Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements
(Unaudited)
Note 1 - Basis of presentation and summary of significant accounting policies
Docucorp International, Inc. (“Docucorp”), a Delaware corporation, was organized on January 13, 1997 in connection with the acquisition of FormMaker Software, Inc. by Image Sciences, Inc. We develop, market and support Customer Communication Management (“CCM”) solutions via a portfolio of proprietary information software, application service provider (“ASP”) hosting and professional services that enable companies to create, publish, manage and archive complex, high-volume, individualized information. We support the entire information life cycle – from acquisition of the first raw data point to final delivery of personalized information to the customer. The majority of our business is currently derived from companies in the insurance industry. We operate primarily in the United States, Canada and Europe.
The accompanying unaudited interim consolidated financial statements of Docucorp and its wholly owned subsidiaries (“Docucorp”) as of October 31, 2006 and July 31, 2006, and for the three months ended October 31, 2006 and 2005, have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The financial information presented should be read in conjunction with our annual consolidated financial statements for the year ended July 31, 2006. The foregoing unaudited interim consolidated financial statements reflect all adjustments (all of which are of a normal recurring nature), which are, in the opinion of management, necessary for a fair presentation of the results of the interim periods, and include the accounts of Docucorp and our wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Operating results for the three months ended October 31, 2006 are not necessarily indicative of the results to be expected for the year.
Revenue recognition
We derive our revenues from the sale of software licenses, annual software maintenance and support agreements, professional services and ASP hosting services. We recognize revenue in accordance with Statement of Position 97-2, “Software Revenue Recognition” and Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Revenue is recognized when a contract exists, the fee is fixed or determinable, delivery has occurred and collection of the receivable is deemed probable.
We use the residual method to recognize revenue from the sale of software licenses that are bundled with maintenance and support. Under the residual method, the fair value of the undelivered element(s) is deferred and the remaining value of the contract is recognized as revenue. Fair value of an element is based on vendor-specific objective evidence (“VSOE”). VSOE is based on the price charged when the same element is sold separately. We do not generally sell software licenses without selling maintenance and support for the licensed software. As a result, we have established VSOE only for the undelivered element(s) included in a multi-element arrangement. VSOE for maintenance and support is based upon prices customers pay to renew maintenance and support agreements. After expiration of the initial maintenance term, maintenance and support agreements are renewable on an annual basis and include rights to unspecified upgrades, updates and enhancements on a when and if available basis, as well as telephone support and bug fixes. Revenue generated from maintenance and support is recognized ratably over the maintenance term of the agreement. We record deferred revenue for maintenance amounts invoiced prior to the performance of the related services.
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Our standard software license agreements do not provide for rights of software return and/or conditions of acceptance. However, in the rare case that acceptance criteria are provided, revenue is deferred and not recognized until all acceptance provisions are satisfied. Revenue from software licenses which include a cancellation clause is recognized upon expiration of the cancellation period. License revenue related to products still in the testing phase is deferred until formal acceptance of the product by the customer.
Professional services revenue includes implementation, integration, training and consulting services relating to new software license sales and consulting with existing customers to provide additional services. For new software license sales that are sold with installation services, the residual method is applied, whereby the fair value of the services element is deferred along with the fair value of the maintenance and support, with the residual value of the contract recognized as license revenue. The services offered are not essential to the functionality of the software. Professional services revenue is generally billed on a time and material basis and is recognized as the services are performed.
Professional services revenue derived from the installation and integration of software packages under a fixed price contract is recognized on a percentage-of-completion basis measured by the relationship of hours worked to total estimated contract hours. We follow this method because reasonably dependable estimates of the revenue and contract hours applicable to various elements of a contract can be made. Since the financial reporting of these contracts depends upon estimates which are assessed continually during the term of these contracts, recognized revenue and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are reflected in the period in which the facts that give rise to the revisions become known. Accordingly, favorable changes in estimates result in additional revenue recognition and net income, and unfavorable changes in estimates result in a reduction of recognized revenue and net income. When estimates indicate that a loss will be incurred on a contract upon completion, a provision for the expected loss is recorded in the period in which the loss becomes evident.
Revenue from our ASP hosting operations is recognized in accordance with SAB 104, generally on a per transaction basis. ASP hosting agreements are generally one to five years in duration and provide for monthly billing based on transaction volume or contract minimums. Revenue related to the customer’s initial set up and implementation is deferred and subsequently recognized over the expected term of the ASP hosting agreement.
Cash equivalents
We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents are stated at cost, which approximates fair market value.
Accounts receivable
Accounts receivable is composed of billed and unbilled accounts receivable. Unbilled accounts receivable includes amounts recognized as revenue, primarily software license, for which the payments are not yet due and therefore, have not yet been billed.
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Allowance for doubtful accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We take into consideration the current financial condition of our customers, the specific details of the customer accounts, the age of the outstanding balance and the current economic environment when assessing the adequacy of the allowance. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required.
Property and equipment, depreciation and amortization
Property and equipment are carried at cost, less accumulated depreciation and amortization. Software developed for internal use is accounted for in accordance with AICPA Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Depreciation and amortization are computed over the estimated service lives using the straight-line method. Estimated service lives are as follows:
Leasehold improvements | | Lesser of useful life or life of lease |
Computer equipment | | 4-5 years |
Furniture and fixtures | | 5 years |
Equipment under capital leases | | Lesser of useful life or life of lease |
Costs related to repairs and maintenance are expensed as incurred. Major renewals and betterments are capitalized and depreciated over the assets’ remaining estimated service lives. Upon retirement or sale of an asset, the cost and accumulated depreciation are removed from the accounts with any resulting gain or loss included in income.
