the United
States, the Company markets its products through a direct sales force. Sales
representatives are provided with pre-sales technical support by regional
application specialists. Sales representatives and the regional application
specialists are located in Atlanta, Chicago, Cincinnati, Dallas, Minneapolis,
New York City, Pittsburgh, Richmond, Raleigh, Sacramento, Yorba Linda, San
Antonio, San Diego, Seattle and Washington, D.C. The Company distributes its
products through value added reseller (VAR) relationships with Xerox Canada,
Ltd. in Canada, Fuji Xerox Co., Ltd. in Australia, and Xerox Brazil, Ltd. in
Brazil. The Company's subsidiary, Document Sciences Europe, markets and supports
the Company's products in Europe, Africa and the Middle East by providing
channel management, technical support, consulting and training services, and
defining European market and product requirements. The Company licenses its
products in Europe through VARs and, to a lesser extent, direct sales. The VARs
are principally Rank Xerox Ltd. and other Xerox affiliates who remarket the
Company's products. The Company's revenues from export transactions with Xerox
affiliates were $3.1 million, $2.9 million and $2.9 million in 1995, 1996 and
1997, respectively. The sales, marketing, consulting and customer support
organization employed a staff of 114 as of December 31, 1997.
The Company intends to expand its sales and marketing organization to
provide direct sales and support services throughout the world. Such planned
expansion will occur by first addressing the unique product requirements of a
region followed by developing indirect sales channels to market in the region.
As the Company is able to increase its market presence, it may then augment its
alternate channels with a direct sales capability.
In addition, the Company intends to increase both its product offerings and
markets through marketing, sales and distribution, and development relationships
with other companies. Current relationships include formal and informal
marketing and sales alliances with Xerox, IBM, OCE Printing Systems, Computer
Associates, New Dimension Software, RSD, JetForm Corporation, Systemware, and
Anacomp. These
4
5
relationships provide sales leads for the Company's products and have extended
the Company's sales coverage and networking capabilities.
RESEARCH AND DEVELOPMENT
In general, the Company's strategy is to build products that augment and
extend the document composition and assembly capabilities of its core products.
Initially, product development investments were primarily focused on completing
the Autograph family of products, which included delivering products for
document viewing as well as adding support for additional print environments. In
addition, there was a substantial investment in product maintenance and in
software integration, testing, and documentation. The Company supplements its
product development efforts by reviewing customer feedback on existing products
and working with customers and potential customers to anticipate future product
needs.
To date, the Company's Autograph family of products have been applied
mainly to document automation applications producing paper based documents. The
Company believes that its core technology can be extended to provide electronic
document automation for the Internet, intranets, and commercial on-line
services. The short-term strategy is to engage this emerging opportunity with
two complementary initiatives. First, the Company intends to work closely to
define product requirements with existing customers, many of whom have expressed
interest in using the Internet in their document automation solutions. Second,
the Company intends to develop incremental extensions to its Autograph family of
products which can be incorporated by current customers into existing document
automation products provided by the Company. The Company believes that its core
technology can be extended to the Internet, intranets and commercial on-line
services, and has only recently begun initial development activity in this area.
There can be no assurance that the Company 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.
The development organization is composed of self-directed teams, in which
representatives from various disciplines within the Company collectively take
responsibility for the development and delivery of each new feature or product.
The development process includes early review of prototypes and demonstrations
to incorporate customer feedback and provide an opportunity for management
review. A formal sequence of project phases organizes the development and review
process for each team. The Company has a formal release planning process for an
annual maintenance release, and delivers interim versions as needed to support
its customers. The development organization maintains a database of all customer
and internal requests which forms the basis for release planning.
The Company expects to continue to enhance its existing products and to
develop new products, particularly as they relate to electronic publishing
applications. Research and development expenditures have grown substantially
since the Company's inception. Such expenditures were $1.7 million in 1995, $2.3
million in 1996 and $3.3 million in 1997. These amounts do not include product
support activities. The development organization has grown from 22 in 1995 to 32
in 1996 and 58 in 1997. The Company employs independent contractors as needed to
supplement the permanent development staff.
COMPETITION
The market for the Company's document automation products is intensely
competitive, subject to rapid change, and significantly affected by new product
introductions and other market activities of industry participants. The
Company's 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. The Company faces direct and
indirect competition from a broad range of competitors who offer a variety of
products and solutions to the Company's current and potential customers. The
Company's principal competition currently comes from (i) systems developed
in-house by the internal MIS departments of large organizations, (ii) direct
competition in a number of its vertical markets, including Docucorp, which is
partially owned by Xerox, in the insurance industry, M&I Data Services, Inc. in
banking and financial services, and Group 1 Software, Inc. in commercial direct
mailing, and (iii) direct competitors such as IBM's Direct Composition Facility
(DCF) and Group 1's recently introduced DOC1 product. The Company faces
5
6
market resistance from the large installed base of legacy systems because of the
reluctance of these customers to commit the time and effort necessary to convert
their document automation processes to the Company's document automation
software. Several of the Company's competitors have longer operating histories,
significantly greater financial, technical, marketing and other resources than
the Company, greater name recognition and a larger installed base of customers.
It is also possible that the Company 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 compete with the
Company. Moreover, as the market for document automation software develops, a
number of these or other companies with significantly greater resources than the
Company could attempt to enter or increase their presence in the Company's
market either independently or by acquiring or forming strategic alliances with
competitors of the Company or to otherwise increase 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 the Company's 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 the Company's
business, operating results and financial condition. There can be no assurance
that the Company will be able to compete successfully against current or future
competitors or that competitive pressures faced by the Company will not
materially adversely affect its business, operating results and financial
condition.
The Company believes that the principal competitive factors affecting its
market include product performance and functionality, ease of use, scalability,
operation across multiple computer and operating system platforms, product and
company reputation, client service and support, and price. Although the Company
believes that it currently competes favorably with respect to such factors,
there can be no assurance that the Company will be able to maintain its
competitive position against current and future competitors or that the Company
will be successful in the face of increasing competition from new products or
solutions introduced by existing competitors or by new companies entering the
market. Further, there can be no assurance that the Company can maintain its
position against current and future competitors, especially those with greater
financial, marketing, service, support, technical and other resources than the
Company.
PATENTS AND PROPRIETARY RIGHTS
The Company's success is dependent, in part, on its ability to protect its
proprietary technology. The Company relies primarily on a combination of
copyright and trademark laws, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. The Company seeks to
protect its software, documentation and other written materials under trade
secret and copyright laws, which afford only limited protection. The Company
presently has no patents or patent applications pending. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that the
Company regards as proprietary.
Policing unauthorized use of the Company's products is difficult, and while
the Company is unable to determine the extent to which piracy of its software
products exists, software piracy can be expected to be a persistent problem. In
addition, the laws of some foreign countries do not protect the Company's
proprietary rights to as great an extent as do the laws of the United States.
There can be no assurance that the Company's means of protecting its proprietary
rights will be adequate or that the Company's competitors will not independently
develop similar technology. The Company is not aware that any of its products
infringes upon the proprietary rights of third parties. There can be no
assurance, however, that third parties will not claim infringement by the
Company with respect to current or future products. The Company expects that
software product developers will increasingly be subject to infringement claims
as the number of products and competitors in the Company's 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 the Company to enter
into royalty or licensing agreements.
6
7
Such royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company or at all, which could have a material adverse effect
upon the Company's business, operating results and financial condition.
In addition, the Company also relies on certain software that it licenses
from third parties, including software that is integrated with internally
developed software and used in the Company's 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 the Company 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 the
Company's business, operating results and financial condition.
EMPLOYEES
As of December 31, 1997, the Company had 189 employees including 114 in
sales, marketing, consulting and customer support, 58 in research and
development, and 17 in finance and administration. None of the Company's
employees are represented by a labor union. The Company has experienced no work
stoppages and believes its relationship with its employees is good. Competition
for qualified personnel in the industry in which the Company competes is
intensive. The Company believes that its future success will depend in part on
its continued ability to attract, hire, and retain qualified personnel.
CERTAIN ADDITIONAL BUSINESS RISKS
The Company's business, financial condition and operating results may be
impacted by a number of factors, including but not limited to those set forth
below, any one of which could cause the Company's actual results to vary
materially from recent results or from the Company's anticipated future results.
Limited Operating History. The Company was incorporated in October 1991 as
a wholly-owned subsidiary of Xerox, and Xerox currently owns approximately 62%
of the Company's outstanding shares of Common Stock. The Company's limited
operating history makes the prediction of future operating results difficult,
and the Company's operating history during prior periods cannot necessarily be
regarded as indicative of the Company's prospects as an independent company,
especially in light of the Company's investments in sales, marketing,
professional services and development infrastructure. Accordingly, although the
Company has experienced revenue growth in recent years, there can be no
assurance that the Company will sustain such growth in revenues, if any, or that
the Company will remain profitable on a quarterly or annual basis.
Uncertainty of Future Operating Results; Fluctuations in Quarterly
Operating Results. The Company's total revenues and operating results can vary,
sometimes substantially, from quarter to quarter and are expected to vary
significantly in the future. The Company's revenues and operating results are
difficult to forecast. Future results will depend upon many factors, including
the demand for the Company's products, the level of product and price
competition, the length of the Company's sales cycle, the size and timing of
individual license transactions, the delay or deferral of customer
implementations, the budget cycles of the Company's customers, the level of
commissions on the sale of Xerox printers under the strategic marketing alliance
between the Company and Xerox, the Company's success in expanding its direct
sales force and indirect distribution channels, the timing of new product
introductions and product enhancements by the Company and its 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, the ability of the Company to develop and market new
products and control costs and general domestic and international economic
conditions. In addition, the Company's sales generally reflect relatively high
revenue per order, and the loss or delay of individual orders, therefore, could
have a significant impact on the revenues and quarterly operating results of the
Company. Moreover, the timing of license revenue is difficult to predict because
of the length of the Company's sales cycle, which is typically three to twelve
months from the initial customer contact.
The Company's initial software license products generally are shipped as
orders are received. As a result, initial license fee revenues are substantially
dependent on orders booked and shipped in that quarter. Because
7
8
the Company's operating expenses are based on anticipated revenue levels and
because a high percentage of the Company's expenses are relatively fixed, a
delay in the recognition of revenue from a limited number of license
transactions could cause significant variations in operating results from
quarter to quarter and could result in losses. To the extent such expenses
precede increased revenues, the Company's operating results would be materially
adversely affected.
The Company's business has experienced and is expected to continue to
experience seasonality, in part due to customer purchasing patterns and the
Company's expense patterns. The Company believes that fourth quarter revenues
are positively impacted by year-end capital purchases by large corporate
customers and strong fourth quarter sales of printers by Xerox (which may
generate sales of the Company's products), as well as the Company's sales
compensation plans. As reflected in the fourth quarter of 1997, these seasonal
factors have historically resulted in fourth quarter revenues being
substantially higher than revenues in the preceding three quarters, as well as
being higher than revenues in each of the first two quarters of the next year.
