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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarter Ended September 30, 2003 Commission file number 0-6355
Group 1 Software, Inc.
Incorporated in Delaware IRS EI No. 52-0852578
4200 Parliament Place, Suite 600, Lanham, MD 20706-1860
Telephone Number: (301) 918-0400
Indicate by check mark whether the registrant (1) has filed 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 |_|
Shares Outstanding Effective
Class November 7, 2003
Common Stock, $.50 par value 15,143,168
GROUP 1 SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
September 30, March 31,
2003 2003
------------- ---------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 40,967 $ 56,475
Short-term investments, available-for-sale 16,942 7,712
Trade and installment accounts receivable, less
allowance of $1,471 and $1,755 17,873 18,834
Note receivable 7,000 --
Deferred income taxes 1,721 2,130
Prepaid expenses and other current assets 4,655 4,067
--------- ---------
Total current assets 89,158 89,218
Installment accounts receivable, long-term 20 39
Property and equipment, net 4,902 4,707
Computer software, net 23,519 23,490
Goodwill 12,726 12,716
Other assets 218 206
--------- ---------
Total assets $ 130,543 $ 130,376
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,288 $ 1,358
Current portion of note payable 318 371
Accrued expenses 6,529 7,033
Accrued compensation 5,730 9,454
Current deferred revenues 27,596 31,241
--------- ---------
Total current liabilities 41,461 49,457
Note payable, net of current portion 350 350
Deferred revenues, long-term 1,638 315
Deferred income taxes 4,309 4,694
--------- ---------
Total liabilities 47,758 54,816
--------- ---------
Commitments and contingencies
Stockholders' equity:
6% cumulative convertible preferred stock $0.25 par value;
1,200 shares authorized; none issued -- --
Common stock $0.50 par value; 200,000 and 50,000 shares
authorized; 15,068 and 14,902 shares issued 7,534 7,451
Additional paid in capital 36,491 34,951
Retained earnings 42,224 37,619
Accumulated other comprehensive income 1,181 184
Treasury stock, 1,246 shares, at cost (4,645) (4,645)
--------- ---------
Total stockholders' equity 82,785 75,560
--------- ---------
Total liabilities and stockholders' equity $ 130,543 $ 130,376
========= =========
See notes to consolidated financial statements.
2
GROUP 1 SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
For the Three Month Period Ended For the Six Month Period
September 30, Ended September 30,
-------------------------------- -------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Revenue:
Software license and related revenue $ 10,841 $ 11,329 $ 21,309 $ 21,206
Maintenance and services 14,392 13,691 28,180 27,193
-------- -------- -------- --------
Total revenue 25,233 25,020 49,489 48,399
-------- -------- -------- --------
Cost of revenue:
Software license expense 3,187 3,763 6,986 7,834
Maintenance and service expense 4,061 4,105 8,511 8,379
-------- -------- -------- --------
Total cost of revenue 7,248 7,868 15,497 16,213
-------- -------- -------- --------
Gross profit 17,985 17,152 33,992 32,186
-------- -------- -------- --------
Operating expenses:
Research and development, net (see note 6) 2,955 2,812 5,724 5,554
Sales and marketing 8,350 7,738 15,930 15,248
General and administrative 3,325 3,539 6,525 6,869
-------- -------- -------- --------
Total operating expenses 14,630 14,089 28,179 27,671
-------- -------- -------- --------
3,355 3,063 5,813 4,515
Income from operations
Other income:
Interest income 578 322 821 603
Interest expense (13) (61) (25) (192)
Other income (expense) (53) (146) 493 (191)
-------- -------- -------- --------
Total other income 512 115 1,289 220
-------- -------- -------- --------
Income before provision for income taxes 3,867 3,178 7,102 4,735
Provision for income taxes 1,315 1,207 2,497 1,791
-------- -------- -------- --------
Net income 2,552 1,971 4,605 2,944
Preferred stock dividend requirements -- (14) -- (28)
-------- -------- -------- --------
Net income available to common stockholders $ 2,552 $ 1,957 $ 4,605 $ 2,916
======== ======== ======== ========
Basic earnings per share $ 0.18 $ 0.15 $ 0.33 $ 0.23
======== ======== ======== ========
Diluted earnings per share $ 0.16 $ 0.14 $ 0.29 $ 0.21
======== ======== ======== ========
Basic weighted average shares outstanding 13,810 12,774 13,768 12,695
======== ======== ======== ========
Diluted weighted average shares outstanding 15,811 14,079 15,839 14,048
======== ======== ======== ========
See notes to consolidated financial statements.