Software development costs
Software development costs are accounted for in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed” (“SFAS 86”). SFAS 86 requires the capitalization of certain software development costs, which include salaries and personnel related costs incurred in the development activities, once technological feasibility of the software has been established. Research and development costs incurred prior to the establishment of the technological feasibility of a product are expensed as incurred and are included in product development expense. The cost of capitalized software is amortized on a straight-line basis to cost of license revenue over its estimated useful life, generally three to six years, or the ratio of current revenues to current and anticipated revenues from the software, whichever provides the greater amortization.
Business combinations and goodwill and intangible assets
Upon acquisition of a business, we allocate the purchase price to tangible assets and liabilities acquired and identifiable intangible assets. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates are based on historical experience and information obtained from valuation specialists and the management
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from the acquired company. These estimates can include, but are not limited to, appraisals by valuation specialists, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital. Estimates used in determining the fair value of assets acquired and liabilities assumed are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates.
In accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” we assess the impairment of goodwill within our reporting units annually, during the third quarter, or more often if events or changes in circumstances indicate that the carrying value may not be recoverable. We assess the impairment of identifiable intangible assets whenever events or changes in circumstances indicate that their carrying amount may not be recoverable.
Impairment of long-lived assets
We have evaluated our long-lived assets for impairment, and will continue to do so as events or changes in circumstances indicate that the carrying value of such assets may not be fully recoverable. If facts or circumstances support the possibility of impairment, we prepare a projection of future operating cash flows, undiscounted and without interest. If based on this projection we do not expect to recover our carrying cost, an impairment loss equal to the difference between the fair value of the asset and its carrying value will be recognized in operating income.
Deferred revenue
Deferred revenue relates primarily to maintenance and support agreements that have been invoiced to customers prior to the performance of the related services. Maintenance and support services are generally billed annually in advance for services to be performed over a 12 month period. Maintenance and support provided under an initial software license contract is recorded as deferred revenue based on the VSOE of that maintenance, and is recognized over the term of the associated agreement.
Guarantees
In the ordinary course of business, we include standard indemnification provisions in our customer and distributor agreements. Pursuant to these agreements, we typically indemnify, hold harmless and reimburse the indemnified party for those losses suffered or incurred by the indemnified party arising from any trade secret, trademark, copyright, patent or other intellectual property infringement claim by any third party with respect to our software and services. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments that we could be required to make under these indemnification agreements is unlimited; however, we have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. We believe the estimated fair value of our obligation under these agreements is minimal. Accordingly, we have no liabilities recorded for these agreements as of October 31, 2006.
We currently provide software product warranties to our customers. The product warranties generally provide that the licensed software will operate substantially in accordance with the applicable user documentation for a period typically 90 days from delivery. At October 31, 2006, we did not have material product warranty liabilities.
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We have agreements in place with our directors and officers whereby we indemnify them for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a director and officer insurance policy that may enable us to recover a portion of any future amounts paid.
Translation of foreign currencies
We translate the financial statements of our European subsidiary into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation.” Assets and liabilities of our European subsidiary, whose functional currency is other than the U.S. dollar, are translated at period-end rates of exchange, and revenues and expenses are translated at average exchange rates prevailing during the period. Gains and losses on foreign currency transactions and the translation of our intercompany loan to a consolidated foreign subsidiary are recognized in other income as incurred. All other translation adjustments are reflected in stockholders’ equity as part of other comprehensive income.
Treasury stock
We account for Treasury Stock using the cost method. Gains on sales of Treasury Stock are credited to Additional Paid-in Capital (“APIC”), and losses are charged to APIC to the extent that previous net gains from sales are included therein, otherwise to Retained Earnings. Shares of our Common Stock are issued from our treasury shares as stock options are exercised and restricted shares are granted. Since inception of our stock repurchase program in fiscal 1999, we have repurchased approximately 9,763,000 shares of stock at an average purchase price of $5.39.
Income taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates for the year in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts more likely than not to be realized.
Net income per share
Our basic and diluted net income per share is computed in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Basic net income per share is computed using the weighted average number of common shares outstanding. Diluted net income per share is computed using the weighted average number of common shares outstanding and the assumed exercise of stock options and unvested restricted stock awards, using the treasury stock method. The treasury stock method recognizes the use of proceeds that could be obtained upon exercise of options and the unrecognized compensation on unvested restricted stock in computing diluted net income per share. It assumes that any proceeds would be used to purchase common stock at the average market price during the period. Options and unvested restricted stock will have a dilutive effect under the treasury stock method only when the average market price of common stock during the period exceeds the exercise price of the
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options or the average price computed from the unamortized compensation associated with unvested restricted stock. Following is a reconciliation of the shares used in computing basic and diluted net income per share for the periods indicated (in thousands):
| | Three months ended
October 31, | |
| | 2006 | | 2005 | |
Shares used in computing basic net income per share | | 11,071 | | 10,900 | |
| | | | | |
Dilutive effect of stock options and unvested restricted stock | | 563 | | 605 | |
| | | | | |
Shares used in computing diluted net income per share | | 11,634 | | 11,505 | |
At October 31, 2006 and 2005, options to purchase 96,000 shares and 348,000 shares of Common Stock at average exercise prices of $10.80 and $8.23 per share, respectively, were anti-dilutive and not included in the computation of diluted net income per share, because the options’ exercise prices were greater than the average market price of the Common Stock for the period.
At October 31, 2006 and 2005, 153,000 shares and 120,800 shares of unvested restricted stock, at average exercise prices of $7.99 and $7.12 per share, respectively, were anti-dilutive and not included in the computation of diluted net income per share, because restricted stocks’ calculated exercise prices were greater than the average market price of the Common Stock for the period.