In addition, a significant amount of the Company's revenues occur predominantly
in the third month of each fiscal quarter and tend to be concentrated in the
latter half of the third month.
As a result of these factors, revenues for any quarter are subject to
significant variation, and the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Furthermore, due
to all of the foregoing factors, it is likely that in some future quarter the
Company's operating results will be below the expectations of public market
analysts and investors. In such event, the price of the Company's Common Stock
would likely be materially adversely affected. See "Expansion of Sales and
Distribution Channels" below, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
Control by Xerox. Xerox owns approximately 62% of the outstanding shares
of Common Stock of the Company. Consequently, Xerox controls the Company, is
able to elect the entire Board of Directors of the Company and continues to have
significant input into the Company's 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 the assets of the Company. The voting power of Xerox could
have the effect of delaying or preventing a change in control of the Company,
and may prevent or discourage tender offers for the Company's Common Stock at a
premium price by another person or entity. At present, Xerox affiliates hold
three of the five seats on the Company's Board of Directors. See "Reliance on
Relationships with Xerox; Lack of Independent Sales and Marketing Channels"
below.
Reliance on Relationships with Xerox; Lack of Independent Sales and
Marketing Channels. The Company currently has 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. The Company relies on these relationships and
agreements for a significant portion of its total revenues. In 1995, 1996 and
1997, total revenues derived from relationships with Xerox and affiliates of
Xerox accounted for approximately $3.9 million, $4.2 million and $3.8 million,
representing 37%, 28% and 19% of the Company's total revenues, respectively.
Further, the commissions received by the Company from sales of Xerox printers
under the strategic marketing alliance, which were $752,000, $1.4 million, and
$859,000 in 1995, 1996 and 1997, respectively, have little or no associated
costs, have contributed a substantial portion of the Company's income from
operations and net income for certain prior operating periods, have had a high
degree of inconsistency from quarter to quarter and are difficult to estimate.
Failure to continue to receive such commissions would have a material adverse
effect on the Company's business, operating results and financial condition.
Although neither Xerox nor its affiliated entities has expressed to the Company
any intention to terminate their respective agreements with the Company, these
agreements generally may be terminated on no more than 90 days notice.
Accordingly, there can be no assurance that Xerox or its affiliates will
continue these relationships or, if they do, that they will be on terms
favorable to the Company. Furthermore, there can be no assurance that existing
and potential customers will not be deterred by the existence of these
relationships or by the historical ties between the Company and Xerox and its
affiliates. Though the Company intends to continue its existing relationships
with Xerox, the Company's strategy is to lessen its dependence on Xerox.
However, there can be no assurance that the Company will be able to do so and,
because of the Company's current level of dependence on Xerox, there can be no
assurance that the Company's transition to
8
9
a more independent company will not adversely affect its business, financial
condition or results of operations. The failure by the Company 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 the
Company's business, operating results and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
"Expansion of Sales and Distribution Channels" below.
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 a competitor of the
Company. Xerox could in the future expand these relationships or enter into
additional ones, and as a result the Company's business could be materially
adversely affected. There can be no assurance that Xerox or one of its
affiliated companies will not engage in business directly competitive with the
Company. In addition, Xerox has on-going internal development activities which
could in the future lead to products that compete with the Company.
Expansion of Sales and Distribution Channels. The Company has
substantially increased expenditures in support of its strategy to expand its
global marketing, sales and customer support infrastructure in order to expand
the market for the Company's products by providing direct sales and support
services and increased channel distribution throughout the major markets of the
world. Through this expansion, the Company hopes to lessen its dependence on
Xerox and certain Xerox affiliates. In addition, the Company intends to increase
both its product offerings and markets through marketing, sales and distribution
and development relationships with other companies. The Company intends to
increase the number of these strategic relationships as well as form alliances
with system integrators and consultants. Whether the Company can successfully
generate its own sales leads, introduce new products and enter into new markets
will depend on its ability to expand its direct sales and support services,
expand its indirect channel distribution, and increase its relationships and
alliances with other companies. As a result of its planned expansion, the
Company has and will continue to incur significant costs to build such corporate
infrastructure ahead of anticipated revenues, and any failure to achieve growth
in revenues in excess of increased expenses would have a material adverse affect
on the Company's business, operating results and financial condition. There can
be no assurance that the Company will be able to successfully expand its direct
sales and support services force, expand its indirect channel distribution, or
establish or maintain successful third party relationships. Any failure to do so
will have a material adverse effect on the Company's business, operating results
and financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
Dependence on Success of New Products and Expansion of Professional
Services. The Company's Autograph family of products have been applied mainly
to document automation applications producing paper based documents. The Company
believes its core technology can be extended to address applications requiring
the delivery of customized and personalized electronic documents over electronic
networks such as the Internet, intranets or commercial on-line services.
The Company began shipping Document Viewing Service (DVS), an optional
on-line viewer for electronic documents produced by document automation
application in October 1995. Document Library Services (DLS), an optional
document management tool, was released for general availability in September
1996. Prior to September 1996, DLS was in a limited release, with certain
configurations still in beta testing. Revenues for DVS were $1.26 million in
1996 and $764,000 in 1997. Revenues for DLS were $1.0 million in 1996 and $1.27
million in 1997. Revenues for DVS and DLS were insignificant in 1995.
In addition, the Company is increasing its focus on the consulting services
component of its Professional Services to assist customers in the planning and
implementation of enterprise-wide, mission-critical document automation
applications. The Company has directed a significant amount of its product
development expenditures to the on-going development of DVS and DLS and plans to
devote a significant amount of future sales and marketing resources to the full
commercial introduction of DVS and DLS.
The Company believes that the long-term growth of license and service
revenue will be dependent, in part, upon the success of DVS, DLS and the
expansion of Professional Services. The Company has limited experience in
developing new products. Because of such limited experience, there can be no
assurance that DVS and DLS will not require substantial software enhancements or
modifications to satisfy performance
9
10
requirements of clients or to correct design defects. Further, there can be no
assurance that the Company will be successful in expanding its consulting
services as part of its Professional Services. If clients experience significant
problems with implementation of the software or are otherwise dissatisfied with
the functionality or performance of DVS and DLS, or if DVS or DLS fails to
achieve market acceptance for any reason, or if the Company fails to
successfully expand its Professional Services, the Company's business, operating
results and financial condition will be materially adversely affected.
Lengthy Sales and Implementation Cycles. The license of the Company's
software products is often an enterprise-wide decision by prospective customers
and generally requires the Company to engage in a lengthy sales cycle, typically
between three and twelve months, to provide a significant level of education to
prospective customers regarding the use and benefits of the Company's products.
In addition, the implementation of the Company's products by customers involves
a significant commitment of resources by such customers over an extended period
of time, and is commonly associated with substantial customer business process
reengineering efforts. For these and other reasons, the sales and customer
implementation cycles are subject to a number of significant delays over which
the Company has little or no control. Delay in the sale or customer
implementation of a limited number of license transactions could have a material
adverse effect on the Company's business and results of operations and cause the
Company's operating results to vary significantly from quarter to quarter. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Product Concentration. The Company derived 77% of its initial license
revenues from licenses of CompuSet and related CompuSet option products in 1997.
Initial license fees from DVS and DLS comprised 9% and 14%, respectively, in
1997. As a result, factors adversely affecting the pricing of or demand for
CompuSet and related products, such as competition from other products, negative
publicity or obsolesce of the hardware or software environments in which the
Company's products run, could have a material adverse effect on the Company's
business, operating results and financial condition. The Company's 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
the Company will continue to be successful in developing and marketing CompuSet
products and related services. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
Industry Concentration. Licenses to end users in the insurance and
commercial print services industries for 1995, 1996 and 1997 accounted for 61%,
55% and 61% respectively, of total revenues. The future success of the Company
will depend on its ability to continue to successfully market its products in
such industries, and to successfully market its products in other industries.
The failure of the Company to do so would have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Dependence on New Products and Product Enhancements. The Company's future
business, operating results and financial condition will continue to depend upon
its ability to develop new products that address the future needs of its target
markets and to respond to emerging industry standards and practices. The Company
believes that its core technology can be extended to the Internet, intranets and
commercial on-line services, and has begun initial development activity in this
area. There can be no assurance that the Company 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, or that its new products and product enhancements will adequately
meet the requirements of the marketplace or achieve market acceptance. Delays in
the commencement of commercial shipments of new products or enhancements,
including DVS and DLS, may result in client dissatisfaction and delay or loss of
product revenues. If the Company is 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,
or if new products or new versions of existing products do not achieve market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected. In order to provide its customers with
integrated product solutions, the Company's future success will also depend in
part upon its ability to maintain and enhance relationships with
10
11
its technology partners, such as Computer Associates, JetForm Corporation,
Anacomp and New Dimension Software. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
International Operations. Revenues from export sales, including sales
through its foreign subsidiary accounted for 42%, 34% and 28% of the Company's
total revenues in 1995, 1996 and 1997, respectively. The Company's wholly owned
subsidiary, Document Sciences Europe, markets and supports the Company's
products in Europe. The Company licenses its products in Europe through value
added resellers (VARs) and to a lesser extent, direct sales. The VARs are
principally Xerox affiliates who re-market the Company's products. In Australia,
Canada and Brazil the Company distributes its products through Fuji Xerox Co.,
Ltd., Xerox Canada, Ltd., and Xerox Brazil, Ltd., respectively. Revenues
generated by these Xerox affiliates were $3.1 million, $2.9 million and $2.9
million in 1995, 1996 and the 1997, respectively. In 1995, a substantial portion
of the Company's revenues from export sales were generated through entities
affiliated with Xerox. In order to successfully expand export sales, the Company
must establish additional foreign operations, hire additional personnel and
develop relationships with additional international resellers. To the extent
that the Company is unable to do so in a timely manner, the Company's growth, if
any, in international export sales will be limited, and the Company's business,
operating results and financial condition could be materially adversely
affected. In addition, there can be no assurance that the Company will be able
to maintain or increase international market demand for its products. Additional
risks inherent in the Company's international business activities generally
include currency fluctuations, unexpected changes in regulatory requirements,
tariffs and other trade barriers, costs of and the Company's limited experience
in localizing products for foreign countries, lack of acceptance of localized
products in foreign countries, longer accounts receivable payment cycles,
difficulties in managing 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 the
Company's business is conducted in currencies other than the U.S. dollar,
primarily the French franc. Although to date exchange rate fluctuations have not
had a significant impact on the Company, fluctuations in the value of the
currencies in which the Company conducts its business relative to the U.S.
dollar could cause currency transaction gains and losses in future periods. The
Company does not currently engage in currency hedging transactions, and there
can be no assurance that fluctuations in the currency exchange rates in the
future will not have a material adverse impact on international revenues and
thus the Company's business, operating results or financial condition. There can
be no assurance that such factors will not have a material adverse effect on the
Company's future international operations and, consequently, the Company's
results of operations. See "Control by Xerox" above and "Management's Discussion
and Analysis of Financial Condition and Results of Operations".