3
GROUP 1 SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
For the Six Month Period
Ended September 30,
------------------------
2003 2002
-------- --------
Cash flows from operating activities:
Net income $ 4,605 $ 2,944
Adjustments to reconcile net income from operations to net cash provided by
operating activities:
Amortization expense 4,887 4,683
Depreciation expense 779 1,077
Provision for doubtful accounts (310) 375
Deferred income taxes 26 (61)
Net gain on sale of intellectual property and other property and
equipment (346) --
Tax benefit from exercises of stock options 673 312
Foreign currency transaction loss 47 192
Changes in assets and liabilities:
Accounts receivable 1,452 (1,546)
Prepaid expenses and other current assets (560) 14
Other assets (5) (7)
Deferred revenues (2,480) 79
Accounts payable (96) 351
Accrued expenses and accrued compensation (4,331) 2,314
-------- --------
Net cash provided by operating activities 4,341 10,727
-------- --------
Cash flows from investing activities:
Purchases and development of computer software (4,049) (3,705)
Purchases of property and equipment (1,442) (790)
Purchases of marketable securities (23,416) (9,209)
Sales of marketable securities 14,186 9,244
Proceeds from sale of intellectual property 375 --
Issuance of notes receivable (7,000) --
-------- --------
Net cash used in investing activities (21,346) (4,460)
-------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options 949 1,480
Repayment of principal on long-term debt (53) (3,102)
Dividends paid -- (28)
-------- --------
Net cash provided by (used in) financing activities 896 (1,650)
-------- --------
Net (decrease) increase in cash and cash equivalents (16,109) 4,617
Effect of exchange rate on cash and cash equivalents 601 710
Cash and cash equivalents at beginning of period 56,475 22,936
-------- --------
Cash and cash equivalents at end of period $ 40,967 $ 28,263
======== ========
Supplemental disclosure of non-cash investing and financing activities:
Mature shares tendered in payment for stock option exercises $ -- $ 26
See notes to consolidated financial statements.
4
GROUP 1 SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
For the Three Month Period For the Six Month Period Ended
Ended September 30, September 30,
-------------------------- ------------------------------
2003 2002 2003 2002
------ ------ ------ ------
Net income $2,552 $1,971 $4,605 $2,944
Foreign currency translation
adjustments 243 311 997 1,418
------ ------ ------ ------
Comprehensive income $2,795 $2,282 $5,602 $4,362
====== ====== ====== ======
See notes to consolidated financial statements.
5
Group 1 Software, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
1. The consolidated financial statements for the three months ended September
30, 2003 and 2002 are unaudited. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included and are of a
recurring nature in the normal course of business. Limited footnote information
is presented in accordance with quarterly reporting requirements. The results of
operations for the three months ended September 30, 2003 are not necessarily
indicative of the results for the year ending March 31, 2004. The information
contained in the annual report on the Form 10-K for the year ended March 31,
2003, should be referred to in connection with the unaudited interim financial
information.
2. On April 15, 2003, the Company entered into an agreement to acquire key
assets of Sagent Technology, Inc. ("Sagent") for up to $17 million, payable in
cash and debt forgiveness. Group 1 provided Sagent with $7 million in bridge
financing, secured by all of Sagent's assets. The purchase agreement was
approved by Group 1's and Sagent's board of directors. The transaction was
subject to approval by Sagent's shareholders and certain other closing
conditions. On July 31, 2003, Group 1 entered into an amendment to extend the
maturity date of the existing secured loans to September 30, 2003 and to
increase the borrowing limit under the agreement from $7 million to $9 million.
On October 1, 2003, with the approval of Sagent's shareholders, the Company
acquired key assets of Sagent in a business combination recorded using the
purchase method of accounting. In consideration for the purchase, Group 1 has
delivered $6,000,000 in cash, forgiven $7,000,000 in debt and will deliver
$4,000,000, less adjustments, in cash in accordance with the Asset Purchase
Agreement.
3. On December 10, 2002, under authorization of the Board of Directors the
Company moved to redeem all of the outstanding 6% cumulative convertible
preferred stock. On January 15, 2003, the holders of all 47,500 shares
outstanding elected to exchange their preferred shares for 142,500 common shares
in accordance with the conversion provision of the preferred stock.
4. On November 5, 2002, the Board of Directors declared a two-for-one common
stock split for stockholders of record as of November 15, 2002. There was no
change in the par value of the stock as a result of the split. The additional
shares were issued on December 2, 2002. The effect of the stock split has been
retroactively reflected in the consolidated financial statements for all periods
presented.
5. Certain prior period amounts have been reclassified to conform to current
period presentation.
6. Research and development costs, before the capitalization of computer
software development costs, were $4,591,000 and $4,675,000 for the three months
ended September 30, 2003 and 2002, respectively. Capitalization of computer
software development costs for the three months ended September 30, 2003 and
2002 were $1,636,000 and $1,863,000, respectively. Research and development
costs, before the capitalization of computer software development costs, were
$9,409,000 and $9,260,000 for the six months ended September 30, 2003 and 2002,
respectively. Capitalization of computer software development costs for the six
months ended September 30, 2003 and 2002 were $3,685,000 and $3,706,000,
respectively. Amortization expense related to developed and acquired software
costs was $1,933,000 and $2,100,000 in the three months ended September 30, 2003
and 2002, respectively and $4,477,000 and $4,196,000 in the six months ended
September 30, 2003 and 2002, respectively.
7. Earnings per share
Basic earnings per share (EPS) is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted EPS is computed using the weighted average number of
shares of common stock and dilutive common stock equivalents outstanding during
the period. Potentially dilutive common stock equivalents consist of convertible
preferred stock (computed using the if
6
converted method) and stock options and warrants (computed using the treasury
stock method). Potentially dilutive common stock equivalents are excluded from
the computation if the effect is anti-dilutive.