Stock-based compensation
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised), “Share-Based Payment” (“SFAS 123R”). SFAS 123R requires employee stock-based compensation awards to be accounted for under the fair value method and eliminates the ability to account for these instruments under the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). We adopted SFAS 123R on a modified prospective basis beginning August 1, 2005 for stock-based compensation awards granted after that date and for unvested awards outstanding at that date. In addition, we followed the transition method for calculating the excess tax benefits available to absorb any future tax deficiencies that will be recognized subsequent to the adoption of SFAS 123R (the “APIC Pool”). Tax deficiencies arise when actual tax benefits realized upon the exercise of stock options are less than the recorded tax benefit. We determined our APIC pool utilizing the alternative transition method.
Stock-based compensation expense of $239,000 and $169,000 for the three months ended October 31, 2006 and 2005, respectively, relates to restricted stock and a recent option grant. Tax benefits from stock option exercises of $244,000 and $73,000 for the three months ended October 31, 2006 and 2005, respectively were reflected as an outflow from operating activities and an inflow from financing activities in the Consolidated Statement of Cash Flows.
In August 2006, the Compensation Committee of the Board of Directors granted 100,000 shares of restricted stock to certain executive officers. Based on the market value of our Common Stock, these restricted stock grants were valued at approximately $750,000. The restricted stock vests ratably over five years. Compensation expense related to the restricted stock grant is being recognized ratably over the vesting period.
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In September 2006, the Compensation committee of the Board of Directors approved the grant of 75,000 options, which have a fair value of $4.83 per option. The fair value of our stock-based awards was estimated using the Black-Scholes option pricing model with the following weighted average assumptions used for the grant: risk-free interest rate of 4.64%; no expected dividend yield; expected life of 6.50 years, and volatility of 59.3%. The Black-Scholes model was not developed for use in valuing employee stock options, but was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, it requires the use of subjective assumptions including expectations of future dividends and stock price volatility. Such assumptions are only used for making the required fair value estimate and should not be considered as indicators of future dividend policy or stock price appreciation. Because changes in the subjective assumptions can materially affect the fair value estimate, and because employee stock options have characteristics significantly different from those of traded options, the use of the Black-Scholes option-pricing model may not provide a reliable estimate of the fair value of employee stock options.
Management estimates
The preparation of our financial statements, in accordance with accounting principles generally accepted in the United States of America (“GAAP”), requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses at the date of the financial statements. On an ongoing basis, management evaluates its estimates and judgments. Actual results could differ from those estimates. Certain accounting policies require higher degrees of judgment than others in their application. The following accounting policies require significant estimates: revenue recognition, accounts receivable and allowance for doubtful accounts, fair value of acquired intangible assets and goodwill, impairment of long-lived assets, software development costs and income taxes.
Advertising costs
We expense advertising costs as incurred.
Royalty costs
We incur royalty costs associated with the licensing of certain software products. These fees vary based upon the terms of the royalty agreement.
Recently issued accounting guidance
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”), which prescribes accounting for and disclosure of uncertainty in tax positions. FIN 48 defines the criteria that must be met for the benefits of a tax position to be recognized. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, which is our fiscal 2008. We may need to record an obligation under FIN 48 associated with the transfer pricing issues impacting our 2002 and 2000 tax years, however, no amount has been determined. We are evaluating other potential impacts of this interpretation on our future results of operations and financial condition.
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On September 13, 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”), which provides consistency between how registrants quantify financial statement misstatements. SAB 108 allows companies to either (1) retroactively adjust prior financial statements as if an adjustment had always been recorded or (2) record the cumulative effect of initially applying an adjustment to the carrying values of assets and liabilities as of August 1, 2006 with a offsetting adjustment recorded to the opening balance of retained earnings. We will apply the interpretive guidance contained in SAB 108 during the fourth quarter of our fiscal 2007. Upon the initial application of SAB 108, we expect to record an increase for deferred rent in other long-term liabilities of $2.2 million and in increase in property and equipment of $2.2 million. We are still evaluating other potential impacts of SAB 108 on our future results of operations and financial condition. The accompanying financial statements do not reflect any adjustment for SAB 108.
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board or other standard setting bodies which we adopt as of the specified effective date. Unless otherwise discussed, we believe the impact of recently issued standards which are not yet effective will not have a material impact on our consolidated financial statements upon adoption.
Note 2 – Business segments
As set forth in the criteria of Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information,” we are organized into two reportable segments: Software and ASP hosting. The Software segment consists of initial software license sales, professional services consulting relating to our software products and continued customer support and maintenance of the software products. The ASP hosting segment provides processing, print, mail, archival and Internet delivery of documents for customers who outsource these activities. The table below presents information about reported segments for the three months ended October 31, 2006 and 2005 (in thousands):
| | Three months ended
October 31, | |
| | 2006 | | 2005 | |
Revenues: | | | | | |
Software | | $ | 13,484 | | $ | 12,770 | |
ASP hosting | | 8,218 | | 8,048 | |
Total revenues | | $ | 21,702 | | $ | 20,818 | |
| | | | | |
Software gross profit, net of product development costs | | $ | 4,951 | | $ | 4,910 | |
ASP hosting gross profit | | 851 | | 688 | |
Sales and marketing | | (2,618 | ) | (2,569 | ) |
General and administrative | | (2,032 | ) | (2,155 | ) |
Consolidated operating income | | $ | 1,152 | | $ | 874 | |
Note 3 – Commitments and contingencies
The Internal Revenue Service (“IRS”) has completed their examination of our tax years ended July 31, 2002 and 2000 and issued a notice of proposed adjustment for transfer pricing issues impacting
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intercompany interest and royalty income. Although these proposed adjustments would increase our U.S. taxable income for these tax years, we vigorously disagree with the proposed adjustments and are aggressively contesting these matters through applicable IRS and judicial processes, as appropriate. We have filed a written protest to these proposed adjustments thereby requesting an appeals conference with the IRS Office of Appeals. As of October 31, 2006, we concluded that the potential loss was not probable. With respect to the tax years under audit, the potential exposure ranges between $0 and $443,000, excluding interest and penalties.