Dependence on Emerging Markets for Document Automation Software. The
market for document automation software is relatively new, 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. There can be no
assurance that the market for document automation software will develop or that,
if it does develop, organizations will adopt the Company's products. The Company
has spent, and intends to continue to spend, significant resources educating
potential customers about the benefits of its products. However, there can be no
assurance that such expenditures will enable the Company's products to achieve
further market acceptance, and if the document automation software market fails
to develop or develops more slowly than the Company currently anticipates, the
Company's business, operating results and financial condition would be
materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
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 the Company's
products designed for this market will depend, in part, on their compatibility
with such services. It is difficult to predict with any assurance whether the
Internet, intranets and commercial on-line services will prove to 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 the
11
12
Company's products and services and the introduction of new products and
services, there can be no assurance that the Company will be able to effectively
or successfully compete in this emerging market.
Management of Change; Dependence Upon Key Personnel. The Company has
recently experienced a period of growth in total revenues. The Company's ability
to compete effectively and to manage future change will require the Company to
continue to improve its financial and management controls, reporting systems and
procedures on a timely basis and to expand, train and manage its employee work
force. There can be no assurance that the Company will be able to do so
successfully. The Company's failure to do so could have a material adverse
effect on the Company's business, operating results and financial condition. The
Company's future performance depends in significant part upon the continued
service of its key technical, sales and senior management personnel, none of
whom are parties to employment agreements with the Company. The loss of the
services of one or more of the Company's executive officers could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company's future success also depends on its continuing
ability to attract and retain highly-qualified product development, sales and
managerial personnel. Competition for such personnel is intense, and there can
be no assurance that the Company will be able to retain its key employees or
that it will be able to attract, assimilate or retain other highly qualified
product development, sales and managerial personnel in the future. See "Control
by Xerox" above.
Recent Changes In Senior Management. On March 11, 1998, the Company
announced the retirement of Tony N. Domit from his positions as President and
Chief Executive Officer, and that a committee of the Company's Board of
Directors had been established to conduct a search for Mr. Domit's replacement.
While the Company intends to name a new President and Chief Executive Officer as
soon as practicable, there can be no assurance that the change in senior
management and related uncertainties will not adversely affect the Company's
consolidated operating results and financial condition during the period until a
new President and Chief Executive Officer is hired and afterward. The Company's
failure to recruit, retain and assimilate new executives, or the failure of any
such executive to perform effectively, or the loss of any such executive, could
have a material adverse impact on the Company's business, financial condition
and results of operations.
Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two-digit entries in the date code
field. Beginning in the year 2000, these date code fields will need to accept
four-digit entries to distinguish 21st century dates from 20th century dates. As
a result, in fewer than two years, computer systems and/or software used by many
companies may need to be upgraded to comply with such "Year 2000" requirements.
Significant uncertainty exists concerning the potential effects associated with
such compliance. Any Year 2000 compliance problem of any of the Company, its
customers, or its suppliers could result in a material adverse effect on the
Company's business, financial condition, and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Product Liability. The Company's license agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential product liability claims. However, it is possible that the limitation
of liability provisions contained in the Company's license agreements may not be
effective under the laws of certain jurisdictions. Although the Company has not
experienced any product liability claims to date, the sale and support of
products by the Company may entail the risk of such claims, and there can be no
assurance that the Company will not be subject to such claims in the future. A
successful product liability claim or claim arising as a result of professional
services rendered by the Company brought against the Company could have a
material adverse effect upon the Company's business, operating results and
financial condition.
Risk of Product Defects. Software products as complex as those offered by
the Company, particularly the Company's new DVS and DLS products, may contain
undetected defects or errors when first introduced or as new versions are
released. As a result, the Company could in the future lose or delay recognition
of revenues as a result of software errors or defects. In addition, the
Company's products are typically intended for use in applications that may be
critical to a customer's business. As a result, the Company expects that its
customers and potential customers have a greater sensitivity to product defects
than the market for software products generally. Although the Company's business
has not been adversely affected by any such errors to
12
13
date, there can be no assurance that, despite testing by the Company and by
current and potential customers, errors will not be found in new products or
releases after commencement of commercial shipments, resulting in loss of
revenue or delay in market acceptance, diversion of development resources,
damage to the Company's reputation, or increased service and warranty costs, any
of which would have a material adverse effect upon the Company's business,
operating results and financial condition.
ITEM 2. PROPERTIES.
The Company's principal administrative, sales, marketing, training, and
research and development facilities occupy approximately 33,102 square feet in
San Diego, California, pursuant to a lease which expires on February 28, 2002.
In addition, the Company's subsidiary in France occupies approximately 3,500
square feet of office space with a renewable lease expiring in February 1999.
Sales representatives and field technical support personnel operate from their
homes.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party, nor is its 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 1997.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company and their ages, as of March 13, 1998
are as follows:
NAME AGE POSITION
- ----------------------------------- --- --------------------------------------------
Alan H. Lynchosky.................. 45 Acting President and Chief Executive Officer
Robert D. Gerhart.................. 43 Acting Chief Financial Officer
Thomas Anthony..................... 62 Vice President, Sales
Peter L. Bradshaw.................. 42 Vice President, Development
Daniel J. Fregeau.................. 41 Vice President, Business Development
Robert J. Pryor.................... 45 Vice President, Marketing
Alan H. Lynchosky has served as Acting President and Chief Executive
Officer since March 1998 and Vice President, Professional Services since April
1997. Prior to joining the Company, Mr. Lynchosky served in a variety of
executive and other positions at Control Data Systems, Inc. over a twenty four
year period. Most recently serving as Vice President, Managed Services Division,
where he created a new global business division focusing on outsourced
electronic commerce services. Other positions within Control Data included a
variety of Vice President and General Manager roles managing several different
business units both domestically and abroad.
Robert D. Gerhart has served as Acting Chief Financial Officer since
November 1997 and Corporate Controller since 1996. Prior to joining the Company,
Mr. Gerhart served as Chief Financial Officer and Vice President of Finance at
Software Sorcery, a multimedia software publishing company from 1994 to 1995.
From 1983 to 1994, Mr. Gerhart served as Managing Partner at Gerhart & Gerstein
P.C. Certified Public Accountants, a local certified public accounting firm.
Thomas Anthony has served as Vice President, Sales since June 1994. Prior
to joining the Company, Mr. Anthony was Executive Vice President, Marketing and
Sales for Innovatech, Inc. from 1992 to 1994, Acer America from 1990 to 1992,
Sweda International from 1987 to 1990, and Frame Technologies from 1986 to 1987.
Mr. Anthony was Vice President, Sales for Altos Computer Systems from 1983 to
1986 and Vice President Marketing and Sales from 1979 to 1983 for Onyx Systems.
Prior to Onyx, Mr. Anthony was with National Semiconductor as a Vice President
and founder of the Datachecker Systems Business Unit.
13
14
Peter L. Bradshaw has served as Vice President of Development since March
1994. Prior to joining the Company, 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, Business Development since
1997. From 1994 to 1997 Mr. Fregeau served as Vice President, Marketing and from
1992 to 1994, he served as Vice President, Sales for the Company. Prior to
joining the Company, 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.
Robert J. Pryor has served as Vice President, Marketing since May 1997.
Prior to joining the Company, Mr. Pryor served as a principal with web.in.sight,
an Internet consulting group from 1995 to 1997, and was retained by Document
Sciences Corporation to help formulate the Company's Internet strategy. Mr.
Pryor served as President and Chief Executive Officer of Design Intent Software,
Inc. from 1993 to 1995.
Executive officers of the Company 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 the Company.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock of the Company is traded on the Nasdaq Market under the
symbol "DOCX". The following table sets forth the range of high and low sales
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 1996
September 20, 1996 through September 30, 1996............... $14.50 $12.00
Forth quarter ended December 31, 1996....................... $16.38 $ 9.50
FISCAL 1997
First quarter ended March 31, 1997.......................... $10.13 $ 3.88
Second quarter ended June 30, 1997.......................... $ 5.50 $ 3.00
Third quarter ended September 30, 1997...................... $ 4.75 $ 3.63
Fourth quarter ended December 31, 1997...................... $ 3.82 $ 2.50
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.
14
15
YEARS ENDED DECEMBER 31,
----------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------ -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF INCOME
Net revenues................................. $19,740 $15,319 $10,512 $7,171 $ 3,491
Income (loss) from operations................ (58) 1,665 1,685 1,354 720
Net income................................... 838 1,361 1,052 712 413
Net income per share......................... .08 .14 .12 .09 .06
Shares used in per share calculations........ 11,013 9,615 8,563 8,256 7,290
BALANCE SHEET
Working capital.............................. $23,896 $25,807 $ 1,353 $ 537 $ 84
Total assets................................. 34,229 32,022 6,289 4,209 1,805
Capital lease obligations, less current...... 52 116 99 20 18
portion Stockholders' equity (deficit)....... 27,691 26,910 856 71 (308)
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. The Company's
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 "Certain Additional
Business Risks" on pages 6 through 11. Readers are cautioned not to place undue
reliance on these forward-looking statements, and the Company undertakes 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 and services used in high volume electronic
publishing applications. The Company was incorporated in Delaware in October
1991 as a wholly-owned subsidiary of Xerox Corporation ("Xerox"), and following
the Company's initial public offering of stock in September 1996, Xerox
ownership was reduced to approximately 62%.
On May 7, 1997, the Company purchased substantially all of the assets of
Data Retrieval Corporation of America ("Data Retrieval") from the West Group.
Included in the purchase were exclusive ownership of the TextComply, Text DBMS,
TextGen, TextMigrate and TextBook software products and the installed base of
commercial accounts. The Company has retained employees responsible for the
development, product support and customer service of the software products. In
addition, the Company will continue to provide training and consulting support
for existing and future customers. See Note 2 of Notes to Consolidated Financial
Statements.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
REVENUES
Total revenues were $10.5 million, $15.3 million and $19.7 million in 1995,
1996 and 1997, respectively, representing increases of 46% from 1995 to 1996 and
29% from 1996 to 1997. The Company's 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 principally of license fees for the first year of use
of the Company's products by end user customers. Annual renewal license and
support fees are comprised principally of mandatory fees paid by customers
annually for continued use and support of the licensed products. Services and
other revenues are comprised principally of fees for
15
16
consulting, application development and training services performed by the
Company as well as fees received from Xerox in connection with the sale of
certain Xerox printer products. The Company recognizes revenue in accordance
with AICPA Statement of Position on Software Revenue Recognition No. 91-1.
