-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, I+AN5/e427NZAiM3Wug0PgLYN0TUMbNIc9THo5YbckphyfyR5kdg9OxQYCye8mOt FJaERb+m1c3Bcfi4X+eeSA== 0000891618-98-004905.txt : 19981116 0000891618-98-004905.hdr.sgml : 19981116 ACCESSION NUMBER: 0000891618-98-004905 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EDIFY CORP CENTRAL INDEX KEY: 0000879898 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 770250992 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-28480 FILM NUMBER: 98747478 BUSINESS ADDRESS: STREET 1: 2840 SAN TOMAS EXPERSSWY CITY: SANTA CLARA STATE: CA ZIP: 95051 BUSINESS PHONE: 4089822000 MAIL ADDRESS: STREET 1: 2840 SAN TOMAS EXPRESSWAY CITY: SANTA CLARA STATE: CA ZIP: 95051 10-Q 1 FORM 10-Q W/ PERIOD ENDING 9/30/1998 1 ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------------------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998 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: 0-28480 EDIFY CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 77-0250992 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 2840 SAN TOMAS EXPRESSWAY SANTA CLARA, CALIFORNIA 95051 (Address of principal executive offices) ----------------------------- (408) 982-2000 (Registrant's telephone number, including area code) ----------------------------- Indicate by checkmark 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. (1) Yes X No ------ ------ As of September 30, 1998, there were 17,322,681 shares of the Registrant's common stock outstanding. ================================================================================ 2 EDIFY CORPORATION FORM 10-Q INDEX
PAGE PART I FINANCIAL INFORMATION NUMBER ITEM 1: Condensed Consolidated Financial Statements (Unaudited) Condensed Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997......... 3 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 1998 and 1997............................................................. 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 1998 and 1997........................................................................... 5 Notes to Condensed Consolidated Financial Statements......................................... 6 ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations........ 9 ITEM 3: Quantitative and Qualitative Disclosures About Market Risk................................... 18 PART II OTHER INFORMATION ITEM 1: Legal Proceedings............................................................................ 19 ITEM 2: Changes in Securities and Use of Proceeds.................................................... 19 ITEM 3: Defaults Upon Senior Securities.............................................................. 20 ITEM 4: Submission of Matters to a Vote of Security Holders.......................................... 20 ITEM 5: Other Information............................................................................ 20 ITEM 6: Exhibits and Reports on Form 8-K............................................................. 20 Signatures................................................................................... 21
-2- 3 PART I: FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) EDIFY CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED)
SEPTEMBER 30, DECEMBER 31, 1998 1997 -------- -------- ASSETS Current assets: Cash, cash equivalents and short-term investments ... $ 40,164 $ 43,161 Accounts receivable, net ............................ 21,076 16,668 Prepaid expenses and other current assets ........... 1,984 1,457 -------- -------- Total current assets ......................... 63,224 61,286 Property and equipment, net ............................. 7,196 6,953 Other assets ............................................ 312 241 -------- -------- Total assets ................................. $ 70,732 $ 68,480 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable .................................... $ 3,121 $ 1,062 Current installments of capital lease obligations ... 327 424 Accrued expenses .................................... 6,444 6,265 Accrued intellectual property settlement ............ 5,000 -- Unearned revenue .................................... 4,213 4,581 -------- -------- Total current liabilities .................... 19,105 12,332 -------- -------- Capital lease obligations, excluding current installments 115 340 Commitments and contingencies Stockholders' equity: Common stock ........................................ 17 17 Additional paid-in capital .......................... 69,035 66,624 Deferred compensation and other ..................... (88) (193) Accumulated deficit ................................. (17,452) (10,640) -------- -------- Total stockholders' equity ................... 51,512 55,808 -------- -------- Total liabilities and stockholders' equity ... $ 70,732 $ 68,480 ======== ========
See notes to condensed consolidated financial statements. -3- 4 EDIFY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 1998 1997 1998 1997 -------- -------- -------- -------- Net revenues: License ................................................ $ 10,087 $ 8,742 $ 26,324 $ 23,681 Services and other ..................................... 8,623 5,478 24,005 16,386 -------- -------- -------- -------- Total net revenues .................................. 18,710 14,220 50,329 40,067 Cost of license revenues ................................. 465 162 987 498 Cost of services and other revenues ...................... 6,034 4,136 16,792 12,787 -------- -------- -------- -------- Gross profit ........................................ 12,211 9,922 32,550 26,782 -------- -------- -------- -------- Operating expenses: Product development .................................... 3,305 2,721 8,723 7,330 Sales and marketing .................................... 7,918 5,329 22,758 14,803 General and administrative ............................. 1,418 1,160 4,265 3,342 Intellectual property settlement ....................... 5,000 -- 5,000 -- -------- -------- -------- -------- Total operating expenses ............................ 17,641 9,210 40,746 25,475 -------- -------- -------- -------- Income (loss) from operations ....................... (5,430) 712 (8,196) 1,307 Interest income, net ..................................... 481 476 1,465 1,470 -------- -------- -------- -------- Income (loss) before income taxes ................... (4,949) 1,188 (6,731) 2,777 Provision for income taxes ............................... 26 95 81 224 -------- -------- -------- -------- Net income (loss) ................................... $ (4,975) $ 1,093 $ (6,812) $ 2,553 ======== ======== ======== ======== Basic net income (loss) per share ........................ $ (0.29) $ 0.07 $ (0.40) $ 0.16 ======== ======== ======== ======== Shares used in computing basic net income (loss) per share .............................................. 17,252 16,454 17,007 16,356 ======== ======== ======== ======== Diluted net income (loss) per share ...................... $ (0.29) $ 0.06 $ (0.40) $ 0.14 ======== ======== ======== ======== Shares used in computing diluted net income (loss) per share ....................................... 17,252 18,137 17,007 18,011 ======== ======== ======== ========
