License revenues decreased 52% to $3.0 million for the three months ended October 31, 2004 from $6.3 million for the three months ended October 31, 2003. The decrease in license revenues is primarily attributable to a $3.4 million federal enterprise license transaction that was recorded during the year-ago period and the absence of a like sized transaction for the third quarter of fiscal 2005. Federal license revenues decreased by 78% compared to the same period last year due to the aforementioned large transaction. Commercial license revenues decreased by 21% over the same period last year due to fewer new customers during the period. International license revenues increased 221% compared to the same quarter last year due primarily to a large country license renewal that represented approximately 27% of the total International revenue for the quarter. License revenues for the nine months ended October 31, 2004 were $11.1 million, a decrease of 27% from license revenues of $15.1 million reported for the corresponding period last year. International license revenues for the nine-month period increased 15% over the same period last year, while commercial and federal license revenues decreased 32% and 43%, respectively.
Services revenues, which include amounts generated through software implementation, training and other professional services, increased 72% to $ 1.3 million for the three months ended October 31, 2004 from $0.7 million for the three months ended October 31, 2003. Services revenues for the commercial and federal sectors increased 125% and 81%, respectively, while international services revenues decreased 49% over the third quarter last year. For the nine months ended October 31, 2004, services revenues declined 15% to $2.9 million from $3.4 million in the same period last year. This decrease is attributable to the timing of certain services engagements realized within the prior year nine-month period versus the nine-month period of the current fiscal year. Commercial services revenues increased during the three and nine-month periods of the current fiscal year compared to last year due to a significant services agreement signed in the second fiscal quarter of the current year.
Software maintenance and customer support revenues increased 8% to $1.8 million for the quarter ended October 31, 2004 from $1.7 million in the same quarter last year. For the nine months ended October 31, 2004, software maintenance and customer support revenues increased 13% to $5.4 million from $4.8 million in the prior year period. The increase in maintenance revenues in the current quarter and for the nine-month period compared to the same periods last year is due to increased Federal and International client renewals offset by a decline in Commercial compared to last fiscal year.
For the three and nine months ended October 31, 2004, total revenues derived from sales to agencies of the U.S. Federal government were approximately $2.9 million and $9.1 million, representing 47% of total revenues in each period. No single customer accounted for 10% or more of the Company’s revenues for the current fiscal quarter. One reseller accounted for approximately 11% and 20% of the Company’s total revenues for the three and nine-month periods ended October 31, 2004, respectively. Revenues derived from one single customer accounted for 39% and 15% of the Company’s total revenues for the three and nine months ended October 31, 2003, respectively.
Revenues from international operations are generated primarily from software licenses and related support services with various European commercial and government customers. The Company’s international sales operation, Convera Technologies International, Ltd. (“CTIL”), is headquartered in the United Kingdom, with offices in Germany and France. As of July 31, 2004 the French office was closed. CTIL revenues increased 155% for the three months ended October 31, 2004 to $2.0 million from $0.8 million in the third quarter last year. For the nine months ended October 31, 2004, revenues from CTIL increased 8% to $6.0 million from $5.5 million in the comparable period last year.
Cost of Revenues
Cost of license revenues increased 40% to $516,000 in the current quarter from $368,000 in the third quarter last year. Cost of license revenues as a percentage of license revenues was 17% in the current quarter compared to 6% in the same quarter last year. For the nine months ended October 31, 2004, cost of license revenues increased 24% to $1.6 million from $1.3 million in the first nine months of last year. As a percentage of license revenues, cost of license revenues was 15% and 9% for the nine months ended October 31, 2004 and 2003, respectively. An increase in third party licensing costs accounts for the increase in cost of licenses as a percentage of revenues for both the three and nine-month periods ended October 31, 2004.