Initial license revenue is recognized upon shipment of the product to customers
if no significant Company obligations remain and collection of the receivable is
deemed probable. The portion of the initial license revenue which represents the
software support for the first year is deferred and 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 and training services are
recognized as the related services are performed.
The growth of total revenue in each year was due primarily to increased
numbers of initial software license customers and growth in services and other
revenue, and to the expansion of the Company's sales force and product
consultants.
The Company sells its products principally through a direct sales force
domestically, and internationally principally through distributors and value
added resellers (VARs) and, to a lesser extent, through its direct sales force.
Revenues from export sales and sales through the Company's foreign subsidiary
were $4.4 million, $5.2 million and $5.5 million in 1995, 1996 and 1997,
respectively, representing increases of 18% from 1995 to 1996 and 6% from 1996
to 1997. Revenue from export sales were 42%, 34% and 28% of total revenue for
the 1995, 1996 and 1997, respectively. The increase in total export revenue is
due to the Company's increased presence in foreign markets and the continued
success of the foreign subsidiary in Europe which was established in 1994. This
growth has not paralleled the domestic growth since Professional Services have
been generally performed by VARs in these markets.
The Company and Xerox maintain a strategic marketing alliance agreement
under which the parties have agreed to pay each other fees on referrals that
lead to the successful licensing or sales of each other's products. The
Company's revenues from the strategic marketing alliance, principally
commissions from sales of Xerox printers, were $752,000, $1.4 million and
$859,000 in 1995, 1996 and 1997, respectively. These commissions were 7% of
total revenue in 1995, 9% of total revenue in 1996 and 4% of total revenue in
1997. Failure to continue to receive such commissions would have a material
adverse effect on the Company's business, operating results and financial
condition.
The Company has entered into distributorship agreements with various Xerox
foreign affiliates to remarket the Company's products internationally. The
Company's revenues from such distributorship agreements relating to the
licensing, maintenance and support of the Company's products were $3.1 million,
$2.9 million and $2.9 million in 1995, 1996 and 1997, respectively.
Initial license fees. Initial license fee revenues were $6.3 million, $8.6
million and $8.8 million for 1995, 1996 and 1997, respectively, representing
increases of 37% from 1995 to 1996 and 2% from 1996 to 1997. Initial license
revenues as a percentage of total revenue were 60%, 56% and 44% in 1995, 1996
and 1997, respectively. Initial license revenues have increased in absolute
dollars in each period as a result of increased demand for Professional Services
and have increased in 1997 due to an increase in annual renewal license and
support fees associated with the Data Retrieval acquisition.
Annual renewal license and support fees. Revenues from annual renewal
licenses were $1.9 million, $2.4 million and $4.6 million for 1995, 1996 and
1997, respectively, representing increases of 25% from 1995 to 1996 and 91% from
1996 to 1997. The increase in both periods was principally due to an increase in
the installed base of users of the Company's software products including the
increase in the Company's installed base of customers resulting from the Data
Retrieval purchase. As a percentage of total revenue, annual renewal license and
support fees were 18%, 16% and 23% in 1995, 1996 and 1997, respectively.
Services and other. Revenues from services and other were $2.3 million,
$4.3 million and $6.4 million in 1995, 1996 and 1997, respectively, representing
increases of 90% from 1995 to 1996 and 48% from 1996 to 1997. The increase in
each period was principally due to the increased number of new customer licenses
of the Company's software generating increased demand for services as well as
the increasing scope of professional
16
17
services offered. Revenues from services and other were 22%, 28% and 32% of
total revenues in 1995, 1996 and 1997, respectively.
COST OF REVENUES AND OPERATING EXPENSES
Cost of initial license fees. Cost of initial license revenues were
$351,000, $696,000 and $677,000 in 1995, 1996 and 1997, respectively,
representing 6%, 8% and 8% of initial license revenues in 1995, 1996 and 1997,
respectively. Cost of initial licenses of software includes documentation,
reproduction costs, product packaging, packaging design, product media,
employment costs for training, installation and distribution personnel, the cost
of third party software and amortization of previously capitalized software
development costs. The decrease in the cost of initial licenses was primarily
the result of decreased payments for third party software integrated into the
Company's DLS products which technology was obtained in the purchase of Data
Retrieval.
Cost of annual licenses renewals. Cost of annual licenses renewals
consists principally of the employment-related costs for the Company's technical
support staff, which performs technical software support services. Cost of
annual licenses renewals revenues was $370,000, $497,000 and $750,000 in 1995,
1996 and 1997, respectively, representing 19%, 21% and 16% of annual licenses
renewals revenues. This increase in absolute dollars is attributable to the
additional technical support personnel necessary to support the customer base
acquired from Data Retrieval as well as an increase in the installed base of
users of the Company's software products.
Cost of services and other. Cost of services and other revenues were
$424,000, $1.1 million and $3.1 million in 1995, 1996 and 1997, respectively,
representing 19%, 25% and 48% of services and other revenue. Cost of services
and other consists principally of the employment-related costs for the Company's
staff of product consultants and trainers. The increase in cost of services and
other revenues resulted principally from the additional staffing to perform the
Company's professional services. There are little or no costs related to
commissions from the sale of Xerox printers under the strategic marketing
alliance.
Research and development. Research and development expenses were $1.7
million, $2.3 million and $3.3 million in 1995, 1996 and 1997, respectively,
representing increases of 35% from 1995 to 1996 and 42% from 1996 to 1997.
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 developing product documentation. As a
percentage of total revenue, research and development expenses were 17%, 15% and
17% in 1995, 1996 and 1997, respectively. The Company anticipates that it will
continue to direct significant resources to development and enhancement of
products.
The Company expenses all costs for research and development of new products
until technological feasibility has been assured. Thereafter, costs of
production are capitalized until general release of the product. The capitalized
costs of software production 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 lives
of the products. The Company capitalized software development costs of $291,000,
$104,000 and $831,000 in 1995, 1996 and 1997, respectively. The increase in
capitalized software development costs in 1997 compared to 1996 was principally
due to the expansion of the engineering staff and increased costs due to the
development of software that has reached technological feasibility as compared
to prior periods when there were enhancements to existing products.
Selling and marketing. Selling and marketing expenses were $4.4 million,
$7.4 million and $9.1 million in 1995, 1996 and 1997, respectively, representing
increases of 67% from 1995 to 1996 and 23% from 1996 to 1997. Selling and
marketing expenses consist primarily of salaries, commissions, marketing
programs and related costs for pre- and post-sales activity. The increase for
both periods was the result of adding personnel to increase geographic coverage
of the selling organization and, to a lesser extent, the higher commissions
associated with increased revenues. The increase in 1995 compared to 1996 was
also the result of adding employees to develop and deliver the professional
services. The increase from 1996 to 1997 was due principally to increased sales,
sales support and marketing personnel and the related costs and commissions
associated
17
18
with increased revenues. Selling and marketing expenses were 42%, 48% and 46% of
total revenues in 1995, 1996 and 1997, respectively.
General and administrative. General and administrative expenses consist of
employment-related costs for finance, administration and human resources, and
general corporate management and services. General and administrative expenses
were $1.5 million in 1995, $1.7 million in 1996 and $2.9 million in 1997,
representing 14%, 11% and 15% of total revenue in 1995, 1996 and 1997,
respectively. The increase in general and administrative expenses in absolute
dollars was the result of growth in the finance and administrative operations to
support the growth of the Company and increased expenses associated with being a
publicly traded company.
Interest income (expense), net. Interest income (expense) is primarily
composed of interest income from cash and cash equivalents and short term
investments offset by financing charges related to equipment leases. Interest
income (expense), net was $5,000, $318,000 and $1,079,000 in 1995, 1996 and
1997, respectively. The increase in dollar amount is primarily due to higher
cash balances resulting from the infusion of cash from the Company's initial
public offering of common stock completed in September 1996.
Provision for income taxes. Effective tax rates were approximately 38%,
31% and 22% in 1995, 1996 and 1997, respectively. These rates differ from the
federal statutory rate in 1997 primarily due to the benefits received from
certain credits and to benefits received from tax exempt interest income. During
1996 the Company recognized a benefit from a net operating loss carryforward
from the Company's foreign subsidiary. From its inception to September 19, 1996,
the Company's operating results were included in the consolidated tax returns of
Xerox Corporation. Subsequent to the Company's initial public offering on
September 19, 1996, the Company was no longer included in the consolidated tax
returns of Xerox Corporation.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
The Company's total revenues and operating results can vary, sometimes
substantially, from quarter to quarter and are expected to vary significantly in
the future. The Company's revenues and operating results are difficult to
forecast. Future results will depend upon many factors, including the demand for
the Company's products, the level of product and price competition, the length
of the Company's sales cycle, the size and timing of individual license
transactions, the delay or deferral of customer implementations, the budget
cycles of the Company's customers, the Company's success in expanding its direct
sales force and indirect distribution channels, the timing of new product
introductions and product enhancements by the Company and its 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, the ability of the Company to develop and market new
products and control costs, and general domestic and international economic
conditions. In addition, the Company's sales generally reflect a relatively high
amount of revenues per order, and, therefore, the loss or delay of individual
orders could have a significant impact on revenues and quarterly operating
results of the Company. In addition, a significant amount of the Company's
revenues occur predominantly in the third month of each fiscal quarter and tend
to be concentrated in the latter half of that third month.
The Company's software products generally are shipped as orders are
received. As a result, initial license revenues in any quarter are substantially
dependent on orders booked and shipped in that quarter. The timing of receipt of
initial license revenue is difficult to predict because of the length of the
Company's sales cycle, which is typically three to twelve months from the
initial contact. Because the Company's operating expenses are based on
anticipated revenue trends and because a high percentage of the Company's
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, the Company's operating results would be materially
adversely affected.
Due to the foregoing factors, revenues and operating results for any
quarter are subject to significant variation, and the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
18
19
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had $21.8 million in cash, cash
equivalents and short-term investments. Net cash provided by operating
activities was $1.2 million and $1.7 million in 1995 and 1996, respectively. Net
cash used in operating activities was $637,000 in 1997. Net cash used in
investing activities was $589,000 and $23.8 million in 1995 and 1996,
respectively. In 1995 net cash used in investing activities was primarily used
for the purchase of fixed assets. In 1996, net cash used in investing activities
was primarily used for purchase of short-term investments and to a lesser
extent, for the purchase of fixed assets. Net cash provided by investing
activities was $2.0 million in 1997. In 1995 net cash provided by financing
activities was $27,000, primarily from issuance of the Company's common stock
pursuant to exercise of options granted under the Employee Stock Option Plan,
offset by payments of capital lease obligations. Net cash provided by financing
activities in 1996 was $23.3 million, primarily from net proceeds from the
initial public offering of the Company's common stock. Net cash used in
financing activities was $285,000 in 1997, primarily from the purchase of
treasury stock.