Assurance cannot be given that these tax matters will be resolved in our favor in view of the inherent uncertainties involved in settlement initiatives and tax proceedings. Further, an unfavorable settlement may result in additional exposure for other open tax years. An unfavorable resolution of these tax matters may also have a material adverse impact on our consolidated financial position and results of operations.
Note 4 – Lease abandonment
At July 31, 2006, we had $1.3 million of obligations associated with abandoned leased facilities. During the three months ended October 31, 2006, we made payments of approximately $163,000 for these obligations. At October 31, 2006, our remaining obligations associated with abandoned leased facilities were approximately $1.1 million, net of an anticipated recovery from estimated sublease activity.
Note 5 – Subsequent event
In an effort to reduce product development costs and improve synergies within our product development organization, subsequent to the end of the quarter, we decided to relocate certain product development staff in Maryland to our office in Atlanta and to close our Maryland office facility, as the facility lease expires in December 2006. We expect to incur severance and relocation costs in the range of $600,000 to $1.1 million during the current fiscal year. Finalization of these transition plans are expected to be concluded by January 31, 2007.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-looking Statements
Certain information contained herein may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts included herein, are forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which include, but are not limited to, those discussed in the section entitled “Item 1A. Risk Factors” in our Form 10-K for the year ended July 31, 2006. Should one or more of these risks or uncertainties, among others as set forth herein, materialize, actual results may vary materially from those estimated, anticipated or projected. Although we believe that the expectations reflected by such forward-looking statements are reasonable based on information currently available to us, no assurance can be given that such expectations will prove to have been correct. Cautionary statements identifying important factors that could cause actual results to differ materially from our expectations are set forth herein. All forward-looking statements included herein and all subsequent oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements.
Overview
Docucorp develops, markets and supports CCM solutions via a portfolio of proprietary information software, ASP hosting and professional services that enable companies to create, publish, manage and archive complex, high-volume, individualized information. We support the entire information lifecycle – from acquisition of the first raw data point to final delivery of personalized information to the customer.
Our software products support leading hardware platforms, operating systems, printers and imaging systems. These products are designed to personalize, produce and manage documents such as insurance policies, utility statements, telephone bills, bank and mutual fund statements, invoices, health care provider directories, correspondence, bills of lading and other customer-oriented documents. Our ASP offerings include customer statement and bill generation, electronic bill presentment and payment, insurance policy production, provider directory generation, disaster recovery and electronic document archival.
Operating in four key vertical markets, insurance, utilities, financial services and health care, we currently have an installed base of more than 1,300 customers worldwide. More than half of the 200 largest United States insurance companies use our software products and services, including nine of the top 10 life and health insurance companies, nine of the top 10 property and casualty insurance companies and more than 600 MGAs. Many of the largest North American health care, utility companies and major international financial services institutions use our products and services.
We derive our revenues from ASP hosting fees, professional services fees, software license fees and recurring maintenance fees related to our software products. ASP hosting revenue consists of transactional fees earned from customers who outsource production of customer statements, insurance policies, utility statements, health care provider directories, disaster recovery and electronic document archival. Professional services revenue includes fees for implementation, integration, training and consulting services. Software license revenue is generally derived from the sale of perpetual licenses of software products. Maintenance revenue consists primarily of annual software maintenance and support agreements.
Our operating results are strongly tied to software license revenue. Software license sales generally have a high margin and ultimately drive additional professional services and maintenance revenues. A large portion of our software license revenue is generated from a small number of relatively large agreements
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executed in the latter part of a quarter. The timing of such large agreements is often unpredictable and impacted by events beyond our control, therefore making it difficult to forecast software license revenue accurately. Due to the nature of our software license sales, revenues and profits may vary from quarter to quarter.
Net income for the first quarter of fiscal 2007 increased 40% to $765,000, or $.07 per diluted share, from $546,000, or $.05 per diluted share, for first quarter of the prior year. Increases in revenues from ASP hosting, professional services and maintenance, combined with a reduction in G&A expenses, resulted in improved profitability during the first quarter of the current fiscal year. Partially offsetting these profit improvements were the effects of lower license revenue and increased software amortization and third party license royalties. Our financial position remains strong with $8.9 million of cash on hand and available borrowings under our revolving credit facility of $20.0 million at October 31, 2006.
Going forward, business and market uncertainties may affect results. For a discussion of key factors that could impact results, please refer to the section entitled “Risk Factors” in our Form 10-K for the year ended July 31, 2006.
Critical Accounting Policies and Estimates
The accompanying “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. We base our estimates and assumptions on historical experiences and various other factors that are believed to be reasonable under the circumstances. These estimates and assumptions are evaluated on an ongoing basis. Actual results may differ from previously estimated amounts due to different assumptions or conditions. The following critical accounting policies, which involve significant judgments and estimates, are used in the preparation of our consolidated financial statements:
Revenue recognition
We derive our revenues from the sale of software licenses, annual software maintenance and support agreements, professional services and ASP hosting services. We recognize revenue in accordance with Statement of Position 97-2, “Software Revenue Recognition” and Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Revenue is recognized when a contract exists, the fee is fixed or determinable, delivery has occurred and collection of the receivable is deemed probable.
We use the residual method to recognize revenue from the sale of software licenses that are bundled with maintenance and support. Under the residual method, the fair value of the undelivered element(s) is deferred and the remaining value of the contract is recognized as revenue. Fair value of an element is based on vendor-specific objective evidence (“VSOE”). VSOE is based on the price charged when the same element is sold separately. We do not generally sell software licenses without selling maintenance and support for the licensed software. As a result, we have established VSOE only for the undelivered element(s) included in a multi-element arrangement. VSOE for maintenance and support is based upon prices customers pay to renew maintenance and support agreements. After expiration of the initial maintenance term, maintenance and support agreements are renewable on an annual basis and include rights to unspecified upgrades, updates and enhancements on a when and if available basis, as well as telephone support and bug fixes. Revenue generated from maintenance and support is recognized ratably over the maintenance term of the agreement. We record deferred revenue for maintenance amounts invoiced prior to the performance of the related services.