Cost of services revenues of $1.1 million for the three months ended October 31, 2004 increased 12% from $1.0 million in the third quarter last fiscal year. Cost of services revenues as a percentage of services revenues was 84% in the current quarter compared to 130% in the same quarter last year. For the first nine months of the current fiscal year, cost of services revenues decreased to $2.6 million, or 31%, from $3.8 million in the first nine months of last year. As a percentage of services revenues, cost of services revenues were 89% and 110% for the nine months ended October 31, 2004 and 2003, respectively. The increase in cost of service revenues during the current quarter compared to last year is attributable to an increase in Federal services personnel required to address current market opportunities and customer requests. The decrease in the year-to-date costs compared to last year is attributable to lower personnel related costs in both Commercial and International services.
Cost of maintenance revenues of $428,000 for the three months ended October 31, 2004 decreased by 20% compared to $534,00 for the third quarter of the prior fiscal year. As a percentage of maintenance revenues, cost of maintenance was 24% for the current quarter compared to 32% for the third fiscal quarter last year. For the nine months ended October 31, 2004, cost of maintenance revenues of $1.4 million decreased 8% from the comparable period last year. Cost of maintenance revenues as a percentage of maintenance revenues was 26% in the nine months ended October 31, 2004 compared to 31% in the same period last year. The decrease in cost of maintenance revenues as compared to the third quarter last year was due to the reduction of personnel in the customer support organization.
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Operating expenses
Sales and marketing expenses decreased 33% in the quarter ended October 31, 2004 to $2.9 million from $4.4 million in the third quarter last year, representing 48% and 50% of total revenues, respectively. For the first nine months of the current fiscal year, sales and marketing expenses decreased 11% compared to the corresponding period last year. Sales and marketing expenses represented 63% of total revenues for the nine months ended October 31, 2004 compared to 59% of revenues for the nine months ended October 31, 2003. The decrease in sales and marketing expense in the current quarter is attributable to three factors; reduced personnel related costs, lower sales commissions and lower marketing program expenses. On a nine month basis, these three factors as well as decreased consulting fees contributed to the lower sales and marketing expenses compared to the same period last fiscal year.
Total research and product development costs increased 5% to $3.0 million in the current quarter compared to $2.9 million in the same quarter last year. Research and product development costs as a percentage of total revenues were 50% in the current quarter compared to 33% in the third quarter last year. For the nine months ended October 31, 2004, research and product development costs increased 10% to $10.3 million from $9.4 million in the comparable period last year, representing 53% and 40% of total revenues, respectively. The Company continues to invest in its Web indexing initiative which is an advanced development program focused on applying portions of the Company’s existing technology to assist customers in locating contextually relevant information on the World Wide Web. This development effort has resulted in increased personnel-related costs in the current fiscal year and the Company expects to continue with this resource allocation.
General and administrative expenses decreased 25% to $2.2 million in the current quarter from $2.9 million in the third quarter of last year, representing 36% and 33% of total revenues, respectively. For the nine months ended October 31, 2004, general and administrative expenses decreased 4% to $7.1 million from $7.4 million in the corresponding period last fiscal year, representing 37% and 32% of total revenues, respectively. The decrease in general and administrative expenses compared to last year is primarily due a decrease in accounting and legal fees in the current quarter and year-to-date periods compared to last fiscal year. Personnel related costs have also contributed to this decrease.
Restructuring charges
On August 18, 2004, the Company adopted a restructuring plan in an effort to further reduce operating costs and streamline operations. As part of the restructuring, the Company reduced its personnel related costs, eliminated certain marketing programs, renegotiated real estate obligations and decreased other general operating expenses. The restructuring is expected to result in annualized savings of approximately $12 million that will begin to be realized during the fourth quarter of fiscal 2005. As a result of this action, the Company reduced its workforce by 36 employees worldwide, including 13 individuals from the engineering group, six from the sales group, nine from the professional services group, four from the marketing group and four from the G&A group. In the current quarter the Company recorded a restructuring charge of $518 related to severance costs for terminated employees. The Company paid $445 of the severance costs in the third quarter and expects to settle the remaining balance of $73 by the close of the current fiscal year.