The Company believes that its existing cash balances and anticipated cash
flows from operations will be sufficient to meet its anticipated cash needs for
working capital and capital expenditures at least through the next twelve
months. A portion of the Company's cash could be used to acquire or invest in
complementary businesses or products or obtain the right to use complementary
technologies. The Company is currently evaluating, in its ordinary course of
business, potential investments such as businesses, products or technologies.
The Company has no current understandings, commitments or agreements with
respect to any acquisition of other businesses, products or technologies.
In September 1996, the Company completed an initial public offering of its
common stock. In October 1996, the Underwriters of the offering exercised their
over allotment option. The net proceeds received by the Company from the
offering were approximately $23.3 million. The Company thus far used the
proceeds from the offering as follows:
(i) Approximately $1,380,000 was used to pay income taxes to Xerox
Corporation.
(ii) Approximately $507,000 was used to purchase certain assets of Data
Retrieval Corporation of America.
(iii) Approximately $21,400,000 is available for general working capital
purposes.
RECENTLY ENACTED ACCOUNTING STANDARDS
The Financial Accounting Standards Board recently approved the new American
Institute of Certified Public Accountants Statement of Position, Software
Revenue Recognition (SOP 97-2). This statement provides guidance for recognizing
revenue and related to sales by software vendors. SOP 97-2 will be effective for
the Company beginning in the first quarter of 1998. The Company does not believe
the adoption of SOP 97-2 will have a significant impact on its revenue
recognition policy, its policy for capitalization of software development costs,
or its results of operations or financial position.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
Reporting Comprehensive Income and No. 131, Disclosures About Segments of an
Enterprise and Related Information. SFAS No. 130 establishes rules for reporting
and displaying comprehensive income. SFAS No. 131 will require the Company to
use the "management approach" in disclosing segment information. Both statements
are effective for the Company during 1998. The Company does not believe that the
adoption of either SFAS No. 130 or SFAS No. 131 will have a material impact on
the Company's results of operations, cash flows, or financial position.
YEAR 2000 COMPLIANCE
The Company has determined that it will need to modify or replace
significant portions of its software so that its computer systems will function
properly with respect to dates in the year 2000 and beyond. The Company also
intends to initiate discussions with its significant suppliers, large customers
and financial
19
20
institutions to ensure that those parties have appropriate plans to remediate
Year 2000 issues where their systems interface with the Company's systems or
otherwise impact its operations. The Company plans to assess the extent to which
its operations are vulnerable should those organizations fail to remediate
properly their computer systems.
The Company will verify that activities are designed to ensure that there
is no adverse effect on the Company's core business operations and that
transactions with customers, suppliers and financial institutions are fully
supported. The Company expects to have all necessary changes implemented by
1999. While the Company believes its planning efforts are adequate to address
its Year 2000 concerns, there can be no guarantee that the Company's systems or
the systems of other companies on which the Company's systems and operations
rely will be converted on a timely basis and will not have a material effect on
the Company. The cost of the Year 2000 initiatives is not expected to be
material to the Company's results of operations or financial position.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
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
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
The information required by this item concerning the Company's directors is
incorporated by reference to the information set forth in the section entitled
"Election of Directors -- Nominees" in the Company's Proxy Statement for the
1998 Annual Meeting of Stockholders to be filed with the Commission within 120
days after the end of the Company's fiscal year ended December 31, 1997, except
that the information required by this item concerning the executive officers of
the Company 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 the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders to be filed with the Commission within 120 days
after the end of the Company's fiscal year ended December 31, 1997.
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 the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders to be filed with the Commission within 120 days
after the end of the Company's fiscal year ended December 31, 1997.
20
21
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 the Company's Proxy Statement
for the 1998 Annual Meeting of Stockholders to be filed with the Commission
within 120 days after the end of the Company's fiscal year ended December 31,
1997.
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,
and related notes thereto, of the Company 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, 1996 and 1997
Consolidated Statements of Income -- Fiscal Years Ended December 31, 1995,
1996 and 1997
Consolidated Statements of Redeemable Preferred Stock and Stockholders'
Equity -- Four Year Period Ended December 31, 1997
Consolidated Statements of Cash Flows -- Fiscal Years Ended December 31,
1995, 1996 and 1997
Notes to Consolidated Financial Statements
2. Financial Statement Schedule. The following financial statement
schedule of the Company for the fiscal years ended December 31, 1995, 1996 and
1997 is filed as part of this Form 10-K and should be read in conjunction with
the Consolidated Financial Statements, and related notes thereto, of the
Company.
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 the Company
during the fiscal quarter ended December 31, 1997.
(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.
21
22
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 31st day of
March 1998.
DOCUMENT SCIENCES CORPORATION
By: ALAN H. LYNCHOSKY
-----------------------------------
Alan H. Lynchosky
Acting President and Chief Executive
Officer
Dated: March 31, 1998
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Alan H. Lynchosky 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 the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ALAN H. LYNCHOSKY Acting President and Chief Executive March 31, 1998
- --------------------------------------------- Officer (principal executive officer)
Alan H. Lynchosky
/s/ ROBERT D. GERHART Acting Chief Financial Officer March 31, 1998
- --------------------------------------------- (principal financial and accounting
Robert D. Gerhart officer)
/s/ THOMAS L. RINGER Chairman of the Board of Directors March 31, 1998
- ---------------------------------------------
Thomas L. Ringer
/s/ JAMES J. COSTELLO Director March 31, 1998
- ---------------------------------------------
James J. Costello
Director March , 1998
- ---------------------------------------------
Tony N. Domit
/s/ BARTON L. FABER Director March 31, 1998
- ---------------------------------------------
Barton L. Faber
22
23
SIGNATURE TITLE DATE
--------- ----- ----
Director March , 1998
- ---------------------------------------------
Charles P. Holt
/s/ COLIN J. O'BRIEN Director March 31, 1998
- ---------------------------------------------
Colin J. O'Brien
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 Income........................... F-3
Consolidated Statements of Redeemable Preferred Stock and
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, 1996 and 1997, and the related
consolidated statements of income, redeemable preferred stock and stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1996 and 1997, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
San Diego, California
January 23, 1998
F-1
26
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------------
1996 1997
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 2,465,694 $ 3,526,301
Short-term investments.................................... 23,142,885 18,228,527
Accounts receivable, less allowance for doubtful accounts
of $227,112 and $218,278 in 1996 and 1997,
respectively........................................... 2,257,025 6,468,751
Due from affiliates....................................... 2,377,364 851,717
Work in process on development contract................... -- 288,932
Deferred income taxes..................................... 170,700 326,500
Other current assets...................................... 232,304 279,888
----------- -----------
Total current assets........................................ 30,645,972 29,970,616
Property and equipment, net................................. 998,203 2,135,930
Goodwill, net of accumulated amortization of $46,749........ -- 1,005,111
Computer software costs, net of accumulated amortization of
$384,785 and $476,125 in 1996 and 1997, respectively...... 377,342 1,117,319
----------- -----------
$32,021,517 $34,228,976
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 698,711 $ 673,657
Accrued compensation...................................... 831,541 787,511
Other accrued liabilities................................. 457,492 348,559
Deferred revenue.......................................... 2,477,723 3,812,365
Current income tax payable to affiliate................... 311,000 387,443
Current portion of obligations under capital leases....... 62,439 65,108
----------- -----------
Total current liabilities................................... 4,838,906 6,074,643
Obligations under capital leases............................ 115,740 52,236
Deferred income taxes....................................... 156,500 411,500
Commitments
Stockholders' equity Common stock, $.001 par value;
Authorized shares -- 30,000,000
Issued and outstanding shares -- 10,722,168 in 1996 and
10,803,369 in 1997..................................... 10,722 10,803
Deferred compensation..................................... (351,473) (241,469)
Treasury stock............................................ -- (240,515)
Unrealized gain on short-term investments................. 13,222 69,506
Additional paid-in capital................................ 25,382,203 25,398,897
Retained earnings......................................... 1,855,697 2,693,375
----------- -----------
Total stockholders' equity.................................. 26,910,371 27,690,597
----------- -----------
$32,021,517 $34,228,976
=========== ===========
See accompanying notes.
F-2
27
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------------
1995 1996 1997
----------- ----------- -----------
Revenues:
Initial license fees (including $2,518,700,
$2,289,300 and $1,765,000 from affiliates in
1995, 1996 and 1997, respectively)........... $ 6,299,230 $ 8,593,220 $ 8,758,364
Annual renewal license and support fees
(including $461,500, $476,500 and $888,700
from affiliates in 1995, 1996 and 1997,
respectively)................................ 1,942,353 2,420,780 4,622,810
Services and other (including $934,700,
$1,456,000 and $1,117,300 from affiliates in
1995, 1996 and 1997 respectively)............ 2,270,460 4,305,294 6,359,135
----------- ----------- -----------
Total revenues.................................... 10,512,043 15,319,294 19,740,309
Cost of revenues:
Initial license fees............................ 350,860 695,750 677,324
Annual renewal license and support fees......... 369,732 496,871 750,069
Services and other.............................. 423,888 1,092,219 3,096,362
----------- ----------- -----------
Total cost of revenues............................ 1,144,480 2,284,840 4,523,755
----------- ----------- -----------
Gross profit...................................... 9,367,563 13,034,454 15,216,554
Operating expenses:
Research and development........................ 1,747,194 2,336,252 3,321,397
Selling and marketing (including $167,200,
$180,600 and $121,000 to affiliates in 1995,
1996 and 1997, respectively)................. 4,415,158 7,359,336 9,088,486
General and administrative...................... 1,519,865 1,673,928 2,864,868
----------- ----------- -----------
Total operating expenses.......................... 7,682,217 11,369,516 15,274,751
----------- ----------- -----------
Income (loss) from operations..................... 1,685,346 1,664,938 (58,197)
Interest income (expense), net.................... 5,079 317,508 1,127,075
----------- ----------- -----------
Income before provision for income taxes.......... 1,690,425 1,982,446 1,068,878
Provision for income taxes........................ 638,400 621,500 231,200
----------- ----------- -----------
Net income........................................ 1,052,025 1,360,946 $ 837,678
=========== =========== ===========
Net income per share -- basic..................... $ 0.15 $ 0.16 $ 0.08
=========== =========== ===========
Weighted average shares used in basic
calculation..................................... 7,259,210 8,525,172 10,743,352
=========== =========== ===========
Net income per share -- diluted................... $ 0.12 $ 0.14 $ 0.08
=========== =========== ===========
Weighted average shares used in diluted
calculation..................................... 8,562,515 9,614,682 11,012,635
See accompanying notes.