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Our standard software license agreements do not provide for rights of software return and/or conditions of acceptance. However, in the rare case that acceptance criteria are provided, revenue is deferred and not recognized until all acceptance provisions are satisfied. Revenue from software licenses which include a cancellation clause is recognized upon expiration of the cancellation period. License revenue related to products still in the testing phase is deferred until formal acceptance of the product by the customer.
Professional services revenue includes implementation, integration, training and consulting services relating to new software license sales and consulting with existing customers to provide additional services. For new software license sales that are sold with installation services, the residual method is applied, whereby the fair value of the services element is deferred along with the fair value of the maintenance and support, with the residual value of the contract recognized as license revenue. The services offered are not essential to the functionality of the software. Professional services revenue is generally billed on a time and material basis and is recognized as the services are performed.
Professional services revenue derived from the installation and integration of software packages under a fixed price contract is recognized on a percentage-of-completion basis measured by the relationship of hours worked to total estimated contract hours. We follow this method because reasonably dependable estimates of the revenue and contract hours applicable to various elements of a contract can be made. Since the financial reporting of these contracts depends upon estimates which are assessed continually during the term of these contracts, recognized revenue and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are reflected in the period in which the facts that give rise to the revisions become known. Accordingly, favorable changes in estimates result in additional revenue recognition and net income, and unfavorable changes in estimates result in a reduction of recognized revenue and net income. When estimates indicate that a loss will be incurred on a contract upon completion, a provision for the expected loss is recorded in the period in which the loss becomes evident.
Revenue from our ASP hosting operations is recognized in accordance with SAB 104, generally on a per transaction basis. ASP hosting agreements are generally one to five years in duration and provide for monthly billing based on transaction volume or contract minimums. Revenue related to the customer’s initial set up and implementation is deferred and subsequently recognized over the expected term of the ASP hosting agreement.
Allowance for doubtful accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We take into consideration the current financial condition of our customers, the specific details of the customer accounts, the age of the outstanding balance and the current economic environment when assessing the adequacy of the allowance. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required.
Software development costs
Software development costs are accounted for in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed” (“SFAS 86”). SFAS 86 requires the capitalization of certain software development costs once technological feasibility is established. The capitalized costs are then amortized on a straight-line basis over the estimated product life, or on the ratio of current revenues to total projected product revenues, whichever provides the greater amortization. Management periodically assesses the realizability of software development costs when events and circumstances indicate a potential decline in value.
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Business combinations
Upon acquisition of a business, we allocate the purchase price to tangible assets and liabilities acquired and identifiable intangible assets. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates are based on historical experience and information obtained from valuation specialists and the management from the acquired company. These estimates can include, but are not limited to, appraisals by valuation specialists, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital. Estimates used in determining the fair value of assets acquired and liabilities assumed are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates.
Valuation of long-lived and intangible assets and goodwill
We recognize an impairment charge associated with our long-lived assets, including property and equipment, goodwill and other intangible assets whenever we determine that recovery of such long-lived assets is not probable. Such determination is made in accordance with the applicable GAAP requirement associated with the long-lived asset, and is based upon, among other things, estimates of the amount of future net cash flows to be generated by the long-lived asset and estimates of the current fair value of the asset. Adverse changes in future net cash flows or fair value could result in the inability to recover the carrying value of the long-lived asset, thereby requiring an impairment charge to be recognized and could have a material adverse impact on our results of operations. We perform an impairment analysis in accordance with Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets,” annually, during the third quarter, and whenever events and circumstances indicate that an impairment might be present. Our impairment analysis for our existing goodwill utilizes various assumptions and factors to estimate future cash flows to determine the fair value of the business. No impairment has been recognized to date; however, if our estimates of cash flow or other factors adversely change, an impairment charge might be recorded in the future.
Deferred taxes and valuation allowance
We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of the assets and liabilities. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. It is possible that in the future we may change our estimate of the amount of the deferred income tax assets that will more likely than not be realized, which will result in an adjustment to the valuation allowance that would either increase or decrease, as applicable, reported net income in the period such change in estimate was made.
Translation of foreign currency
We translate the financial statements of our European subsidiary into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation.” Assets and liabilities of our European subsidiary, whose functional currency is other than the U.S. dollar, are translated at period-end rates of exchange, and revenues and expenses are translated at average exchange rates prevailing during the period. Gains and losses on foreign currency transactions and the translation of our intercompany loan to a consolidated foreign subsidiary are recognized in other income as incurred.
We account for unrealized gains or losses on our foreign currency translation adjustments in accordance with Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” which requires adjustments to be accumulated in stockholders’ equity as part of other comprehensive income. Currently, we do not engage in foreign currency hedging activities.