See notes to condensed consolidated financial statements. -4- 5 EDIFY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 1998 1997 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) .......................................................... $ (6,812) $ 2,553 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization ........................................... 3,207 2,332 Amortization of deferred compensation ................................... 105 201 Changes in operating assets and liabilities: Accounts receivable .................................................. (4,408) (5,014) Prepaid expenses and other current assets ............................ (527) (482) Accounts payable ..................................................... 2,059 (351) Accrued expenses ..................................................... 179 341 Accrued intellectual property settlement ............................. 5,000 -- Unearned revenue ..................................................... (368) 696 -------- -------- Net cash provided by (used in) operating activities ............... (1,565) 276 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment, net ................................... (3,450) (3,443) Purchases of short-term investments ........................................ (9,022) (6,391) Sales and maturities of short-term investments ............................. 11,253 11,999 Other assets ............................................................... (71) -- -------- -------- Net cash provided by (used in) investing activities ............... (1,290) 2,165 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments under capital lease obligations ......................... (322) (283) Net proceeds from issuance of common stock ................................. 2,411 2,272 -------- -------- Net cash provided by financing activities ......................... 2,089 1,989 -------- -------- Increase (decrease) in cash and cash equivalents ............................... (766) 4,430 Cash and cash equivalents at beginning of period ............................... 31,790 33,704 -------- -------- Cash and cash equivalents at end of period ..................................... $ 31,024 $ 38,134 ======== ======== Supplemental schedule of cash flow information: Cash paid during the period for interest ................................... $ 65 $ 93 Cash paid during the period for taxes ...................................... $ 170 $ 87 Supplemental schedule of noncash investing and financing activities: Property and equipment acquired under capital lease obligations ............ $ -- $ 35
See notes to condensed consolidated financial statements. -5- 6 EDIFY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) BASIS OF PRESENTATION The Company's unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) considered necessary to fairly state the Company's financial position, results of operations, and cash flows for the periods presented. These consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements included in the Company's Form 10-K for the fiscal year ended December 31, 1997. The results of operations for the three- and nine-month periods ended September 30, 1998 are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire fiscal year ending December 31, 1998. The December 31, 1997 balance sheet was derived from audited consolidated financial statements, but does not include all disclosures required by generally accepted accounting principles. (2) NET INCOME (LOSS) PER SHARE The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" in 1997 and restated all comparative per share amounts for prior periods. SFAS No. 128 requires the presentation of basic earnings per share and, for companies with potentially dilutive securities, such as options, diluted earnings per share. Basic earnings per share is computed using the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed using the weighted average number of shares of common stock and, when dilutive, common equivalent shares from options to purchase common stock and warrants outstanding using the treasury stock method. The following table sets forth the computation of net income (loss) per share (in thousands, except per share data): -6- 7
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ --------------------- 1998 1997 1998 1997 ----------- ------- ----------- ------- Net income (loss) ............................... $(4,975) $ 1,093 $(6,812) $ 2,553 ======= ======= ======= ======= Basic: Weighted average common shares outstanding used in computing basic net income (loss) per share .................................. 17,252 16,454 17,007 16,356 ======= ======= ======= ======= Basic net income (loss) per share ............. $ (0.29) $ 0.07 $ (0.40) $ 0.16 ======= ======= ======= ======= Diluted: Weighted average common shares outstanding ................................ 17,252 16,454 17,007 16,356 Dilutive options outstanding .................. -- 1,683 -- 1,655 ------- ------- ------- ------- Shares used in computing diluted net income (loss) per share .................... 17,252 18,137 17,007 18,011 ======= ======= ======= ======= Diluted net income (loss) per share ........... $ (0.29) $ 0.06 $ (0.40) $ 0.14 ======= ======= ======= =======