Reconciliation of the shares used in the basic EPS calculations to the shares
used in the diluted EPS calculation is as follows (in thousands):
For the Three Month Period For the Six Month Period
Ended September 30, Ended September 30,
-------------------------- ------------------------
2003 2002 2003 2002
------ ------ ------ ------
Weighted average common shares
outstanding-basic 13,810 12,774 13,768 12,695
Effect of dilutive securities:
Stock options and warrants 2,001 1,162 2,071 1,210
Convertible Securities -- 143 -- 143
------ ------ ------ ------
Weighted average shares outstanding-diluted
15,811 14,079 15,839 14,048
====== ====== ====== ======
There were 37,000 additional potentially dilutive common stock options or
warrants in the three months ended September 30, 2003. There were 1,000
additional potentially dilutive common stock options or warrants in the six
months ended September 20, 2003. There were 757,000 and 763,000 additional
potentially dilutive common stock options and warrants in the three and six
months ended September 30, 2002.
The Company accounts for its stock based compensation in accordance with the
provisions of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting
for Stock Issued to Employees" as interpreted by FASB Interpretation No. 44,
"Accounting for Certain Transactions Involving Stock Compensation, and
Interpretation of APB Opinion No. 25," (FIN 44) and present the pro forma
disclosures required by Statement of Financial Accounting Standard No. 123,
"Accounting for Stock Based Compensation" (SFAS 123) as amended by Statement of
Financial Accounting Standard No. 148, "Accounting for Stock Based Compensation
- - Transition and Disclosure" (SFAS 148).
The Company accounts for the activity under the Plans in accordance with APB 25.
Accordingly, no compensation expense has been recognized for the Plans. If
compensation expense had been determined based on the fair value of the options
at the grant dates consistent with the method of accounting under SFAS No. 123,
the Company's net income and earnings per share would have decreased or
increased to the pro forma amounts indicated below (in thousands, except per
share amounts):
Three months ended Six months ended
September 30, September 30, 2002
-------------------------- --------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net income available to common stockholders as reported $ 2,552 $ 1,971 $ 4,605 $ 2,944
Add: stock-based employee compensation expense
included in reported net income -- -- -- --
Deduct: total stock-based employee compensation
expense determined under fair value based method
for all awards (1,099) (791) (2,162) (1,631)
--------- --------- --------- ---------
Pro forma net income available to common
stockholders $ 1,453 $ 1,180 $ 2,443 $ 1,313
========= ========= ========= =========
Earnings per share
Basic, as reported $ 0.18 $ 0.15 $ 0.33 $ 0.23
========= ========= ========= =========
Basic, pro forma $ 0.11 $ 0.09 $ 0.18 $ 0.10
========= ========= ========= =========
Diluted, as reported $ 0.16 $ 0.14 $ 0.29 $ 0.21
========= ========= ========= =========
Diluted, pro forma $ 0.09 $ 0.08 $ 0.15 $ 0.09
========= ========= ========= =========
7
The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants during the three and six months ended September 30,
2003 and 2002, respectively: dividend yield of 0%, expected volatility of 87%
and 104%, a risk-free interest rate of 2.99% and 2.98% and an expected term of
4.03 years for both periods. For the six months ended September 30, 2003 and
2002, the following weighted-average assumptions were used: dividend yield of
0%, expected volatility of 87% and 104%, a risk-free interest rate of 2.63% and
4.04% and an expected term of 4.03 years.
8. Recent Accounting Pronouncements
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." EITF Issue
No. 00-21 provides guidance on how to account for arrangements that involve the
delivery or performance of multiple products, services and/or rights to use
assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
Company believes that the adoption of this standard will have no material impact
on its financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a liability
be recorded in the guarantor's balance sheet upon issuance of a guarantee. In
addition, FIN 45 requires disclosures about the guarantees that an entity has
issued, including a reconciliation of changes in the entity's product warranty
liabilities. The initial recognition and initial measurement provisions of FIN
45 are applicable on a prospective basis to guarantees issued or modified after
September 30, 2003. The adoption of this Statement did not have a material
impact on the Company's financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after September 15, 2003. The adoption of FIN 46 did
not have a material effect on the Company's financial position or results of
operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. The statement requires that contracts with comparable characteristics
be accounted for similarly and clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows. SFAS
No. 149 is effective for contracts entered into or modified after September 30,
2003, except in certain circumstances, and for hedging relationships designated
after September 30, 2003. The Company does not expect that the adoption of this
standard will have a material effect on its financial position or results of
operations.
8
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This Statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances) because that financial instrument embodies an obligation of the
issuer. This Statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after September 15, 2003, except for mandatorily
redeemable financial instruments of nonpublic entities. The Company does not
expect that the adoption of this standard will have a material effect on its
financial position or results of operations.
9. Legal Contingencies
The Company is not a party to any legal proceedings, which in its belief, after
review by the Company's legal counsel, could have a material adverse effect on
the consolidated financial position, cash flows or results of operations of the
Company.