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Historical Operating Results for the three months ended October 31, 2006 and 2005
The following table sets forth selected unaudited interim consolidated statements of operations data expressed in dollars and as a percentage of total revenues for the periods indicated (dollars in thousands):
| | Three months ended
October 31, | |
| | 2006 | | 2005 | |
Revenues | | | | | |
ASP hosting | | $ | 8,218 | | $ | 8,048 | |
Professional services | | 5,987 | | 5,372 | |
License | | 1,876 | | 2,035 | |
Maintenance | | 5,621 | | 5,363 | |
Total revenues | | $ | 21,702 | | $ | 20,818 | |
Percent relationship to total revenues:
| | Three months ended
October 31, | |
| | 2006 | | 2005 | |
Revenues | | | | | |
ASP hosting | | 38 | % | 38 | % |
Professional services | | 28 | | 26 | |
License | | 8 | | 10 | |
Maintenance | | 26 | | 26 | |
Total revenues | | 100 | | 100 | |
| | | | | |
Cost of revenues | | | | | |
ASP hosting | | 34 | | 35 | |
Professional services | | 21 | | 20 | |
License | | 7 | | 6 | |
Maintenance | | 1 | | 2 | |
Total cost of revenues | | 63 | | 63 | |
| | | | | |
Gross Profit | | 37 | | 37 | |
| | | | | |
Operating expenses | | | | | |
Product development | | 11 | | 11 | |
Sales and marketing | | 12 | | 12 | |
General and administrative | | 9 | | 10 | |
Total operating expenses | | 32 | | 33 | |
| | | | | |
Operating income | | 5 | | 4 | |
Interest expense | | 0 | | (1 | ) |
Other income, net | | 1 | | 1 | |
| | | | | |
Income before income taxes | | 6 | | 4 | |
Provision for income taxes | | 2 | | 1 | |
| | | | | |
Net income | | 4 | % | 3 | % |
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Comparative analysis of quarterly results for the three months ended October 31, 2006 and 2005
Revenues
The following table summarizes revenues (in thousands) and the percent change over the same period of the prior year:
| | Three months ended October 31, | |
| | 2006 | | 2005 | | % change | |
ASP hosting | | $ | 8,218 | | $ | 8,048 | | 2 | % |
Professional services | | 5,987 | | 5,372 | | 11 | |
License | | 1,876 | | 2,035 | | (8 | ) |
Maintenance | | 5,621 | | 5,363 | | 5 | |
Total revenues | | $ | 21,702 | | $ | 20,818 | | 4 | % |
Total revenues increased 4%, or $884,000, for the three months ended October 31, 2006, due to increases in ASP hosting revenue, professional services revenue and maintenance revenue, partially offset by a decrease in license revenue. For the three months ended October 31, 2006, ASP hosting revenue increased $170,000, or 2%. ASP hosting revenue for the current quarter includes a settlement fee of $270,000 that is attributable to a customer’s decision to cancel their contract prior to beginning any production, as a result of a change in their business direction. Professional services revenue increased 11%, or $615,000, for the three months ended October 31, 2006. Approximately 68% of the increase in professional services revenue was the result of a 65% increase in work performed in our EMEA operations. The remaining increase in professional services revenue was primarily due to improved billing rates in North America. Maintenance revenue increased 5%, or $258,000, for the three months ended October 31, 2006, primarily due to maintenance agreements associated with new license sales during the preceding twelve month period. License revenue declined 8%, or $159,000, for the three months ended October 31, 2006, primarily due to a decline in EMEA license sales.
Cost of revenues
The following table summarizes cost of revenues (in thousands) and the percent change over the same period of the prior year:
| | Three months ended October 31, | |
| | 2006 | | 2005 | | % change | |
ASP hosting | | $ | 7,367 | | $ | 7,360 | | 0 | % |
Professional services | | 4,531 | | 4,134 | | 10 | |
License | | 1,440 | | 1,174 | | 23 | |
Maintenance | | 279 | | 359 | | (22 | ) |
Total cost of revenues | | $ | 13,617 | | $ | 13,027 | | 5 | % |
Cost of ASP hosting revenue. Cost of ASP hosting revenue is composed primarily of salary and personnel related costs, facility and equipment costs and postage and supplies expense related to our ASP hosting centers. For the three months ended October 31, 2006, cost of ASP hosting revenue of $7.4 million was consistent with the same period of the prior year. For the three months ended October 31, 2006 and 2005, cost of ASP hosting revenue represented 90% and 91% of ASP hosting revenue, respectively. The decrease in cost as a percentage of ASP hosting revenue is primarily due to the recognition of $270,000 in ASP hosting revenue associated with a customer settlement fee. If the cost as a percentage of ASP hosting revenue was adjusted to exclude the revenue from the customer settlement fee, the cost as a
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percentage of ASP hosting revenue would have been 93%. Compared to the prior year, this increase in cost as a percentage of ASP hosting revenue is largely attributable to a change in the mix of our ASP hosting revenue. We expect the variable components of cost of ASP hosting revenue will continue to increase as ASP hosting revenue increases.
Cost of professional services revenue. Cost of professional services revenue consists of costs incurred in providing implementation, integration, training and consulting services. For the three months ended October 31, 2006, cost of professional services increased 10%, or $397,000, primarily due to an increase in salary and personnel related costs of $167,000 and a $134,000 increase in travel and living expenses. These increases are largely attributable to additional headcount and travel necessary to accommodate the increase in revenue. For the three months ended October 31, 2006 and 2005, cost of professional services revenue represented 76% and 77% of professional services revenue, respectively. We expect the cost of professional services revenue to increase as professional services activities and revenue increase both domestically and internationally.
Cost of license revenue. Cost of license revenue includes amortization of capitalized software development costs and royalties paid to third parties. For the three months ended October 31, 2006, cost of license revenue increased 23%, or $266,000. Approximately half of this increase is attributable to increased amortization expense related to new products recently introduced to the marketplace and the remainder of the increase is attributable to the increases in royalty costs primarily related to sales of the Forms Integrity Manager product. For the three months ended October 31, 2006 and 2005, cost of license revenue represented 77% and 58% of license revenue, respectively. The increase in costs as a percent of license revenue is due to lower software license sales during the first quarter of fiscal 2007 and the increase in software amortization and royalty costs. We anticipate cost of license revenue to increase as amortization of capitalized development costs increases as new products become generally available and if sales of products requiring third party royalties continue to increase.
Cost of maintenance revenue. Cost of maintenance revenue consists of costs incurred in providing customer telephone and online support. Cost of maintenance revenue decreased 22%, or $80,000, for the three months ended October 31, 2006, primarily due to a reduction in maintenance staffing that was enabled by a lower demand for support of our mature legacy products. For the three months ended October 31, 2006 and 2005, cost of maintenance revenue represented approximately 5% and 7% of maintenance revenue, respectively. The cost of maintenance revenue is expected to increase as salaries and personnel related costs increase due to annual merit raises and extending customer support hours to accommodate certain international customers. However, the increase in cost of maintenance revenue is expected to be at a slower rate than the expected increase in maintenance revenue.