As of September 30, 1998, there were options to acquire 3,474,891 shares of common stock with weighted-average exercise prices of $7.17 which could potentially dilute basic earnings per share in the future but which were not included in diluted per share results for the three months and nine months ended September 30, 1998. These options were excluded because the Company reported an operating loss for the three months and nine months ended September 30, 1998. Therefore, these options would be antidilutive for purposes of this calculation. As of September 30, 1997, there were options to acquire 272,691 and 594,577 shares of common stock with weighted-average exercise prices of $18.17 and $16.38, respectively, in which the exercise price was greater than the average market price of the common stock for the three-month and nine-month period ended September 30, 1997. These options were not included in diluted per share results for the three months and nine months ended September 30, 1997, as these options would be antidilutive for purposes of this calculation. In July 1998, the Board of Directors approved the repricing of all incentive stock options granted during the period from May 1, 1996 through July 24, 1998. The repricing does not include incentive stock options granted to the Company's officers or Board of Directors. Employees had the choice of exchanging any stock options granted from May 1, 1996 through July 24, 1998 for new options that would have a new exercise price of $8.625, the then current market value of the Company's stock. Options to purchase 1,096,393 shares of common stock were exchanged under this option repricing program. (3) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from -7- 8 changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. This Statement is effective for annual financial statements for periods beginning after June 15, 1999. The Company believes that this Statement will not have a significant impact on its financial condition or results of operations when such statement is adopted. (4) STOCKHOLDER RIGHTS PLAN On August 7, 1998, the Board of Directors adopted a stockholder rights plan designed to protect the long-term value of the Company for its shareholders during any future unsolicited acquisition attempt. In connection with the plan, the Board declared a dividend of one preferred share purchase right for each share of the Company's common stock outstanding on August 14, 1998 (the "Record Date") and further directed the issuance of one such right with respect to each share of the Company's common stock that is issued after the Record Date, except in certain circumstances. The rights will expire on August 10, 2008. The rights are initially attached to the Company's common stock and will not trade separately. If a person or a group (an "Acquiring Person") acquires 20 percent or more of the Company's common stock, or announces an intention to make a tender offer for the Company's common stock, the consummation of which would result in a person or group becoming an Acquiring Person, then the rights will be distributed (the "Distribution Date"). After the Distribution Date, each right may be exercised for one-hundredth of a share of a newly designated Series A Junior Participating Preferred Stock, par value of $0.001 per share, at an exercise price of $70.00. The preferred stock has been structured so that the value of one-hundredth of a share of such preferred stock will approximate the value of one share of common stock. (5) SUBSEQUENT EVENT In April 1996, the Company received a letter from Lucent Technologies, Inc. ("Lucent") inviting the Company to negotiate a license of Lucent's patents. Lucent asserted that certain of the Company's products infringe certain of Lucent's patents and offered to license those patents to the Company for a substantial payment. In November 1997, the Company received a letter from Lucent in which Lucent made similar assertions with respect to other patents it holds. The Company believes that it has substantial arguments that its current products do not violate any valid claims of the Lucent patents referenced in the April 1996 letter and in the November 1997 letter. On November 2, 1998, the Company entered into a patent cross-license agreement with Lucent, under which each party released the other from claims of past infringement and settled their patent disputes. Under the cross-license agreement, Edify paid Lucent a one-time fee and, in addition, will pay future license fees that are not expected to be material to the Company's results of operations. In connection with this settlement, the Company recorded a non-recurring charge of $5 million (approximately $0.29 per basic and diluted share), which is reflected in the condensed consolidated financial statements for the three and nine months ended September 30, 1998. -8- 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Form 10-Q contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those indicated by the forward-looking statements herein. Factors that could cause or contribute to such differences include, but are not limited to, those set forth below in "Factors That May Affect Future Operating Results" as well as those discussed in the "Business Risks" section included in the Company's Form 10-K for the fiscal year ended December 31, 1997. RESULTS OF OPERATIONS NET REVENUES Total net revenues were $18.7 million for the quarter ended September 30, 1998 as compared to $14.2 million for the comparable 1997 quarter, representing an increase of 31.6%. Total net revenues were $50.3 million for the nine months ended September 30, 1998, an increase of 25.6% as compared to $40.1 million for the same period a year ago. The Company's revenues are principally derived from software licenses and fees for services, which generally are charged separately. Revenues are recorded net of reserves for potential product returns. In the three- and nine-month periods ended September 30, 1998 and 1997, 6% or less of the Company's total net revenues were derived from international sales. Over time, the Company intends to expand its international operations and enter additional international markets. International operations entail a number of risks including those associated with product customization and regulatory compliance, and there can be no assurance that such expansion will be successful. LICENSE REVENUES. License revenues were $10.1 million for the quarter ended September 30, 1998 as compared to $8.7 million for the comparable 1997 quarter. License revenues for the nine-month period ended September 30, 1998 were $26.3 million as compared to $23.7 million for the comparable period in 1997. The increases in license revenues were due to an increase in unit volume as a result of the market's growing awareness and acceptance of Electronic Workforce, Electronic Banking System, and Employee Service System, increased follow-on business from existing customers, and expansion of the Company's field sales force. The Company does not believe that the historical growth rates of license revenues are indicative of future results. SERVICES AND OTHER REVENUES. Services and other revenues consist primarily of fees from consulting, post-contract customer support and, to a lesser extent, training and installation services. Services and other revenues were $8.6 million for the quarter ended September 30, 1998 as compared to $5.5 million for the comparable 1997 