During the first quarter of fiscal year 2004, the Company adopted a restructuring plan as a part of its continued efforts to streamline operations. In connection with this reorganization, the Company reduced its workforce by 11 employees worldwide, including four individuals from the general and administrative group, four from the marketing group, two from the sales group and one from the engineering group. The Company recorded a restructuring charge of $0.3 million related to severance costs for terminated employees. The Company estimated that annualized expense and cash savings resulting from the termination of employees would be approximately $1.7 million, which included approximately $1.3 million in estimated sales and marketing expense savings, approximately $0.3 million in estimated general and administrative expense savings, and approximately $0.1 million in estimated research and development expense savings. The savings were estimated to begin being realized in the second quarter of fiscal year 2004. In the second quarter of fiscal year 2004, the Company announced an additional reduction in force. As a result of this action, the Company reduced its workforce by 17 employees worldwide, including nine individuals from the engineering group, three from the sales group, three from the professional services group and two from the marketing group. The Company recorded a restructuring charge of $0.3 million related to severance costs for terminated employees. The Company estimated that annualized expense and cash savings resulting from the second fiscal quarter termination of employees would be approximately $2.2 million, which included approximately $1.0 million in estimated sales and marketing expense savings, approximately $1.0 million in estimated research and development expense savings, and approximately $0.2 million in estimated cost of revenues savings. The savings were estimated to begin being realized in the third fiscal quarter of fiscal year 2004.
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Interest income, net
Net interest income for the third quarter of the current fiscal year is comparable to the third quarter of last fiscal year. For the nine months ended October 31, 2004, net interest income decreased to $112,000 from $145,000 in the same period last year. Interest income in the current quarter was flat compared to the same period last year. Interest rate increases in the current quarter were offset by less invested funds compared the third quarter in the prior fiscal year. The decrease in the year-to-date totals is a result of lower interest income due to lower invested funds.
Liquidity and Capital Resources
The Company’s combined balance of cash, cash equivalents and short-term investments at October 31, 2004 as compared to January 31, 2004 is summarized below (in thousands).
| | October 31,
2004 | | January 31,
2004 | | Change | |
| |
| |
| |
| |
| | Cash and cash equivalents | $ | 22,662 | | $ | 30,530 | | $ | (7,868 | ) |
| Investments | | 71 | | | 71 | | | — | |
| |
| |
| |
| |
| Total | $ | 22,733 | | $ | 30,601 | | $ | (7,868 | ) |
| |
| |
| |
| |
During the nine months ended October 31, 2004, the Company used cash of $17.0 million to fund operating activities, compared to $11.3 million used in the same period last year. The net loss of $16.3 million was offset by non-cash charges totaling $2.4 million including depreciation of $1.1 million, provision for doubtful accounts of $0.1 million, amortization of developed technology of $0.2 million, and amortization of deferred stock compensation of $1.0 million. Increases to accounts receivable used $1.3 million while decreases to prepaid expenses and other assets provided $0.7 million. Decreases to accounts payable, accrued expenses, accrued bonuses used cash of $1.0 million, while increases to deferred revenues provided cash of $0.1 million. Decreases to the restructuring reserve and other long-term liabilities used cash of $1.6 million. During the nine months ended October 31, 2003, the Company used cash of $11.3 million to fund operating activities. The prior year nine month net loss of $14.3 million was offset by non-cash charges totaling $2.1 million including depreciation of $1.3 million, bad debt expense of $0.2 million, amortization of intangible assets of $0.2 million, and amortization of deferred stock compensation of $0.4 million. Increases in deferred revenues, accounts payable, accrued expenses and accrued bonuses as well as a decrease in prepaid expenses and other assets provided cash of $2.5 million, while an increase in accounts receivable used cash of $0.3 million. The decrease in the restructuring reserve used net cash of $1.2 million.
For the nine months ended October 31, 2004, cash flows from investing activities used cash of $1.5 million related to purchases of equipment and leasehold improvements. For the nine months ended October 31, 2003 cash flows from investing activities provided the Company cash of $19.6 million. Proceeds from the maturity of U.S. treasury bills provided cash of $20.0 million, while purchases of equipment and leasehold improvements used cash of $0.4 million.