F-3
28
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF REDEEMABLE
PREFERRED STOCK AND STOCKHOLDERS' EQUITY
STOCKHOLDERS' EQUITY
--------------------------------------------------------
SERIES A REDEEMABLE
PREFERRED STOCK COMMON STOCK TREASURY STOCK ADDITIONAL
------------------------ -------------------- ------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT SHARE AMOUNT CAPITAL
---------- ----------- ---------- ------- ------- --------- -----------
Balance at December 31, 1993........ 6,000,000 $ 584,750 3,000 $ 3 $ -- $ -- $ 45,593
Accretion on Series A Redeemable
Preferred Stock.................... -- 333,000 -- -- -- -- --
Net income.......................... -- -- -- -- -- -- --
---------- ----------- ---------- ------- ------- --------- -----------
Balance at December 31, 1994........ 6,000,000 917,750 3,000 3 -- -- 45,593
Issuance of common stock upon
exercise of options................ -- -- 1,308,423 1,308 -- -- 64,957
Accretion on Series A Redeemable
Preferred Stock.................... -- 333,000 -- -- -- -- --
Net income.......................... -- -- -- -- -- -- --
---------- ----------- ---------- ------- ------- --------- -----------
Balance at December 31, 1995........ 6,000,000 1,250,750 1,311,423 1,311 -- -- 110,550
Issuance of common stock upon
initial public offering............ -- -- 2,182,500 2,183 -- -- 23,331,329
Issuance of common stock upon
exercise of options................ -- -- 88,245 88 -- -- 6,964
Accretion on Series A Redeemable.... -- 249,750 -- -- -- -- --
Preferred Stock Deferred
compensation....................... -- -- -- -- -- -- 440,000
Amortization of deferred
compensation....................... -- -- -- -- -- -- --
Redemption of Series A Redeemable
Preferred Stock.................... (6,000,000) (1,500,500) 7,140,000 7,140 -- -- 1,493,360
Unrealized gain on short-term
investments........................ -- -- -- -- -- -- --
Net income.......................... -- -- -- -- -- -- --
---------- ----------- ---------- ------- ------- --------- -----------
Balance at December 31, 1996........ -- -- 10,722,168 10,722 25,382,203
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....................... -- -- -- -- -- -- --
Unrealized gain on short-term
investments........................ -- -- -- -- -- -- --
Net income.......................... -- -- -- -- -- -- --
---------- ----------- ---------- ------- ------- --------- -----------
Balance at December 31, 1997........ -- -- 10,803,369 $10,803 60,072 $(240,515) $25,398,897
========== =========== ========== ======= ======= ========= ===========
STOCKHOLDERS' EQUITY
-----------------------------------------------------
UNREALIZED
GAIN ON RETAINED
DEFERRED SHORT-TERM EARNINGS
COMPENSATION INVESTMENT (DEFICIT) TOTAL
------------ ----------- ---------- -----------
Balance at December 31, 1993........ $ -- $ -- $ (353,299) $ (307,703)
Accretion on Series A Redeemable
Preferred Stock.................... -- -- (333,000) (333,000)
Net income.......................... -- -- 711,775 711,775
--------- ------- ---------- -----------
Balance at December 31, 1994........ -- -- 25,476 71,072
Issuance of common stock upon
exercise of options................ -- -- -- 66,265
Accretion on Series A Redeemable
Preferred Stock.................... -- -- (333,000) (333,000)
Net income.......................... -- -- 1,052,025 1,052,025
--------- ------- ---------- -----------
Balance at December 31, 1995........ -- -- 744,501 856,362
Issuance of common stock upon
initial public offering............ -- -- -- 23,333,512
Issuance of common stock upon
exercise of options................ -- -- -- 7,052
Accretion on Series A Redeemable.... -- -- (249,750) (249,750)
Preferred Stock Deferred
compensation....................... (440,000) -- -- --
Amortization of deferred
compensation....................... 88,527 -- -- 88,527
Redemption of Series A Redeemable
Preferred Stock.................... -- -- -- 1,500,500
Unrealized gain on short-term
investments........................ -- 13,222 -- 13,222
Net income.......................... -- -- 1,360,946 1,360,946
--------- ------- ---------- -----------
Balance at December 31, 1996........ (351,473) 13,222 1,855,697 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 -- -- 110,004
Unrealized gain on short-term
investments........................ -- 56,284 -- 56,284
Net income.......................... -- -- 837,678 837,678
--------- ------- ---------- -----------
Balance at December 31, 1997........ $(241,169) $69,506 $2,693,375 $27,690,597
========= ======= ========== ===========
See accompanying notes.
F-4
29
DOCUMENT SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
---------- ------------ ------------
OPERATING ACTIVITIES
Net income....................................... $1,052,025 $ 1,360,946 $ 837,678
Adjustments to reconcile net income to net cash
provided used in operating activities
Depreciation and amortization.................. 141,685 254,373 455,663
Amortization of goodwill....................... -- -- 46,749
Loss on disposal of fixed assets............... -- 313 --
Amortization of computer software costs........ 136,068 104,066 91,340
Amortization of deferred compensation.......... -- 88,527 110,004
Current income tax expense payable to
affiliates.................................. 591,400 (1,071,100) 76,443
Deferred income taxes.......................... 47,000 (92,000) 99,200
Provision for doubtful accounts................ 9,344 204,155 432,451
Changes in operating assets and liabilities, net
of effects of acquired business
Accounts receivable............................ (920,885) (1,073,212) (2,677,245)
Work in process on development contracts....... -- -- (288,932)
Other current assets........................... (23,258) (68,071) (47,584)
Accounts payable............................... 209,087 370,102 (25,054)
Accrued liabilities............................ (508,671) 714,137 (152,963)
Deferred revenue............................... 515,250 880,758 404,780
---------- ------------ ------------
Net cash provided by (used in) operating
activities..................................... 1,249,045 1,672,994 (637,470)
INVESTING ACTIVITIES
Purchases of short term investments.............. -- (23,129,663) (16,905,885)
Sales of short-term investments.................. -- -- 19,220,812
Maturities of short-term investments............. -- -- 2,599,431
Purchases of property and equipment, net......... (297,964) (526,895) (1,593,389)
Cash paid for acquired business.................. -- -- (507,000)
Proceeds from disposal of assets................. -- 8,000 --
Additions to computer software costs............. (290,980) (104,236) (831,317)
---------- ------------ ------------
Net cash provided by (used in) investing
activities..................................... (588,944) (23,752,794) 1,982,652
FINANCING ACTIVITIES
Principal payments under capital lease
obligations.................................... (39,080) (66,190) (60,835)
Purchase of treasury stock....................... -- -- (285,000)
Sale of treasury stock........................... -- -- 44,485
Proceeds from issuance of common stock........... 66,265 23,340,564 16,775
---------- ------------ ------------
Net cash provided by (used in) financing
activities..................................... 27,185 23,274,374 (284,575)
---------- ------------ ------------
Increase in cash and cash equivalents............ 687,286 1,194,574 1,060,607
Cash and cash equivalents at beginning of year... 583,834 1,271,120 2,465,694
---------- ------------ ------------
Cash and cash equivalents at end of year......... $1,271,120 $ 2,465,694 $ 3,526,301
========== ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid.................................... $ 12,283 $ 29,430 $ 17,777
========== ============ ============
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Capital lease obligations entered into for
property and equipment......................... $ 130,941 $ 101,769 $ --
========== ============ ============
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 (the "Company") was incorporated on October
18, 1991 in Delaware as a subsidiary of Xerox Corporation ("Xerox"). The Company
develops, markets and supports a family of document automation software products
and services used in high volume electronic publishing applications. Autograph,
the Company's document automation software architecture, enables personalized
publishing solutions for many industries including insurance, managed
healthcare, financial services, telecommunications, government agencies and
commercial print service bureaus.
The Company currently derives substantially all of its license revenues
from licenses of CompuSet, Autograph's flagship product, and related products
and from fees for services related to the CompuSet software. The Company's
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 the Company will continue to be successful in developing and
marketing CompuSet products and related services.
The Company currently has 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. The failure by the Company to maintain these
relationships with Xerox and its affiliates could have a material adverse effect
on the Company's financial statements.
BASIS OF PRESENTATION
In 1994, the Company established a wholly-owned subsidiary, Document
Sciences Europe, in Sophia Antipolis, France in order to market and support its
products to the European community. The accompanying consolidated financial
statements include the accounts of the Company and its subsidiary. 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 the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
FOREIGN OPERATIONS
The functional currency of the Company's France subsidiary is the French
Franc. The balance sheet accounts of the subsidiary are translated into United
States 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. Net realized translation adjustments were insignificant in
1995, 1996 and 1997. Foreign currency transaction gains and losses are included
in the consolidated statements of income and were not material during the years
ended December 31, 1995, 1996 and 1997.
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. The Company
F-6
31
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
evaluates the financial strength of institutions at which significant
investments are made and believes the related credit risk is limited to an
acceptable level.
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity
Securities, and classifies its 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
The Company sells its products primarily to large, multinational customers
in the United States, Europe, Canada and Australia. The Company derived 42%, 34%
and 28% of its total revenues from customers outside the United States for the
years ended December 31, 1995, 1996 and 1997, respectively. A significant
concentration of the Company's customers are in the insurance and commercial
print service industries. No customer has accounted for 10% or more of the
Company's revenue in any one year.
Credit is extended based on an evaluation of the customer's financial
condition and a cash deposit is generally not required. The Company estimates
its potential losses on trade receivables on an ongoing basis and provides for
anticipated losses in the period in which the revenues are recognized. Credit
losses have historically been minimal and have been within management's
expectations.
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, the Company
records 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 assets' 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 software costs 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 (generally five years). 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 the results of operations in future periods.
DEPRECIATION AND AMORTIZATION
Depreciation is provided on a straight-line method over the estimated
useful lives of the assets (generally five years). Amortization of leasehold
improvements is provided over the lesser of the remaining lease term or the
estimated useful life of the improvements.
F-7
32
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REVENUE RECOGNITION
The Company recognizes revenue in accordance with AICPA Statement of
Position on Software Revenue Recognition No. 91-1. Initial license fee revenue
is recognized upon shipment of the product to customers if no significant
Company obligations remain and collection of the receivable is deemed probable.
The portion of the initial license fee revenue which represents the software
support for the first year is deferred and recognized ratably over the contract
period. In subsequent years, customers pay annual license fees for continued use
and support of licensed software. Annual renewal license and support fees
revenue is deferred and 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 and training services are recognized as the related
services are performed.
COMPUTATION OF NET INCOME PER SHARE
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, Earnings per Share, which supersedes Accounting Principles Board Opinion
No. 15. SFAS No. 128 replaces the presentation of primary earnings per share
(EPS) with "Basic EPS" which 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. SFAS No.
128 is effective for financial statements issued for periods ending after
December 15, 1997. On February 3, 1998, the SEC issued Staff Accounting Bulletin
(SAB) No. 98, which revised the previous instructions for determining the
dilutive effects in earnings per share computations of common stock and common
stock equivalents issued at prices below the IPO price prior to the
effectiveness of the IPO. The Company has calculated its net income per share in
accordance with both SFAS No. 128 and SAB No. 48.