quarter. Services and other revenues for the nine months ended September 30, 1998 were $24.0 million as compared to $16.4 million for the comparable period of 1997. Services and other revenues -9- 10 as a percentage of total net revenues increased to 46.1% for the quarter ended September 30, 1998 from 38.5% for the quarter ended September 30, 1997, and increased to 47.7% for the nine months ended September 30, 1998 from 40.9% for the comparable 1997 period. The increase in services and other revenues in absolute dollars and as a percentage of total net revenues occurred primarily due to increased demand for consulting services, as well as increases in post-contract customer support and installation services associated with the increased installed base of the Company's software. The Company does not expect historical growth rates of its services revenues to be sustainable. To the extent services and other revenues is a higher percentage of total net revenues, overall gross profit margins may be adversely impacted. COST OF REVENUES COST OF LICENSE REVENUES. Cost of license revenues consists primarily of the cost of product media, product duplication, documentation and royalties paid to third parties under technology licenses. Cost of license revenues was $465,000 and $162,000 for the quarters ended September 30, 1998 and 1997, representing 4.6% and 1.9% of the related license revenues for the respective quarters. Cost of license revenues was $987,000 for the nine months ended September 30, 1998 as compared to $498,000 for the comparable 1997 period, representing 3.7% and 2.1% of the related license revenues for the respective periods. The increase in the cost of license revenues in absolute dollars and as a percentage of license revenues for the comparable periods was due primarily to the costs of third-party technology used for particular customers. If the Company were required to obtain licenses from or pay royalties to third parties under patent or other intellectual property rights, the cost of license revenues could increase significantly. COST OF SERVICES AND OTHER REVENUES. Cost of services and other revenues consists primarily of personnel-related costs and fees for third-party consultants incurred in providing consulting, post-contract customer support, training and installation services to customers. Cost of services and other revenues was $6.0 million and $4.1 million for the quarters ended September 30, 1998 and 1997, representing 70.0% and 75.5% of the related services and other revenues for the respective quarters. Cost of services and other revenues was $16.8 million for the nine months ended September 30, 1998 as compared to $12.8 million for the comparable 1997 period, representing 70.0% and 78.0% of the related services and other revenues for the respective periods. The increase in absolute dollars for the comparable periods was due primarily to increases in personnel-related costs as the Company continued to expand its consulting and customer support organizations. The increase in gross profit margins was due primarily to increased demand for consulting services, as well as increases in post-contract customer support and installation services associated with the increased installed base of the Company's software. The Company does not expect historical growth rates of its gross profit margins to be sustainable. The cost of services and other revenues as a percentage of services and other revenues may vary between periods due to the amount and mix of services provided by the Company and to varying levels of expenditures to build the services organizations. Any significant decline in the demand for the Company's consulting services would have a material adverse impact on the Company's revenues and, as a result of the under-utilization of consulting personnel, on the Company's gross profit and results of operations. -10- 11 PRODUCT DEVELOPMENT Product development expenses were $3.3 million and $2.7 million, or 17.7% and 19.1% of total net revenues, for the quarters ended September 30, 1998 and 1997, respectively. Product development expenses were $8.7 million and $7.3 million, or 17.3% and 18.3% of total net revenues, for the nine-month periods ended September 30, 1998 and 1997, respectively. Product development expenses consist primarily of salaries and other related expenses for research and development personnel, as well as the cost of facilities and depreciation of capital equipment. The increase in absolute dollars for the comparable periods was attributable primarily to increased staffing related to the development of the Company's application products and ongoing enhancements to Electronic Workforce. The decrease in product development expenses as a percentage of total net revenues was due primarily to a decrease in the personnel-related costs associated with the development of the Company's Windows NT-based software, which was delivered in the fourth quarter of 1997. The Company believes that significant investments in product development are required to remain competitive. As a result, the Company expects that product development expenses will increase in absolute dollars in the future and will not decline significantly as a percentage of total net revenues from their current levels. In accordance with SFAS No. 86, the Company expects to capitalize eligible computer software development costs upon the achievement of technological feasibility, subject to net realizable value considerations. The Company has defined technological feasibility as completion of a working model. To date, the Company believes its process for developing software was essentially completed concurrently with the establishment of technological feasibility, and, accordingly, no software development costs have been capitalized in the accompanying consolidated balance sheet. SALES AND MARKETING Sales and marketing expenses were $7.9 million and $5.3 million, or 42.3% and 37.5% of total net revenues, for the quarters ended September 30, 1998 and 1997, respectively. Sales and marketing expenses were $22.8 million and $14.8 million, or 45.2% and 36.9% of total net revenues, for the nine-month periods ended September 30, 1998 and 1997, respectively. Sales and marketing expenses consist primarily of salaries and commissions earned by sales and marketing personnel and promotional expenses. The increase in absolute dollars and as a percentage of total net revenues for the comparable periods was due primarily to the expansion of the Company's field and indirect sales operations and increased marketing activities. The Company expects to continue to expand its field sales