Operating expenses
The following table summarizes operating expenses (in thousands) and the percent change over the same period of the prior year:
| | Three months ended October 31, | |
| | 2006 | | 2005 | | % change | |
Product development | | $ | 2,283 | | $ | 2,193 | | 4 | % |
Sales and marketing | | 2,618 | | 2,569 | | 2 | |
General and administrative | | 2,032 | | 2,155 | | (6 | ) |
Total operating expenses | | $ | 6,933 | | $ | 6,917 | | 0 | % |
Product development. Product development expense consists primarily of costs associated with developing new products prior to establishing technological feasibility, enhancing existing products, testing software products and developing product documentation. For the three months ended October 31, 2006, product development expense increased 4%, or $90,000, primarily due to approximately
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$250,000 of severance expense related to staff reductions, partially offset by an increase in capitalization of software development costs. The staff reductions were made in response to a decrease in requirements for continuing development and hotline call support for legacy products. In a further effort to reduce product development costs and improve synergies within our product development organization, subsequent to the end of the quarter, we decided to relocate certain product development staff in Maryland to our office in Atlanta and to close our Maryland office facility, as the facility lease expires in December 2006. We expect to incur severance and relocation costs in the range of $600,000 to $1.1 million during the current fiscal year. Finalization of these transition plans are expected to be concluded by January 31, 2007.
Sales and marketing. Sales and marketing expense consists primarily of salaries and personnel related costs, incentive compensation and costs associated with marketing programs. Sales and marketing expense were relatively flat increasing 2%, or $49,000, for the three months ended October 31, 2006.
General and administrative. General and administrative expense consists primarily of salary and personnel related costs for accounting, human resources, legal and information technology, as well as outside legal, accounting and other services. General and administrative expense decreased 6%, or $123,000, for the three months ended October 31, 2006, primarily due to a decrease in accounting fees associated with lower audit, Sarbanes-Oxley compliance and annual report costs.
Lease abandonment. At July 31, 2006, we had $1.3 million of obligations associated with abandoned leased facilities. During the three months ended October 31, 2006, we made payments of approximately $163,000 for these obligations. At October 31, 2006, our remaining obligations associated with abandoned leased facilities were approximately $1.1 million, net of an anticipated recovery from estimated sublease activity.
Interest expense
For the three months ended October 31, 2006, interest expense decreased $43,000, primarily due to principal payments made to reduce our outstanding bank debt.
Other income, net
Other income, net increased $36,000 for the first quarter ended October 31, 2006, primarily due to an increase in interest income generated by higher interest rates.
Provision for income taxes
The effective tax rate for the three months ended October 31, 2006 and 2005 was 37.5% and 37.0%, respectively. For the first quarter, the rate differs from the federal statutory rate due primarily to the state tax accrual rate and certain recurring permanent differences. We expect our effective rate for fiscal 2007 to be consistent with fiscal 2006.
The Internal Revenue Service (“IRS”) has completed their examination of our tax years ended July 31, 2002 and 2000 and issued a notice of proposed adjustment for transfer pricing issues impacting intercompany interest and royalty income. Although these proposed adjustments would increase our U.S. taxable income for these tax years, we vigorously disagree with the proposed adjustments and are aggressively contesting these matters through applicable IRS and judicial processes, as appropriate. We have filed a written protest to these proposed adjustments thereby requesting an appeals conference with the IRS Office of Appeals. As of October 31, 2006, we concluded that the potential loss was not probable. With respect to the tax years under audit, the potential exposure ranges between $0 and $443,000, excluding interest and penalties.
Assurance cannot be given that these tax matters will be resolved in our favor in view of the inherent uncertainties involved in settlement initiatives and tax proceedings. Further, an unfavorable settlement
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may result in additional exposure for other open tax years. An unfavorable resolution of these tax matters may also have a material adverse impact on our consolidated financial position and results of operations.
Liquidity and Capital Resources
At October 31, 2006, our principal sources of liquidity consisted of cash and cash equivalents of $8.9 million and our revolving credit facility, which had available borrowings of $20 million. Cash and cash equivalents for the three months ended October 31, 2006, decreased $909,000 from $9.8 million at July 31, 2006.
Cash provided by operating activities was $1.8 million and $3.4 million for the three months ended October 31, 2006 and 2005, respectively. Significant changes in assets and liabilities for the three months ended October 31, 2006 that impacted cash flow from operations included a decrease in accounts payable and accrued liabilities of $699,000 and $193,000, respectively primarily due to payments made during the quarter.
During the three months ended October 31, 2006 and 2005, cash used in investing activities was $2.2 million and $1.6 million, respectively. Cash used for the purchase of property and equipment was $799,000 and $363,000 for the three months ended October 31, 2006 and 2005, respectively. Cash used in the investment of capitalized software development costs was $1.4 million and $1.3 million for the three months ended October 31, 2006 and 2005, respectively.
Cash used in financing activities was $576,000 and $923,000 for the three months ended October 31, 2006 and 2005, respectively. Cash used in financing activities during the three months ended October 31, 2006, primarily related to principal payments made under our debt and lease obligations of $903,000 and $461,000, respectively, partially offset by proceeds of $544,000 received from the exercise of stock options.
In December 2002, we entered into various capital lease arrangements for the rental of computer equipment at our ASP hosting facilities in the aggregate amount of $3.2 million. The lease agreements require monthly payments of principal and interest of approximately $65,000 and expire in December 2007.