The difference between weighted average shares used in determining Basic
EPS versus Diluted EPS relates to dilutive common stock options totaling
434,435, 108,015, and 269,288 shares in 1995, 1996, and 1997, respectively.
389,430 and 248,182 common stock options were excluded from the calculation of
weighted average shares used in determining Diluted EPS for 1996 and 1997,
respectively, as their effect would have been antidilutive. None were excluded
for the 1995 calculation.
STOCK OPTIONS
As permitted by SFAS No. 123, the Company has elected to follow APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related Interpretations in
accounting for its employee stock options. Under APB 25, when the exercise price
of the Company's employee stock options is not less than the market price of the
underling stock on the date of grant, no compensation expense is recognized.
INCOME TAXES
The Company follows the liability method of accounting for income taxes, as
set forth in SFAS No. 109. Through September 19, 1996, the Company was included
in the consolidated tax returns of Xerox, and the Company's share of Xerox's
consolidated income tax liability was determined on a separate company basis
computed under Internal Revenue Code guidelines. Subsequent to the Company's
initial public offering on September 19, 1996, the Company has no longer been
included in the consolidated tax returns of Xerox and is filing separate tax
returns.
NEW ACCOUNTING PRONOUNCEMENTS
The American Institute of Certified Public Accountants Statement of
Position, Software Revenue Recognition (SOP 97-2) provides guidance for
recognizing revenue related to sales by software vendors. SOP
F-8
33
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
97-2 will be effective for the Company beginning in the first quarter of 1998.
The Company does not believe the adoption of SOP 97-2 will have a significant
impact on its revenue recognition policy.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
Reporting Comprehensive Income and No. 131, Disclosures About Segments of an
Enterprise and Related Information. SFAS No. 130 establishes rules for reporting
and displaying comprehensive income. SFAS No. 131 will require the Company to
use the "management approach" in disclosing segment information. Both statements
are effective for the Company during 1998. The Company does not believe that the
adoption of either SFAS No. 130 or SFAS No. 131 will have a material impact on
the Company's results of operations, cash flows, or financial position.
RECLASSIFICATIONS
Certain reclassifications, none of which affect net income, have been made
to prior year's amounts in order to conform to the current year's presentation.
2. ACQUISITION
In 1997, the Company acquired certain assets and liabilities of Data
Retrieval Corporation of America (Data Retrieval) for cash consideration of
$507,000. The acquisition has been accounted for as a purchase, and accordingly,
the total purchase price has been allocated to the assets acquired and
liabilities assumed at their estimated fair values in accordance with the
provisions of Accounting Principles Board Opinion No. 16. The estimated excess
of the purchase price over the net assets acquired of $1,052,000 is being
carried as intangible assets, and will be amortized over an estimated life of 15
years. The Company's consolidated financial statements included the results of
Data Retrieval from May 7, 1997.
A summary of the Data Retrieval acquisition costs and an allocation of the
purchase price to the assets acquired and liabilities assumed is as follows:
Total acquisition cost:
Cash paid................................................. $ 507,000
----------
Allocated as follows:
Current assets............................................ $ 135,000
Equipment and capitalized software........................ 232,000
Acquired intangibles...................................... 1,052,000
Liabilities assumed....................................... (912,000)
----------
$ 507,000
==========
Assuming that the acquisition of Data Retrieval Corporation of America had
occurred on the first day of the Company's fiscal year-ended December 31, 1996
and 1997, pro forma condensed consolidated results of operations would be as
follows:
PRO FORMA RESULTS OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31,
--------------------------
1996 1997
----------- -----------
Net sales................................................... $17,730,000 $21,005,000
Net income.................................................. $ 140,700 $ 590,000
Net income per share........................................ $ .01 $ .05
F-9
34
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. FINANCIAL STATEMENT INFORMATION
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and consist of the following at
December 31:
1996 1997
---------- ----------
Computer equipment........................................ $ 929,241 $1,632,403
Office furniture and fixtures............................. 236,573 741,618
Office equipment.......................................... 168,432 223,984
Leasehold improvements.................................... 168,246 497,877
---------- ----------
1,502,492 3,095,882
Less accumulated depreciation and amortization............ (504,289) (959,952)
---------- ----------
$ 998,203 $2,135,930
========== ==========
Equipment acquired under capital leases totaled $145,112, $192,611 and
$140,519 (net of accumulated depreciation of $35,085, $75,161 and $141,866) at
December 31, 1995, 1996 and 1997, respectively.
INVESTMENTS
The Company has classified all of its marketable securities as
available-for-sale securities. The following table summarizes available-for-sale
securities at December 31, 1996 and 1997:
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
DECEMBER 31, 1996 COST GAINS LOSSES FAIR VALUE
- ------------------------------------- ----------- ---------- ---------- -----------
U.S. treasury securities............. $ 3,513,585 $ -- $ 8,305 $ 3,505,280
U.S. government agency obligations... 2,969,622 1,271 772 2,970,121
Obligations of states, territories
and political subdivisions......... 14,600,365 37,440 15,491 14,622,314
U.S. corporate securities............ 1,544,517 311 1,232 1,543,596
U.S. corporate commercial paper...... 501,574 -- -- 501,574
$23,129,663 $39,022 $25,800 $23,142,885
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
DECEMBER 31, 1996 COST GAINS LOSSES FAIR VALUE
- ------------------------------------- ----------- ---------- ---------- -----------
U.S. treasury securities............. $ 1,515,289 $ 1,750 $ -- $ 1,517,039
U.S. government agency obligations... 2,526,628 1,943 -- 2,528,571
Obligations of states, territories
and political subdivisions......... 10,339,124 64,932 -- 10,404,056
U.S. corporate securities............ 2,299,540 881 -- 2,300,421
U.S. corporate commercial paper...... 1,478,440 -- -- 1,478,440
$18,159,021 $69,506 $ -- $18,228,527
F-10
35
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated fair value of available-for-sale
securities at December 31, 1997, by contractual maturity, are shown below:
ESTIMATED
COST FAIR VALUE
----------- -----------
Due in one year or less................................. $ 2,505,480 $ 2,505,484
Due after one year through five years................... 15,653,539 15,723,043
----------- -----------
$18,159,019 $18,228,527
=========== ===========
4. DOMESTIC AND FOREIGN OPERATIONS
The table below summarizes the Company's domestic operations and those of
its subsidiary, Document Sciences Europe.
UNITED STATES FRANCE ELIMINATIONS TOTAL
------------- ---------- ------------ -----------
YEAR ENDED DECEMBER 31, 1995
Sales to unaffiliated customers...... $ 5,350,838 $1,246,305 $ -- $ 6,597,143
Sales to affiliates.................. 1,929,300 1,985,600 -- 3,914,900
Transfers between geographic areas... 1,528,352 -- (1,528,352) --
----------- ---------- ----------- -----------
Revenues............................. $ 8,808,490 $3,231,905 $(1,528,352) $10,512,043
=========== ========== =========== ===========
Operating income (loss).............. $ 1,691,074 $ (5,728) $ -- $ 1,685,346
=========== ========== =========== ===========
Identifiable assets.................. $ 4,748,787 $1,557,161 $ (16,666) $ 6,289,282
=========== ========== =========== ===========
YEAR ENDED DECEMBER 31, 1996
Sales to unaffiliated customers...... $10,165,741 $ 931,753 $ -- $11,097,494
Sales to affiliates.................. 3,919,970 301,830 -- 4,221,800
Transfers between geographic areas... 254,611 999,738 (1,254,349) --
----------- ---------- ----------- -----------
Revenues............................. $14,340,322 $2,233,321 $(1,254,349) $15,319,294
=========== ========== =========== ===========
Operating income..................... $ 1,167,424 $ 497,514 $ -- $ 1,664,938
=========== ========== =========== ===========
Identifiable assets.................. $31,335,821 $ 702,362 $ (16,666) $32,021,517
=========== ========== =========== ===========
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
Transfers between geographic areas... 3,182,658 -- (3,182,658) --
----------- ---------- ----------- -----------
Revenues............................. $18,477,683 $4,445,284 $(3,182,658) $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
=========== ========== =========== ===========
The Company uses affiliated distributors to sell its products in Canada,
Australia and New Zealand (See Note 9).
F-11
36
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. LEASES
The Company leases its corporate office in San Diego, California under an
operating lease which expires in 2000. Under the terms of the lease, effective
February 1, 1997, monthly rental payments will be increased annually by 4%. The
lease provides the Company with an option to extend the lease term for an
additional three years at the base rent in effect for the last year of the
initial lease term. In addition, the Company may exercise a one-time
cancellation option effective any time after January 31, 1998 with the payment
of certain penalties. The Company also leases certain equipment under capital
leases. Annual future minimum lease payments are as follows:
OPERATING CAPITAL
YEARS ENDING DECEMBER 31, LEASES LEASES
- ------------------------- ---------- --------
1998....................................................... $ 503,130 $ 75,667
1999....................................................... 494,707 43,527
2000....................................................... 528,476 12,346
2001....................................................... 563,770 2,058
2002....................................................... 153,092 --
---------- --------
$2,243,175 133,598
==========
Less amount representing interest.......................... (16,254)
--------
Present value of net minimum lease payments................ 117,344
Less current portion....................................... (65,108)
--------
Long-term portion of capital lease obligations............. $ 52,236
========
Rent expense for the years ended December 31, 1995, 1996 and 1997 was
$255,599, $292,098 and $522,694, respectively.
6. SERIES A REDEEMABLE PREFERRED STOCK
Each share of Series A Redeemable Preferred Stock was converted into 1.19
shares of Common Stock upon the Company's initial public offering.
7. STOCKHOLDERS' EQUITY
STOCK SPLIT
On June 19, 1996, the Company's Board of Directors authorized a 3 for 1
stock split for all outstanding Common Stock and Series A Redeemable Preferred
Stock, which received stockholder approval and became effective on September 19,
1996. All share and per share amounts in the accompanying consolidated financial
statements have been retroactively restated to reflect the stock split. Upon
completion of the public offering on September 19, 1996, the authorized capital
stock of the Company consisted of 30,000,000 shares of Common Stock and
2,000,000 shares of Preferred Stock.