and marketing efforts, its third party value added reseller ("VAR") distribution channel and its operations outside the United States and, therefore, anticipates that sales and marketing expenditures will increase in absolute dollars in the future. In addition, sales and marketing expenses as a percentage of total net revenues may fluctuate between periods due to varying levels of expenditures to build the sales and marketing organizations. -11- 12 GENERAL AND ADMINISTRATIVE General and administrative expenses were $1.4 million and $1.2 million, or 7.6% and 8.2% of total net revenues, for the quarters ended September 30, 1998 and 1997, respectively. General and administrative expenses were $4.3 million and $3.3 million, or 8.5% and 8.3% of total net revenues, for the nine months ended September 30, 1998 and 1997, respectively. General and administrative expenses consist primarily of salaries and other related expenses of administrative, executive and financial personnel and outside professional fees. The increase in absolute dollars for the comparable quarter was attributable primarily to increased infrastructure costs to support the growth of the Company's business and an increase in the provision for doubtful accounts. The decrease in general and administrative expenses as a percentage of total net revenues for the comparable quarter was due primarily to the growth in total net revenues. The increase in absolute dollars and as a percentage of total net revenues for the comparable nine-month period was primarily due to increased infrastructure costs and an increase in the provision for doubtful accounts. The Company expects to continue to expand its staffing and other items related to infrastructure and, therefore, anticipates that general and administrative expenses will increase in absolute dollars in the future. INTELLECTUAL PROPERTY SETTLEMENT Intellectual property settlement represents a non-recurring charge of $5 million related to the resolution of the Company's patent discussions with Lucent in November 1998, which was recorded as a subsequent event in the quarter ended September 30, 1998. See Note 5 of Notes to Condensed Consolidated Financial Statements for further discussion of this settlement. INTEREST INCOME, NET Interest income, net was $481,000 for the quarter ended September 30, 1998, compared to $476,000 for the quarter ended September 30, 1997. Interest income, net for each of the nine months ended September 30, 1998 and 1997 was $1.5 million. For the three and nine months ended September 30, 1998, interest income, net consists primarily of interest earned from the Company's cash, cash equivalents, and short-term investments. PROVISION FOR INCOME TAXES The provision for income taxes was $26,000 and $95,000 for the quarters ended September 30, 1998 and 1997, respectively. The provision for income taxes was $81,000 and $224,000 for the nine months ended September 30, 1998 and 1997, respectively. For the three and nine months ended September 30, 1998, the provision for income taxes relates primarily to state income and foreign withholding taxes. -12- 13 LIQUIDITY AND CAPITAL RESOURCES At September 30, 1998, the Company's cash, cash equivalents and short-term investments totaled $40.2 million. At September 30, 1998, the Company also had available an $8.0 million unsecured revolving bank line of credit agreement which expires in December 1998 and contains certain financial covenants, with which the Company was in compliance. Borrowings accrue interest at the bank's prime rate. As of September 30, 1998, there were no borrowings outstanding under this line of credit. For the nine months ended September 30, 1998, operating activities used cash of $1.6 million, resulting primarily from the net loss, offset by an increase in accrued intellectual property settlement. Investing activities used cash of $1.3 million from the purchase of $3.5 million in property and equipment, partially offset by the net sale and maturity of $2.2 million in short-term investments. The Company expects that its capital expenditures will increase as the Company's employee base grows. Net cash generated from financing activities of $2.1 million was related primarily to proceeds from the issuance of the Company's common stock through its Employee Stock Purchase Plan and stock option exercises. At September 30, 1998, the Company's working capital was $44.1 million. The Company has no significant capital spending or purchase commitments other than normal purchase commitments and commitments under its facilities and capital leases. The Company believes that its working capital, together with its bank line of credit and anticipated cash flows from operations, if any, will be sufficient to meet its working capital and capital expenditure requirements for at least the next 12 months. FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS Except for the historical information contained in this Form 10-Q, the matters discussed herein are forward-looking statements. These forward-looking statements concern matters which include, but are not limited to, the sustainability of historical revenue growth rates, the Company's expected mix of revenues, expected gross margins on license revenues and services and other revenues, certain expected operating expense levels and the Company's liquidity and capital needs. These matters involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. The revenue levels and results of operations achieved during the quarter and nine months ended September 30, 1998 are not necessarily indicative of the results that may be achieved in any future period. There can be no assurance that the Company will achieve or sustain profitability or experience growth in revenues in any future quarter. The Company's revenues, margins and operating results have fluctuated in the past, and are expected to continue to fluctuate in the future, on an annual and quarterly basis as a result of a number of factors, such as demand for the Company's products, including new products and product enhancements, sales force initiatives, transitions to new products, the mix of products and services sold, the mix of distribution channels through which the Company's products are sold, customer order deferrals in anticipation of new products or product enhancements, purchasing patterns of value added resellers and customers, Company decisions regarding hiring and other expenses and competitive conditions in the industry. In particular, the -13- 14 Company plans to increase its operating expenses to expand its sales and marketing operations, expand its distribution channels, expand