10. Segment Information
The following table presents certain financial information relating to each
reportable segment:
Three Months Six Months
Ended September 30, Ended September 30,
--------------------- ---------------------
Segment Information (in thousands) 2003 2002 2003 2002
- -------------------------------------- ------- ------- ------- -------
Revenue:
Enterprise Solutions $17,843 $16,915 $35,265 $33,042
DOC1 7,390 8,105 14,224 15,357
------- ------- ------- -------
Total Revenue $25,233 $25,020 $49,489 $48,399
======= ======= ======= =======
Gross Profit:
Enterprise Solutions $13,825 12,099 $26,420 $23,008
DOC1 4,160 5,053 7,572 9,178
------- ------- ------- -------
Total Gross Profit $17,985 17,152 $33,992 $32,186
======= ======= ======= =======
Amortization of capitalized developed and acquired software associated with the
Enterprise Solutions segment was $975,000 and $1,347,000 in the three months and
$2,581,000 and $2,723,000 in the six months ended September 30, 2003 and 2002,
respectively. Amortization of capitalized developed and acquired software
associated with the DOC1 segment was $958,000 and $753,000 in the three months
and $1,896,000 and $1,473,000 in the six months ended September 30, 2003 and
2002.
As of September 30, 2003 and March 31, 2003, the Company determined that the
identifiable assets for its reportable segments were as follows (in thousands):
September 30, March 31,
2003 2003
------------- ---------
Enterprise Solutions $ 39,609 $ 39,075
DOC1 28,642 32,039
Corporate 62,292 59,262
-------- --------
Total assets $130,543 $130,376
======== ========
9
The changes in the carrying amount of goodwill for the three months ended
September 30, 2003 for each reportable segment were as follows (in thousands):
Enterprise Solutions DOC1
-------------------- -------
Balance as of March 31, 2003 $ 4,497 $8,219
Effect of sale of intellectual property (8) --
Effect of currency translation on goodwill -- 18
------- ------
Balance as of September 30, 2003 $ 4,489 $8,237
======= ======
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Results of Operations
Any statements in this Quarterly Report on Form 10-Q concerning the Company's
business outlook or future economic performance, anticipated profitability,
revenues, expenses or other financial items, together with other statements that
are not historical facts, are "forward-looking statements" as that term is
defined under the Federal Securities Laws. Forward looking statements may
include words such as "may vary", "believes", "anticipates" and "expects".
Actual results may differ materially from the expectations expressed or implied
in the forward-looking statements. Forward-looking statements are subject to
risks, uncertainties and other factors which could cause actual results to
differ materially from those stated in such statements. Such risks,
uncertainties and factors include, but are not limited to, changes in currency
exchange rates, changes and delays in new product introduction, customer
acceptance of new products, changes in government regulations, changes in
pricing or other actions by competitors and general economic conditions, as well
as other risks detailed in the Company's other filings with the Securities and
Exchange Commission. The Company undertakes no obligation to update any
forward-looking statement.
For the three months ended September 30, 2003 and 2002, the Company had revenues
of $25.2 million and $25.0 million, respectively. Net income available to common
stockholders for the three months ended September 30, 2003 was $2.6 million or
$0.16 diluted earnings per share compared with $2.0 million or $0.14 diluted
earnings per share in the same period in the prior year. The increase in
earnings for the three month period is primarily due to increased revenue, lower
royalty expense and higher non-operating income.
All of Group 1's operations are based in the two business segments defined as
Enterprise Solutions and DOC1. Enterprise Solutions revenue accounted for 71%
and 68% of Group 1's total revenue for the second fiscal quarters ended
September 30, 2003 and 2002, respectively. DOC1 revenue was 29% and 32% of total
revenue for the second quarters of fiscal 2004 and fiscal 2003, respectively.
For the six months ended September 30, 2003 and 2002, Enterprise Solutions
revenue was 71% and 68% of total revenue and DOC1 revenue was 29% and 32% of
total revenue, respectively.
International revenues were 15% and 16% of Group 1's total revenue in the second
quarters of fiscal 2004 and 2003, respectively. International revenues were 13%
and 15% of total revenue in the first six months of fiscal 2004 and 2003,
respectively. The decrease in international revenue is primarily due to lower
sales of the DOC1 product in Europe.
Software license and related revenue of $10.8 million for the second fiscal
quarter of 2004 decreased 4% from $11.3 million the same period the prior year.
As a percent of total revenue, second quarter software license and related
revenues were 43% in fiscal 2004 compared with 45% in fiscal 2003. Software
license and related revenue was $21.3 million for the six months ended September
30, 2003, or 43% of revenue and $21.2 million or 44% of revenue in the prior
year six month period.
10
Enterprise Solutions license revenue increased 9% to $8.5 million in the three
month period ended September 30, 2003. The increase in the quarter is due to
higher sales of Data Quality products.
License fees from DOC1 for the three months ended September 30, 2003 were $2.3
million, compared with $3.5 million the prior year. DOC1 license revenue was
$4.5 million and $6.2 million for the six months ended September 30, 2003 and
2002, respectively. The decrease in DOC1 license revenue was due lower sales
both domestically and internationally.