Financing activities provided cash of $10.8 million for the nine months ended October 31, 2004. A private placement of 3,433,333 newly-issued shares of common stock to several investors, including affiliates of Allen & Company Incorporated, a significant stockholder of the company, and certain directors resulted in proceeds of $10.3 million. The shares were priced on September 7, 2004 at $3.00 per share, representing a premium to the $2.80 closing market price on such date. Additionally, cash of approximately $0.1 million was provided by the issuance of stock under the employee stock purchase plan and cash of $0.4 million was provided from the exercise of employee stock options. Financing activities provided cash of $16.7 million for the nine months ended October 31, 2003. Net proceeds of $16.0 million were provided by a private placement of 4,714,111 shares of common stock to a group of unaffiliated institutional investors at a purchase price of $3.60 per share. Cash of approximately $0.1 million was provided by the issuance of stock under the employee stock purchase plan, and cash of $0.2 million was provided by the exercise of employee stock options. Net cash proceeds of $0.4 million were provided by the issuance of warrants.
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At October 31, 2004 the Company’s balance of cash, cash equivalents and short-term investments was $ 22.7 million. The Company believes that its current balance of cash, cash equivalents and short-term investments and its funds generated from operations, if any, will be sufficient to fund the Company’s current projected cash needs for at least the next twelve months. Excluding the cash acquired as part of the Combination and other acquisitions, the Company has historically been entirely funded by sales of its common stock. If actions taken by management are not effective in achieving profitable operating results, the Company may be required to pursue additional external sources of financing to support its operations and capital requirements. The Company has previously disclosed that it may elect to seek additional funding for its Web indexing initiative. There can be no assurance that external sources of financing will be available if required, or that such financing will be available on terms acceptable to the Company.
Contractual Obligations
The Company has the following contractual obligations:
| Payments Due By Period (in thousands) | |
|
| |
| | | | | | | | | | | |
| Total | | 2005 | | 2006 | | 2007 | | 2008 | |
|
| |
| |
| |
| |
| |
| Operating leases | $ | 4,483 | | $ | 883 | | $ | 2,018 | | $ | 1,182 | | $ | 400 | |
| Other contractual obligations | | 2,901 | | | 602 | | | 2,299 | | | — | | | — | |
|
| |
| |
| |
| |
| |
| Total | $ | 7,384 | | $ | 1,485 | | $ | 4,317 | | $ | 1,182 | | $ | 400 | |
| | • | Operating lease obligations — represents the minimum lease rental payments under non-cancelable leases, primarily for the Company’s office space and operating equipment in various locations around the world. |
| | • | Other contractual obligations — represents the principal amounts due on outstanding contractual obligations relating to a separation agreement with a former executive, a hosting agreement between the Company and AT&T related to the Company’s Web indexing initiative and a settlement agreement between the Company and Intel Corporation, current and long-term, as of October 31, 2004. |
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Forward Looking Statements
Certain written and oral statements made by the Company may constitute “forward-looking statements” as defined under the Private Securities Litigation Reform Act of 1995, including statements made in this report and other filings with the Securities and Exchange Commission. Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will” and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future including statements relating to volume growth, share of sales and earnings per share growth and statements expressing general optimism about future operating results are forward-looking statements. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our Company’s historical experience and our present expectations or projections. As and when made, management believes that these forward-looking statements are reasonable. However, caution should be taken not to place undue reliance on any such forward-looking statements since such statements speak only as of the date when made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following are some of the factors that could cause the Company’s actual results to differ materially from the expected results described in or underlying the Company’s forward-looking statements:
The Company has had a history of operating losses and may incur future losses; if the Company is unable to achieve profitability, the Company’s stock price will likely suffer and steps which the Company may take to reduce its expenditures or preserve its existing funds could harm its sales and financial results