its international operations, fund greater levels of product development, broaden its consulting services and customer support capabilities and increase its administrative infrastructure. A relatively high percentage of the Company's expenses is fixed in the short term as the Company's expense levels are based, in part, on its expectations as to future revenues. If revenues fall below expectations, expenditure levels could be disproportionately high as a percentage of total net revenues, and operating results would be immediately and adversely affected. The Company historically has operated with little backlog because its products are generally shipped as orders are received. As a result, license revenues in any quarter depend on the volume and timing of, and the Company's ability to fill, orders received in that quarter. Individual orders for the Company's products typically are for relatively large dollar amounts. The Company also believes the purchase of its products is relatively discretionary and generally involves a significant commitment of capital resources. Therefore, any downturn in any potential customer's business, or any loss or delay of individual orders for any reason, could have a significant impact on the Company's revenues and quarterly results. In addition, because the Company typically recognizes a substantial portion of its total revenue from transactions booked and shipped in the last weeks, or even days, of the quarter, the magnitude of quarterly fluctuations may not become evident until very late in a particular quarter. Revenues are difficult to forecast because the market for the Company's products is rapidly evolving. Based upon all of the foregoing, the Company believes that its quarterly revenues, expenses and operating results could vary significantly in the future and that period-to-period comparisons should not be relied upon as indications of future performance. There can be no assurance that the Company will be able to grow in future periods or that it will be able to sustain its level of total net revenues or increase or sustain its rate of revenue growth on a quarterly or annual basis. It is likely that, in some future quarters, the Company's operating results will be below the expectations of stock market analysts and investors. In such event, the price of the Company's common stock could be materially adversely affected. The Company's future success will depend on its ability to design, develop, test, sell and support new software products and enhancements of current products on a timely basis in response to changing customer needs, competition, technological developments and emerging industry standards. Versions through 4.x of Electronic Workforce and 1.x of EBS and ESY run on IBM's OS/2 operating system. In October 1997, the Company released its first version of Electronic Workforce Release 5 for the Windows NT operating system. In December 1997, the Company released initial versions of EBS and ESY for NT. Because these products were released in the past year, many customers licensing these versions have not yet fully deployed the product and undetected errors may remain in these versions. The existence of any such errors may delay the release of future versions and adversely affect the acceptance of these products, either of which could have a material adverse effect on the Company's business, operating results and financial condition. In addition, certain features of the OS/2 versions of the Company's software are not available on currently available NT-based versions. Accordingly, the Company is devoting significant engineering and -14- 15 development resources to develop enhancements to the versions of its products that run on the Microsoft Windows NT operating system. It is possible that the newness of or lack of features on the Windows NT-based versions of its products will cause potential customers to defer or forgo purchases of current or future versions of these products, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's future success will depend upon the timely and successful introduction of new versions of its Windows NT-based products. There can be no assurance that the Company will be successful in developing, on a timely basis or at all, fully featured Windows NT-based versions of its products or that such versions, if developed, will achieve customer acceptance. Failure by the Company to develop new Windows NT-based versions successfully and in a timely manner would have a material adverse effect on the Company's business, financial condition and results of operations. The Company intends to invest a significant majority of its product development resources on products and product enhancements for the Windows NT operating system. The Company must manage the effect on its existing OS/2 customers of this focus on the Windows NT operating system. There can be no assurance that updates to and enhancements for the Company's OS/2-based products will be sufficient to encourage its OS/2 customers to continue to purchase additional software or services from the Company. In addition, the Company must provide its customers with an economically reasonable and technologically feasible migration path from the OS/2-based products to the NT-based products. There can be no assurance that the Company's OS/2 customers will migrate to the Company's NT-based products. The failure of a significant number of its existing OS/2 customers to purchase additional software or services from the Company, for any reason, would have a material adverse effect on the Company's business, operating results and financial condition. In April 1996, the Company received a letter from Lucent inviting the Company to negotiate a license of Lucent's patents. Lucent asserted that certain of the Company's products infringe certain of Lucent's patents and offered to license those patents to the Company for a substantial payment. In November 1997, the Company received a letter from Lucent in which Lucent made similar assertions with respect to other patents it holds. The Company believes that it has substantial arguments that its current products do not violate any valid claims of the Lucent patents referenced in the April 1996 letter and in the November 1997 letter. On November 2, 1998, the Company entered into a patent cross-license agreement with Lucent, under which each party released the other from claims of past infringement and settled their patent disputes. Under the cross-license agreement, Edify paid Lucent a one-time fee and, in addition, will pay future license fees that are not expected to be material to -15- 16 the Company's results of operations. In connection with this settlement, the Company recorded a non-recurring charge of $5 million (approximately $0.29 per basic and diluted share), which is reflected in the condensed consolidated financial statements for the three and nine months ended September 30, 1998. In the future, the Company may receive additional communications from other parties asserting that the Company's products, trademarks or other proprietary rights require a license of intellectual property rights or infringe, or may infringe, on their property rights. As the number of software products in the industry increases, and the functionality of these products further overlaps, the Company believes that software developers may become increasingly subject to infringement claims. 