Maintenance and service revenue was $14.4 million for the second quarter of
fiscal year 2004 and $13.7 million in the prior year's second fiscal quarter.
Maintenance and service revenue was 57% of total revenue for the quarter ended
September 30, 2003 and 55% of total revenue in the same period in the prior
year. Maintenance and service revenue was $28.2 million, 57% of total revenue,
for the first six months of fiscal year 2004 and $27.2 million, 56% of total
revenue, in the prior year's six month period. Recognized maintenance fees
included in maintenance and service revenue were $11.8 million for the quarter
ended September 30, 2003 and $11.2 million for the same period the prior year,
an increase of 6%. Recognized maintenance fees included in maintenance and
service revenue were $23.6 million for the six months ended September 30, 2003
and $22.2 million for the same period the prior year, an increase of 6%.
For the quarter ended September 30, 2003, Enterprise Solutions recognized
maintenance was $8.3 million, a 1% decrease from the same period in the prior
year. DOC1 recognized maintenance increased 24% to $3.5 million in the quarter
ended September 30, 2003 compared with the comparable period the prior year. For
the six months ended September 30, 2003 and 2002, Enterprise Solutions
recognized maintenance was $16.7 million, in both periods. DOC1 recognized
maintenance was $6.9 million and $5.5 million in the six months ended September
30, 2003 and 2002, respectively. The increase in maintenance revenue in DOC1 was
due to the recognition of a higher level of maintenance renewals based on an
increase in the installed customer base.
Professional and educational service revenue from the Enterprise Solutions
segment was $1.0 million and $0.7 million in the three months ended September
30, 2003 and 2002, respectively. Enterprise Solutions service revenue was $1.8
million and $1.4 million in the six months ended September 30, 2003 and 2002,
respectively. DOC1 service revenue decreased to $1.6 million in the quarter
ended September 30, 2003 from $1.8 million in the same period of the prior
fiscal year. The decrease in professional and educational service revenue in
DOC1 in the three and six month period is due to lower sales of new
installations which require integration services.
Total cost of revenue for the second quarter of fiscal 2004 and 2003 was $7.2
million and $7.9 million, respectively. For the first six months of fiscal 2004
and 2003, total cost of revenue was $15.5 million and $16.2 million. The
separate components of cost of revenue are discussed below.
Software license expense decreased for the three month period ended September
30, 2003 to $3.2 million from $3.8 million for the same period in the prior year
representing 29% and 33% of software license and related revenues, respectively.
Software license expense was $7.0 million and $7.8 million in the six months
ended September 30, 2003 and 2002, representing 33% and 37% of software license
and related revenue in both respective periods. The decrease in software license
expense in the current year is primarily due to decreases in royalty and
amortization of capitalized development expenses, although amortization exceeded
capitalization by $0.3 million in the three month period ended September 30,
2003 and $0.8 million in the six month period ended the same date.
Maintenance and service expense was $4.1 million in both the current and prior
year, representing 28% and 30% of maintenance and service revenue, respectively.
Maintenance and service expense was $8.5 million and $8.4 million in the six
months ended September 30, 2003 and 2002, or 30% and 31% of maintenance and
service revenue, respectively.
11
Included in maintenance and service expense discussed above are professional and
educational service costs which were $2.2 million for both three month periods
ended September 30, 2003 and 2002. Professional and educational service costs
were $4.6 million in both six month periods ended September 30, 2003 and 2002.
Costs of maintenance were $1.9 million for the second fiscal quarters of 2004
and 2003, representing 16% and 17% of maintenance revenue, respectively. Costs
of maintenance were $3.9 million and $3.8 million for the first six months of
fiscal 2004 and 2003, 16% and 17% of maintenance revenue, respectively.
Total operating costs of $14.6 million amounted to 58% of revenue for the
quarter ended September 30, 2003 compared with $14.1 million or 56% of revenue
for the prior year period. Total operating costs of $28.2 million were 57% of
revenue for the six months ended September 30, 2003 compared with $27.7 million
or 57% of revenue for the prior year period. The various components of operating
costs are discussed below.
Software development costs incurred subsequent to establishment of the
software's technological feasibility are capitalized. Capitalization ceases when
the software is available for general release to customers. All costs not
meeting the requirements for capitalization are expensed in the period incurred.
Software development costs include direct labor cost and overhead. Capitalized
software development costs are amortized by the greater of (a) the ratio that
current gross revenues for the product bear to the total of current and
anticipated future gross revenues for that product or (b) the straight-line
method over the remaining estimated economic life of the product including the
period being reported on. At the balance sheet date, the Company evaluates the
net realizable value of the capitalized costs and adjusts the current period
amortization for any impairment of the capitalized asset value. Amortization of
capitalized software is included in the cost of license fees.
Costs of research and development, before capitalization, were $4.6 million and
$4.7 million or 18% and 19% of revenue in the quarters ended September 30, 2003
and 2002, respectively. Costs of research and development, before
capitalization, were $9.4 million and $9.3 million, 19% of revenue in the six
months ended September 30, 2003 and 2002, respectively. Total research and
development expense after capitalization of certain development costs was $3.0
million or 12% of revenue for the three month period ended September 30, 2003
compared with $2.8 million or 11% in the prior year (see footnote 6 of notes to
consolidated financial statements). Amortization expense related to developed
and acquired software costs was $1.9 million and $2.1 million in the three
months ended September 30, 2003 and 2002, respectively and $4.5 million and $4.2
million in the six months ended September 30, 2003 and 2002, respectively.