STOCK INCENTIVE PLANS
The Company's Stock Incentive Plans (the "Plans") provide for the issuance
of incentive and nonstatutory options to purchase Common Shares to eligible
employees, officers, directors of, and consultants to the Company. The Company's
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 include 29,250 shares
F-12
37
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
previously reserved for issuance under the 1993 Plan. The 1995 Plan replaces the
1993 Plan. All outstanding options under the 1993 Plan remain exercisable in
accordance with their original terms. Terms of the 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
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 as of December 31, 1994........... 1,440,750 $ .03 - $ .17 $ .05
Granted................................. 232,575 $ .17 $ .17
Exercised............................... (1,308,423) $ .03 - $ .17 $ .05
Canceled................................ (3,000) $ .17 $ .17
----------
Balance at December 31, 1995.............. 361,902 $ .03 - $ .17 $ .09
Granted................................. 233,538 $ .67 - $15.00 $6.51
Exercised............................... (88,245) $ .03 - $ .17 $ .08
Canceled................................ (9,750) $ .17 - $ 8.50 $ .50
----------
Balance at December 31, 1996.............. 497,445 $ .03 - $15.00 $3.13
Granted................................. 158,850 $3.19 - $ 5.44 $3.94
Exercised............................... (81,201) $ .03 - $ .67 $ .24
Canceled................................ (57,624) $ .03 - $15.00 $4.18
----------
Balance at December 31, 1997.............. 517,470 $ .03 - $15.00 $3.57
==========
As of December 31, 1997, 130,923 of the options were vested and exercisable
and 394,849 were available for future grant. Following is a breakdown of the
options outstanding as of December 31, 1997:
WEIGHTED WEIGHTED WEIGHTED AVERAGE
RANGE OF AVERAGE AVERAGE EXERCISE PRICE
EXERCISE OPTIONS REMAINING EXERCISE OPTIONS OF OPTIONS
PRICES OUTSTANDING LIFE IN YEARS PRICE EXERCISABLE EXERCISABLE
-------- ----------- ------------- -------- ----------- ----------------
$ .03 - $ 3.00 246,963 $5.77 $ 0.28 174,373 $ 0.23
$ 4.00 - $ 9.00 156,150 $9.39 $ 4.07 1,668 $ 8.50
$10.00 - $15.00 114,357 $9.51 $10.48 40,406 $10.41
------- ----- ------ ------- ------
517,470 $7.70 $ 3.68 216,447 $ 2.19
======= ===== ====== ======= ======
In 1996, the Company recorded $440,000 of deferred compensation for options
granted to employees 12 months prior to the initial public offering, which took
place September 19, 1996. The amount recorded represents the difference between
the option grant price and the deemed fair market value of the related shares.
The Company is amortizing such amount ratably over the vesting period of the
options, generally 48 months.
Adjusted pro forma information regarding net income is required by SFAS
123, and has been determined as if the Company had accounted for its employee
stock options under the fair value method of that Statement. For options granted
in the year ended December 31, 1995 and the period ended September 19,
F-13
38
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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%; a
weighted-average expected life of the option of four to seven years. For options
granted from September 19, 1996 to December 31, 1997, 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 .7 to 1.432;
and 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 options' vesting period. The effect
of applying SFAS 123 for purposes of providing pro forma disclosures is not
likely to be representative of the effects on reported net income for future
years because changes in the subjective input assumptions can materially affect
future value estimates. The Company's pro forma information is as follows:
YEARS ENDED DECEMBER 31,
------------------------
1996 1997
----------- ---------
Adjusted pro forma net income.............................. $1,379,289 $592,538
Adjusted pro forma net income per share.................... $ 0.15 $ .05
8. INCOME TAXES
For financial reporting purposes income before income taxes includes the
following components:
1995 1996 1997
---------- ---------- ----------
United States................................ $1,696,153 $1,484,932 $ 778,573
Foreign...................................... (5,728) 497,514 290,305
---------- ---------- ----------
$1,690,425 $1,982,446 $1,068,878
========== ========== ==========
The provision for income taxes is as follows:
YEARS ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- -------- --------
Current:
Federal.......................................... $469,700 $482,000 $ 3,500
State.......................................... 121,700 119,300 19,900
Foreign........................................ -- 112,200 108,600
-------- -------- --------
591,400 713,500 132,000
Deferred (credit):
Federal........................................ 39,500 (85,300) 122,100
State.......................................... 7,500 (6,700) (22,900)
Foreign........................................ -- -- --
-------- -------- --------
47,000 (92,000) 99,200
-------- -------- --------
$638,400 $621,500 $231,200
======== ======== ========
F-14
39
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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,
-----------------------------------
1995 1996 1997
--------- --------- ---------
Deferred tax liability -- computer software
costs....................................... $(157,000) $(156,500) $(411,500)
Deferred tax assets:
Foreign operating loss carryforwards........ 136,065 -- --
Accrued vacation............................ 75,000 100,000 125,100
Provision for doubtful accounts............. 4,200 29,000 76,600
Research and development credits............ -- -- 118,000
State taxes................................. -- 41,700 6,800
--------- --------- ---------
Total deferred tax assets..................... 215,265 170,700 326,500
Valuation allowance........................... (136,065) -- --
--------- --------- ---------
Net deferred tax assets....................... 79,200 170,700 326,500
--------- --------- ---------
Net deferred tax asset (liability)............ $ (77,800) $ 14,200 $ (85,000)
========= ========= =========
In 1995, a valuation allowance was recognized to offset deferred tax assets
attributed to foreign operating loss carryforwards. In 1996, the Company
realized the benefit of the foreign operating loss carryforwards and reduced the
valuation allowance.
As of December 31, 1997, the Company has Federal and California research
and development tax credit carryforwards of approximately $83,000 and $50,000,
respectively, which will begin to expire in 2012 unless previously utilized.
The differences between the Company's income tax provision and the amounts
computed by applying the statutory federal income tax rate of 35% in 1995, 1996
and 1997 to income before income taxes are as follows:
YEARS ENDED DECEMBER 31,
-----------------------------------
1995 1996 1997
--------- --------- ---------
Provision at statutory rate................... $ 591,649 $ 693,856 $ 374,107
Benefit for graduated rates................... (16,904) (19,824) (10,689)
State income taxes, net of federal benefit.... 83,980 73,190 (1,950)
Increase (decrease) in valuation allowance.... 2,005 (136,095) --
Benefit of research credits................... (57,547) (71,665) (118,004)
Permanent differences and other .............. 35,217 82,038 (12,264)
--------- --------- ---------
Provision for income taxes.................... $ 638,400 $ 621,500 $ 231,200
========= ========= =========
9. TRANSACTIONS WITH AFFILIATES
The Company has a strategic marketing alliance with Xerox under which the
parties have agreed to pay each other fees on referrals that lead to the
successful sale or licensing of each other's products. Included in services and
other revenues in the accompanying statements of income are commissions earned
from Xerox totaling $752,000, $1,352,000 and $859,000 in 1995, 1996 and 1997,
respectively. Commissions related to referrals from Xerox are included in
selling and marketing expense in the accompanying statements of income and
totaled $167,000, $181,000 and $121,000 in 1995, 1996 and 1997, respectively.
F-15
40
DOCUMENT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has distribution agreements with affiliates which provide the
affiliates with the non-exclusive right to sub-license the Company's software in
Australia, New Zealand and Canada. The terms of the distributor agreements
provide that the affiliates receive a discount from the list price of the
Company's products licensed, including maintenance and support. Revenues from
the affiliates under these agreements, net of discounts, were $1,088,000,
$819,000 and $1,012,000 in 1995, 1996 and 1997, respectively. Included in
accounts receivable are $193,500, $385,300 and $333,900 from these revenues at
December 31, 1995, 1996 and 1997, respectively.
The Company has distribution agreements with affiliates which provide the
affiliates the non-exclusive right to sub-license the Company's software in
Europe. Revenues under these agreements totaled $1,986,000, $2,051,000 and
$1,900,000 in 1995, 1996 and 1997, respectively. Related accounts receivable are
$482,900, $646,500 and $414,500 at December 31, 1995, 1996 and 1997,
respectively.
10. EMPLOYEE RETIREMENT PLAN
401(K) PLAN
The Company has an employee savings and retirement plan (the "401(k) Plan")
that is intended to be tax-qualified covering substantially all of the Company's
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. The Company may, in its discretion,
match employee contributions, at such rate as it determines, up to a maximum of
$3,000 or 10% of the employee's compensation. The 401(k) Plan has a profit
sharing element whereby the Company 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.
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, 1994
Allowance for doubtful accounts and
returns.............................. $ 10,000 $ 3,613 $ -- $ 13,613
Year Ended December 31, 1995
Allowance for doubtful accounts and
returns.............................. $ 13,613 $ 9,344 $ -- $ 22,957
Year Ended December 31, 1996
Allowance for doubtful accounts and
returns.............................. $ 22,957 $ 204,155 $ -- $ 227,112
Year Ended December 31, 1997
Allowance for doubtful accounts and
returns.............................. $ 227,112 $ 432,451 $ 441,285 $ 218,278
S-1
42
DOCUMENT SCIENCES CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 1997
INDEX TO EXHIBITS
SEQUENTIAL
EXHIBIT PAGE
NUMBER EXHIBIT DESCRIPTION NUMBER
- ---------- ------------------- ----------
3.1(1) Restated Certificate of Incorporation of the Company filed
May 1, 1992.
3.2(1) Form of Amended and Restated Certificate of Incorporation of
the Company.
3.3(1) Amended and Restated Bylaws of the Company.
3.4(1) Form of Certificate of Amendment of Certificate of
Incorporation of the Company.
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2(1) Specimen Stock Certificate.
10.1(1,3) Form of Indemnity Agreement Between the Company and each of
its Officers and Directors.
10.2(1,3) 1993 Stock Option Plan and Form of Agreement.
10.3(3) 1995 Stock Incentive Plan and Form of Agreement, as amended.
10.4(1,3) Stockholder Rights Agreement dated September 1996 Between
the Company and Xerox
10.5(1) Corporation. Tax Sharing Agreement dated August 1996 Between
the Company and Xerox Corporation.
10.6(1) Transfer and License Agreement dated July 1, 1992, as
amended in September 1994,
10.7(1) Between the Company and Xerox Corporation. Strategic
Marketing Alliance Agreement dated September 1, 1993,
Between the Company and
10.8(1) Xerox Corporation. Value Added Remarketer Agreement Between
Xerox Canada Limited and the Company .
10.9(1) Value Added Reseller Agreement Between N.V. Rank Xerox S.A.
and the Company.
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 Company's Principal Facilities, as amended and
Assignment of Lease.
10.15(1,3) Letter Agreement Between Tony Domit and the Company.
10.16(1,3) Letter Agreement Between Thomas Anthony and the Company.
10.17(1,3) Letter Agreement Between Judith A. O'Reilly and the Company.
10.18(1,3) Letter Agreement Between Daniel Fregeau and the Company.
10.19(1,3) Letter Agreement Between Alfred G. Altomare and the Company.
10.20(1) Value Added Reseller Agreement Between Geneva Digital Ltd.
and the Company.
10.21(1) Value Added Remarketer Agreement Between Business and
Business and the Company.
10.22(1,2) 1997 Employee Stock Purchase Plan.
10.23 Tony N. Domit Agreement.
10.24 Xerox Cooperative Marketing Agreement.
10.25 Xerox Canada Cooperative Marketing and Customer Support
Agreement.
21.1(1) List of Subsidiaries.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney. (included on page 22)
27 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 Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1996.
(3) Indicates management compensatory plan, contract or arrangement.