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. 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 on the Company's business, financial condition and results of operations. In addition, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation to determine the validity of any claims could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks, whether or not such litigation is determined in favor of the Company. In the event of an adverse ruling in any such litigation, the Company may be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringing technology. The failure of the Company to develop or license a substitute technology could have a material adverse effect on the Company's business, financial condition and results of operations. An integral part of the Company's strategy is to develop multiple distribution channels, including a field sales force, VARs and OEMs. The Company intends to increase its reliance on third-party distribution partners in the future. The Company is expending and intends to continue to expend significant resources to develop the VAR channel. VARs and OEMs are not, however, subject to any minimum purchase or resale requirements and can cease marketing the Company's products at any time. Certain VARs and OEMs may offer competing products that they produce or that are produced by third parties. There can be no assurance that the Company's existing VARs will continue to provide the level of services and technical support necessary to provide a complete self service solution to the Company's customers, that they will transition smoothly to sales of new products or enhancements of existing products or that they will not emphasize their own or third-party products to the detriment of the Company's products. The loss of VARs, the failure of such parties to perform under agreements with the Company or the inability of the Company to attract and retain new VARs with the technical, industry and application expertise required to market the Company's products successfully in the future could have a material adverse effect on the Company's business, financial condition and results of operations. To the extent that the Company is successful in increasing its sales through VARs, those sales will be at discounted rates, and revenue to the Company for each such sale will be less than if the Company had licensed the same products to the customer directly. -16- 17 Many currently installed computer systems and software products are coded to accept two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. The Company is currently taking steps to address Year 2000 issues in the following three areas: (1) the Company's products; (2) internal systems; and (3) readiness of third party vendors and business partners. The Company has assigned a Year 2000 project team to develop and implement the Year 2000 readiness effort for its domestic operations. The project has executive sponsorship and is regularly reviewed by senior management, the Board of Directors, and the Audit Committee. The Company has designed and tested its current products to be Year 2000 compliant. However, since all customer situations cannot be anticipated, particularly those involving third party products, the Company may see an increase in warranty and other claims as a result of the Year 2000 transition. As such, the impact of customer claims could have a material adverse impact on the Company's business, financial condition and results of operations. The Company's internal systems include both information technology systems such as financial and order entry systems and non-information technology systems such as telephones and facilities. In August 1998, the Company completed the installation of a Year 2000 compliant enterprise resource planning ("ERP") system, which includes the Company's order entry, project accounting, and financial systems. The Company expects to resolve remaining Year 2000 compliance issues substantially through normal replacement and upgrades of software by June 1999. In the first quarter of 1999, the Company will initiate a comprehensive inventory and evaluation of all desktop systems and expects to complete this process by April 1999. The additional costs of remediation are not expected to be material to the Company's financial condition or results of operations. However, if significant new non-compliance issues are identified, the Company's business, financial condition and results of operations could be materially adversely affected. Finally, the Company is in the process of sending detailed questionnaires to critical suppliers and business partners to certify Year 2000 compliance. The Company anticipates this process to be completed by December 1998. Where practicable, the Company will attempt to mitigate its risk with respect to the failure of suppliers and business partners to be Year 2000 ready. However, such failures remain a possibility and could have an adverse impact on the Company's business, financial condition and results of operations. The Company has estimated a preliminary budget of approximately $300,000 for investigating and remedying issues related to Year 2000 compliance involving software or systems used in its internal operations. Costs that have already been incurred to replace and upgrade software and services in the Company's ordinary course of business are not included in the estimated budget. While the Company has dedicated substantial resources towards attaining Year 2000 compliance, there can be no assurance that the Company's Year 2000 compliance program will be completed on a timely basis. In -17- 18 addition, there can be no assurance that there will not be interruption of operations or other limitations of system functionality or that the Company will not incur substantial costs to avoid such limitations. Any failure to effectively