Sales and marketing expenses totaled $8.4 million or 33% of revenue in the
second quarter of fiscal 2004 and $7.7 million or 31% in the prior year second
quarter. Sales and marketing expenses totaled $15.9 million or 32% of revenue in
the first six months of fiscal 2004 and $15.2 million or 32% in the prior year
same period. Sales and marketing expenses for Enterprise Solutions were 28% of
Enterprise Solutions revenue in the second fiscal quarter of 2003 and 27% for
the same period the prior year. In the first six months of fiscal 2004 and 2003,
Enterprise Solutions sales and marketing expenses were 26% and 27% of the
segment's revenue. DOC1 sales and marketing expenses were 46% of DOC1 revenue
for the second fiscal quarter of 2003 and 39% for the same period the prior
year. DOC1 sales and marketing expenses were 47% and 40% of DOC1 revenue in the
first six months of fiscal 2004 and 2003, respectively. The increase in cost as
a percent of revenue in the DOC1 segment is due primarily to lower revenues.
General and administrative expenses were $3.3 million or 13% of total revenue
compared with $3.5 million or 14% of revenue for the three months ended
September 30, 2003 and 2002, respectively. General and administrative expenses
were $6.5 million or 13% of total revenue compared with $6.9 million or 14% of
revenue for the six months ended September 30, 2003 and 2002, respectively. The
decrease in general and administrative expenses in the quarter and six months is
primarily related to a recovery of bad debt expense and a decrease in legal
expenses.
12
Net other income was $0.5 million for the quarter ended September 30, 2003 as
compared with $0.1 million for the same period in the prior year. For the six
months ended September 30, 2003 and 2002, net other income was $1.3 million and
$0.2 million, respectively. The increase in other income in the current year
quarter is due to interest income recognized on the bridge loan to Sagent
Technology, Inc. prior to the asset acquisition on October 1, 2003. The increase
in other income in the current year six-month period is the result of currency
translation gains and a gain on the sale of intellectual property, in addition
to the increased interest income.
The Company's effective tax rates were 34% and 38% for the three month periods
ended September 30, 2003 and 2002, respectively. The current period's rate is
the net effect of a 34% effective tax rate on domestic taxable income and a 32%
rate on foreign losses. The lower effective tax rate in the current quarter and
six month period is primarily due to increased research and development credits
and lower state income tax provisions in the United States .
Critical Accounting Policies
The Securities and Exchange Commission issued Financial Reporting Release No.
60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies"
("FR 60"), in December 2001. FR 60 requires companies to disclose those
accounting policies considered most critical. Note 1 to the audited financial
statements in the Company's annual report on Form 10-K for the year ended March
31, 2003 includes a summary of the Company's significant accounting policies. Of
those policies, the Company has identified the following as the most critical
because they require significant judgment and estimates on the part of
management in their application:
Revenue Recognition: Revenues are primarily derived from the sale of software
licenses and from the sale of related services, which include maintenance and
support, consulting and training services. Revenues from license arrangements
are recognized upon delivery of the product when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable and
collectibility is probable. If the agreement includes acceptance criteria,
revenue is not recognized until the Company can demonstrate that the software or
service can meet the acceptance criteria. If an ongoing vendor obligation exists
under the license arrangement, revenue is deferred based on vendor-specific
objective evidence of the undelivered element. If vendor-specific objective
evidence does not exist for all undelivered elements, all revenue is deferred
until sufficient evidence exists or all elements have been delivered. Revenues
from annual maintenance and support are deferred and recognized ratably over the
term of the contract. Revenues from consulting and training services are
deferred and recognized when the services are performed and collectibility is
deemed probable.
Contracts for professional services are negotiated individually. The Company
generally recognizes revenues from professional service contracts on a time and
materials basis as the work is performed. Revenues from fixed price professional
service contracts are recognized using the percentage-of-completion method as
work is performed, measured primarily by the ratio of labor hours incurred to
total estimated labor hours for each specific contract. When the total estimated
cost of a contract is expected to exceed the contract price, the total estimated
loss is charged to expense in the period when the information is known. During
the three months ended September 30, 2003, the Company has not incurred any
losses on contracts in progress.
Revenue from arrangements where the Company provides Web based services is
recognized over the contract period. Any fees paid or costs incurred prior to
the customer relationship period, such as license fees, consulting,
customization or development services, are deferred and recognized ratably over
the subsequent contract period, which is typically one to two years.
Revenue from products licensed to original equipment manufacturers is recorded
when products have been shipped and the appropriate documentation has been
received by Group 1, provided all other revenue recognition criteria
13
have been satisfied. Revenue from sales through value added resellers or
distributors is recorded when a license agreement is signed with an end user.