With the acquisition of Newbridge in September 2004, we assumed several capital lease obligations in the aggregate amount of $2.3 million. These leases require monthly payments of principal and interest of approximately $51,000 and expire at varying dates over the next two years.
On June 3, 2003, we repurchased 3.1 million shares of our Common Stock along with warrants to purchase approximately 161,000 of additional shares of Common Stock from Safeguard Scientifics, Inc. (“Safeguard”) and a former officer of Safeguard for $5.95 per share. In connection with the repurchase, we entered into a $14.2 million bank term note, of which $2.4 million was outstanding at October 31, 2006. The bank term note bears interest at a fixed annual rate of 3.32% and is repayable in equal monthly installments over four years.
As of October 31, 2006, we held approximately 4.9 million shares of treasury stock at an average per share cost of $5.59. In March 2006, we amended the stock repurchase program to authorize the repurchase of up to 1.0 million additional shares of Common Stock. At October 31, 2006, 4,000 shares have been repurchased under the amended program. Since inception of our stock repurchase program in fiscal 1999, we have repurchased approximately 9.8 million shares of stock at an average purchase price of $5.39. Our Board of Directors believes the repurchase program is an appropriate means of increasing shareholder value.
At October 31, 2006, we have a $20 million revolving credit facility from Comerica Bank, which expires on November 1, 2009. The credit facility bears interest at the bank’s prime rate less 100 basis points or LIBOR rate of interest plus 150 basis points, and is collateralized by substantially all of our assets. As of
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October 31, 2006, there were no borrowings under this credit facility. Under our bank term note and credit facility, we are required to maintain certain financial and non-financial covenants. Based on the financial covenants, availability of funds under our revolving bank credit facility was $20.0 million at October 31, 2006.
Our liquidity needs are expected to arise primarily from the repayment of debt, payments of obligations under leases, funding the continued development activities, including severance and relocation costs, potential purchases of our Common Stock, enhancements and support of our software offerings and sales and marketing costs associated with expansion in new vertical and international markets. A portion of our cash or borrowings under our revolving credit facility could be used to acquire complementary businesses or obtain the right to use complementary technologies.
Our liquidity could be negatively impacted by a decrease in demand for our products, which are subject to rapid technology changes, reduction in capital expenditures by our customers and intense competition, among other factors. Operating leases are our only off balance sheet arrangements.
We currently anticipate that existing cash and cash equivalents, together with cash generated from operations and available borrowings under our credit facility, will be sufficient to satisfy our operating cash needs for the next 12 months.
Recently issued accounting guidance
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”), which prescribes accounting for and disclosure of uncertainty in tax positions. FIN 48 defines the criteria that must be met for the benefits of a tax position to be recognized. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, which is our fiscal 2008. We may need to record an obligation under FIN 48 associated with the transfer pricing issues impacting our 2002 and 2000 tax years, however, no amount has been determined. We are evaluating other potential impacts of this interpretation on our future results of operations and financial condition.
On September 13, 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”), which provides consistency between how registrants quantify financial statement misstatements. SAB 108 allows companies to either (1) retroactively adjust prior financial statements as if an adjustment had always been recorded or (2) record the cumulative effect of initially applying an adjustment to the carrying values of assets and liabilities as of August 1, 2006 with a offsetting adjustment recorded to the opening balance of retained earnings. We will apply the interpretive guidance contained in SAB 108 during the fourth quarter of our fiscal 2007. Upon the initial application of SAB 108, we expect to record an increase for deferred rent in other long term liabilities of $2.2 million and in increase in property and equipment of $2.2 million. We are still evaluating other potential impacts of SAB 108 on our future results of operations and financial condition. The accompanying financial statements do not reflect any adjustment for SAB 108.
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board or other standard setting bodies which we adopt as of the specified effective date. Unless otherwise discussed, we believe the impact of recently issued standards which are not yet effective will not have a material impact on our consolidated financial statements upon adoption.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
We have no derivative financial instruments. We invest our cash and cash equivalents in investment grade, highly liquid investments, consisting of money market instruments and commercial paper. We have fixed rate debt instruments of $2.6 million as of October 31, 2006.
We are exposed to market risk arising from changes in foreign currency exchange rates as a result of selling our products and services outside the U.S. (principally Europe). A portion of our sales generated from our non-U.S. operations are denominated in currencies other than the U.S. dollar, principally British pounds. Consequently, the translated U.S. dollar value of our non-U.S. sales, operating results and cash flows are subject to currency exchange rate fluctuations, which may favorably or unfavorably impact reported earnings and may affect comparability of period-to-period operating results.
For the three months ended October 31, 2006 and 2005, 7% and 6%, respectively, of our revenues were denominated in British pounds. For the three months ended October 31, 2006 and 2005, 10% and 7% of our costs of revenue and operating expenses were denominated in British pounds. Historically, transactional gains and losses from the effect of fluctuations in currency exchange rates have not had a material impact on our operations; however, there can be no guarantees that it will not have a material impact in the future. The exposure to fluctuations in currency exchange rates will increase as we expand our operations outside the U.S.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
Our management, with participation of our Principal Executive Officer and Principal Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on this evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective as defined in Rule 13a-15(e) and 15d-15(e).
Internal control over financial reporting
There were no changes in our internal control over financial reporting during the period ended October 31, 2006, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We are occasionally involved in legal proceedings and other claims arising out of our operations in the normal course of business. No such claims are expected, individually or in the aggregate, to have a material adverse effect on our consolidated financial statements.
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Item 6. Exhibits
31.1 | – | Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. |
| | |
31.2 | – | Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. |
| | |
32.1 | – | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002. |
| | |
32.2 | – | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002. |
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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.
Docucorp International, Inc. | | | | |
(Registrant) | | | | |
| | | | |
| | | | |
/s/ MICHAEL D. ANDERECK | | | | Date | December 5, 2006 |
Michael D. Andereck | | | | |
President and Chief Executive Officer | | | | |
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