monitor, implement or improve the Company's operational, financial, management and technical support systems could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, even if the Company's products are Year 2000 compliant, other systems or software used by the Company's customers may not be Year 2000 compliant. The failure of such non-compliant third-party software or systems could affect the perceived performance of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. The most likely worst case scenarios would include hardware failure and the failure of infrastructure services provided by government agencies, systems vendors, and other third parties (e.g., electricity, telephone service, water transport, internet services, etc.). The Company is in the process of completing its contingency planning for high risk areas at this time and is scheduled to commence contingency planning for medium to low risk areas in by the end of the fiscal year. The Company expects its contingency plans to include, among other things, manual "work-arounds" for software and hardware failures, as well as substitution of systems, if necessary. In addition to the factors discussed above, among the other factors that could cause actual results to differ materially are the following: demand for and market acceptance of application products; the Company's ability to deliver on time, and market acceptance of, new products or upgrades of existing products; customer order deferrals in anticipation of new products; the timing of, or delay in, large customer orders; continued availability of technology and intellectual property license rights; changes in the mix of distribution channels through which the Company's products are offered; competitive conditions in the industry; risks associated with global operations; general economic conditions; and the "Business Risks" listed from time to time in reports that the Company files with the U.S. Securities and Exchange Commission, including but not limited to the Company's Form 10-K for the fiscal year ended December 31, 1997. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. -18- 19 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On August 7, 1998, the Board of Directors adopted a stockholder rights plan designed to protect the long-term value of the Company for its shareholders during any future unsolicited acquisition attempt. In connection with the plan, the Board declared a dividend of one preferred share purchase right for each share of the Company's common stock outstanding on August 14, 1998 (the "Record Date") and further directed the issuance of one such right with respect to each share of the Company's common stock that is issued after the Record Date, except in certain circumstances. The rights will expire on August 10, 2008. The rights are initially attached to the Company's common stock and will not trade separately. If a person or a group (an "Acquiring Person") acquires 20 percent or more of the Company's common stock, or announces an intention to make a tender offer for the Company's common stock, the consummation of which would result in a person or group becoming an Acquiring Person, then the rights will be distributed (the "Distribution Date"). After the Distribution Date, each right may be exercised for one-hundredth of a share of a newly designated Series A Junior Participating Preferred Stock, par value of $0.001 per share, at an exercise price of $70.00. The preferred stock has been structured so that the value of one-hundredth of a share of such preferred stock will approximate the value of one share of common stock. Upon a person or group becoming an Acquiring Person, holders of the rights (other than the Acquiring Person) will have the right to acquire shares of the Company's common stock at a substantially discounted price. Additionally, if a person or group becomes an Acquiring Person and the Company is acquired in a merger or other business combination, or 50 percent or more of its assets are sold in a transaction with an Acquiring Person, the holders of rights (other than the Acquiring person) will have the right to receive shares of common stock of the acquiring corporation at a substantially discounted price. Subsequent to a person or group becoming an Acquiring Person, the Company's Board of Directors may, at its option, require the exchange of outstanding rights (other than those held by the Acquiring Person) for common stock at an exchange ratio of one share of the Company's common stock per right. The Company's Board may redeem outstanding rights at any time prior to a person or group becoming an Acquiring Person at a price of $0.001 per right. Prior to such time, the terms of the rights may be amended by the Board. -19- 20 ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are being filed as part of this Report: 3.01 Certificate of Designations (Series A Junior Participating Preferred Stock (1) 3.02 Bylaws of the Company, as amended and restated effective August 7, 1998 (2) 4.01 Rights Agreement dated August 10, 1998, between the Company and BankBoston, N.A., as Rights Agent, which includes as Exhibit A the form of Certificate of Designations of Series A Junior Participating Preferred Stock, as Exhibit B the Form of Right Certificate and as Exhibit C the Summary of Rights to Purchase Preferred Shares (3) (b) Reports on Form 8-K: On August 11, 1998, the Company filed a Form 8-K to report under Item 5 its adoption of a stockholder rights plan and amendment of its Bylaws. No financial statements were filed. - ----------- (1) Incorporated by reference to Exhibit 3.2 to Registrant's Registration Statement on Form 8-A (No. 000-28480), filed on August 11, 1998. (2) Incorporated by reference to Exhibit 3.1 to Registrant's Current Report on Form 8-K (No. 000-28480), filed on August 11, 1998. (3) Incorporated by reference to Exhibit 4.1 to Registrant's Registration Statement on Form 8-A (No. 000-28480), filed on August 11, 1998. -20- 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. EDIFY CORPORATION Date: November 13, 1998 By: /s/ Stephanie A. Vinella --------------------------------------------- Stephanie A. Vinella Vice President of Finance and Administration, Chief Financial Officer and Secretary -21- 22 EDIFY CORPORATION FORM 10-Q EXHIBIT INDEX
EXHIBITS 27.01 Financial Data Schedule
-22- EX-27.1 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1998 JUL-01-1998 SEP-30-1998 31,024 9,140 21,076 0 0 63,224 7,196 0 70,732 19,105 0 0 0 17 51,495 70,732 10,087 18,710 465 6,499 17,641 0 (481) (4,949) 26 (4,975) 0 0 0 (4,975) (0.29) (0.29)
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