Capitalized Software: In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be
Sold, Leased, or Otherwise Marketed," software development costs are expensed as
incurred until technological feasibility has been established, at which time
such costs are capitalized until the product is available for general release to
customers. Software development costs capitalized include direct labor costs and
fringe labor overhead costs attributed to programmers, software engineers,
quality control and field certifiers working on products after they reach
technological feasibility but before they are generally available to customers
for sale. Capitalized costs are amortized over the estimated product life of
three to five years, using the greater of the straight-line method or the ratio
of current product revenues to total projected future revenues. At the balance
sheet date, the Company evaluates the net realizable value of the capitalized
costs and adjusts the current period amortization for any impairment of the
capitalized asset value.
Goodwill: In accordance with SFAS 142, "Goodwill and Other Intangible Assets",
the Company ceased amortization of goodwill as of April 1, 2001 and tested for
impairment at least annually at the reporting unit level. Goodwill will be
tested for impairment on an interim basis if an event occurs or circumstances
change that would more-likely-than-not reduce the fair value of a reporting unit
below its carrying value. In accordance with FAS 142 provisions, the Company
completed the transitional and the annual goodwill impairment test as of April
1, 2001 and concluded that goodwill of its reporting units was not impaired. The
Company also completed its annual goodwill impairment test for fiscal year 2003
and concluded that goodwill of its reporting units was not impaired.
Goodwill represents the excess of the aggregate purchase price over the fair
market value of the tangible and intangible assets acquired in various
acquisitions and, prior to fiscal year 2002, was amortized on a straight-line
basis over the estimated economic useful life ranging from nine to fifteen
years. There was no goodwill amortization expense during fiscal year 2004 and
2003 in accordance with SFAS Nos. 141 and 142, as discussed above.
Liquidity and Capital Resources
The Company's working capital was $47.7 million at September 30, 2003, as
compared with $39.8 million at March 31, 2003. The current ratio was 2.2 to 1 at
September 30, 2003 and 1.8 to 1 at March 31, 2003. Note that the current portion
of deferred revenue related to maintenance contracts is included in current
liabilities. Accordingly, working capital and current ratios may not be directly
comparable to such data for companies in other industries where similar revenue
deferrals are not typical.
The Company provides for its funding requirements through cash funds generated
from operations. Additionally, the Company maintains a $10 million line of
credit arrangement with a commercial bank, expiring October 31, 2004. The line
of credit bears interest at the bank's prime rate or Libor plus 140 basis
points, at Group 1's option. The line of credit is not collateralized but
requires Group 1 to maintain certain operating ratios. At September 30, 2003 and
at March 31, 2003, there were no borrowings outstanding under the line of
credit.
During fiscal 2004 to date, net income of $4.6 million plus net non-cash
expenses of $5.7 million less a $6.0 million net decrease in assets and
liabilities provided a total of $4.3 million cash from operating activities. The
net changes in assets and liabilities include a decrease in accounts receivable
that increased cash by $1.5 million during the quarter. The decrease in
receivables was due to increased cash collections. Deferred revenues decreased
by $2.5 million, and accrued expenses and compensation decreased by $4.3
million, decreasing cash by a total of $6.8 million. The decreased accrued
compensation was due primarily to payments of prior year incentive compensation
accruals. The decrease in deferred revenue is primarily related to the
recognition of license fees on certain transactions that had been previously
deferred. Other working capital items decreased cash by $0.7 million.
14
Cash flows of $21.3 million used in investing activities consist of expenditures
for investments in software development and capital equipment of $5.5 million,
net purchases of marketable securities of $9.2 million, $7.0 million in notes
receivable issued to Sagent and proceeds of $0.4 million from the sale of
intellectual property.
Proceeds from the exercise of stock options of $0.9 million net of repayments of
long-term debt provided a total of $0.9 million cash from financing activities.
Group 1 continually evaluates the credit and market risks associated with
outstanding receivables. In the course of this review, Group 1 considers many
factors specific to the individual client as well as to the concentration of
receivables within industry groups.
As of September 30, 2003, the Company's capital resource commitments consisted
primarily of non-cancelable operating lease commitments for office space and
equipment. The Company believes that its current minimum lease obligations and
other short-term and long-term liquidity needs can be met from its existing cash
and short-term investment balances and cash flows from operations. The Company
believes that its long-term liquidity needs are minimal and no large capital
expenditures are currently planned, except for the continuing investment in
software development costs, which the Company believes can be funded from
operations during the next twelve months.
The following table lists the Company's contractual obligations and commercial
commitments (in thousands):
- -------------------------------------------------------------------------------------------------------------------------
Total Amount Less than
Contractual Obligations Committed 1 Year 1-3 Years 4-5 Years Over 5 Years
- -------------------------------------------------------------------------------------------------------------------------
Operating leases $27,284 $3,841 $6,344 $4,285 $12,814
- -------------------------------------------------------------------------------------------------------------------------
Notes payable 668 318 350 -- --
- -------------------------------------------------------------------------------------------------------------------------
Total contractual cash obligations $27,952 $4,159 $6,694 $4,285 $12,814
- -------------------------------------------------------------------------------------------------------------------------
Recent Accounting Pronouncements
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
Company believes that the adoption of this standard will have no material impact
on its financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a liability
be recorded in the guarantor's balance sheet upon issuance of a guarantee. In
addition, FIN 45 requires disclosures about the guarantees that an entity has
issued, including a reconciliation of changes in the entity's product warranty
liabilities. The initial recognition and initial measurement provisions of FIN
45 are applicable on a prospective basis to guarantees issued or modified after
September 30, 2003. The adoption of this Statement did not have a material
impact on the Company's financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired
15
prior to February 1, 2003, the provisions of FIN 46 must be applied for the
first interim or annual period beginning after September 15, 2003. The adoption
of FIN 46 did not have a material effect on the Company's financial position or
results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. The statement requires that contracts with comparable characteristics
be accounted for similarly and clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows. SFAS
No. 149 is effective for contracts entered into or modified after September 30,
2003, except in certain circumstances, and for hedging relationships designated
after September 30, 2003. The Company does not expect that the adoption of this
standard will have a material effect on its financial position or results of
operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
Statement establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances) because that financial instrument embodies an
obligation of the issuer. This Statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after September 15, 2003, except
for mandatorily redeemable financial instruments of nonpublic entities. The
Company does not expect that the adoption of this standard will have a material
effect on its financial position or results of operations.
Legal Contingencies
The Company is not a party to any legal proceedings which in its belief, after
review by the Company's legal counsel, could have a material adverse effect on
the consolidated financial position, cash flows or results of operations of the
Company.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
The Company has a subsidiary in the United Kingdom with offices throughout
continental Europe. Additionally, the Company uses third party distributors to
market and distribute its products in other international regions. Transactions
conducted by the subsidiary are typically denominated in the local country
currency, while transactions conducted by the distributors are typically
denominated in pounds sterling. As a result, the Company is primarily exposed to
foreign exchange rate fluctuations as the financial results of its subsidiary
and third party distributors are translated into U.S. dollars in consolidation.
As exchange rates vary, these results, when translated, may vary from
expectations and impact overall expected profitability. Through and as of
September 30, 2003, however, the Company's exposure was not material to the
financial statements taken as a whole. The Company has not entered into any
foreign currency hedging transactions with respect to its foreign currency
market risk. The Company does not have any financial instruments subject to
material market risk.
ITEM 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Our management, with
the participation of our chief executive officer and chief financial officer,
evaluated the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September
30, 2003. Based on this evaluation, our chief executive officer and chief
financial officer concluded that, as of September 30, 2003, our disclosure
controls and procedures were (1) designed to ensure that material information
relating to our Company, including our consolidated subsidiaries, is made known
to our chief executive officer and chief financial officer by others within
those entities, particularly during the period in which this report was being
prepared and (2) effective, in that they provide reasonable assurance that
information required to be disclosed by us in the reports that we file or
16
submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms.
(b) Changes in internal controls. No change in our internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) occurred during the fiscal quarter ended September 30, 2003 that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
17
Part II Other Information
Item 1. Legal Proceedings
NONE
Item 2. Changes in Securities
NONE
Item 3. Defaults Upon Senior Securities
NONE
Item 4. Submission of Matters to a Vote of Security Holders
The following matters were submitted to, and approved by, the required
vote of security holders of the Company at the Company's annual
shareholders' meeting held on September 4, 2003:
To elect three directors to hold office until the third annual
meeting of stockholders of the Company following their election and
until the election and qualification of their successors.
Nominees For Withheld
-----------------------------------------------------------
James P. Marden 10,196,319 2,687,371
Charles A. Mele 12,072,311 811,379
Charles J. Sindelar 10,223,773 2,659,917
All nominees were duly elected. In addition to the newly elected
directors, the terms of office as directors of Messrs. James V.
Manning, Richard Eisenberg, Bruce J. Spohler, Robert S. Bowen,
Thomas S. Buchsbaum and Alan P. Slater continued after the meeting.
Amendment to the Company's Certificate of Incorporation to increase
the number of authorized shares of common stock from 50 million to
200 million shares.
For Against Abstained
--------------------------------------------
8,457,103 3,842,187 79,550
Amendment to the Company's 1995 Incentive Stock Option,
Non-Qualified Stock Option and Stock Appreciation Unit Plan to
increase by 500,000 shares the number of shares subject to the plan.
For Against Abstained
--------------------------------------------
8,457,103 4,373,806 52,781
Item 5. Other Information
NONE
18
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit 31.1 Certification of Robert S. Bowen, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 Certification Mark Funston, Chief Financial Officer, pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 Certifications of Robert S. Bowen, Chief Executive Officer,
and Mark Funston, Chief Financial Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
Form 8-K filed November 7, 2003 for the press release regarding financial
results for the period ended September 30, 2003.
Form 8-K filed October 16, 2003 for the press release regarding
preliminary financial results for the period ended September 30, 2003.
Form 8-K filed October 15, 2003 for the October 1, 2003 agreement for the
purchase of assets of Sagent Technology, Inc.
19
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
Group 1 Software, Inc.
/s/ Robert S. Bowen
Chief Executive Officer
November 14, 2003
/s/ Mark Funston
Chief Financial Officer
November 14, 2003
20