The Company believes that its future profitability will depend on its ability to effectively market existing and newly developed software products through a balanced multi-channel distribution network. The Company cannot assure that its costs to develop, introduce and promote enhanced or new products will not exceed its expectations, or that these products will generate revenues sufficient to offset these expenses. The Company has operated at a loss for each of the past three fiscal years. For the fiscal years ended January 31, 2004, 2003, and 2002, the Company’s net losses were approximately $18.1 million, $29.1 million, and $910.5 million, respectively. For the nine months ended October 31, 2004, the Company had a net loss of $16.3 million. These losses include the Company’s expenditures associated with selling software products and further developing software products during these years. The Company plans to continue to invest in these programs and, accordingly, it cannot assure that its operating losses will not continue in the future. Continued losses could reduce the Company’s liquidity and negatively affect its stock price. As of October 31, 2004, the Company’s balances of cash, cash equivalents and short-term investments were approximately $22.7 million. The Company believes its current balance of cash, cash equivalents and short-term investments, combined with any funds generated from its operations will be sufficient to fund its operations for at least the next twelve months based upon its estimates of funds required to operate its business during such period. However, if, at any point, due to continued losses, the Company ceases to have sufficient funds to continue its operations, it would need to decrease its expenditures (although at this point the Company cannot accurately predict the amount of that decrease). As a result of any decrease in expenditures, the Company may need to terminate employees, curtail research and development programs and take other steps to reduce the amount of funds it expends in its operations. This could have a negative effect on the Company’s ability to develop product improvements or new products that will achieve market acceptance. This could in turn, have a negative impact on the Company’s sales and financial results.
The Company experiences quarterly fluctuations in its operating results, which may adversely affect its stock prices; for example, the Company’s total revenues in the first three quarters of fiscal year 2005 were $8.2 million, $5.1 million and $6.1 million, respectively, and the price per share of its common stock during those quarters ranged from $2.16 to $5.40
The Company’s quarterly operating results have varied substantially in the past and are likely to continue to vary substantially from quarter to quarter in the future, due to a variety of factors including, but not limited to the following:
| | • | | the downturn in capital spending by customers as a result of the current economic slowdown; |
| | • | | reduced customer demand for the Company’s products and services; |
| | • | | the delay or deferral of customer implementations; |
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| | • | | the budget cycles of the Company’s customers; |
| | • | | seasonality of individual customer buying patterns; |
| | • | | an increase in competition in the software industry; |
| | • | | the size and timing of individual transactions; |
| | • | | the timing of new software introductions and software enhancements by the Company and its competitors; |
| | • | | continued success in technological advances and development including the Web initiative; |
| | • | | changes in operating expenses and personnel; |
| | • | | changes in accounting principles, such as a requirement that stock options be included in compensation, as is currently being considered by Congress and, which, if adopted, would increase the Company’s compensation expense and have a negative effect on earnings; |
| | • | | the overall trend towards industry consolidation; and |
| | • | | changes in general economic and geo-political conditions and specific economic conditions in the computer and software industries. |
In particular, the Company’s period-to-period operating results have historically been significantly dependent upon the timing of the closing of significant license agreements. Because purchasing the Company’s products often requires significant capital investment, its customers may defer or decide not to make their purchases. This means sales can involve long sales cycles of nine months or more. The Company derives a significant portion of its revenues from sales to agencies of the U.S. Government, and, therefore, the budget cycle of the U.S. Government impacts the Company’s total revenues. In certain financial quarters, the Company has derived a significant portion of its revenues from a single customer. For example, revenues derived from one reseller accounted for approximately 20% of the Company’s total revenues for the first nine months of fiscal year 2005. The Company has generally recorded a significant portion of its total quarterly license revenues in the third month of a quarter, with a concentration of these revenues occurring in the last half of that third month. The Company expects these revenue patterns to continue. Despite these uncertainties in the Company’s revenue patterns, it bases its operating expenses upon anticipated revenue levels, and the Company incurs them on an approximately ratable basis throughout a quarter. As a result, if expected revenues are deferred or otherwise not realized in a quarter for any reason, the Company’s business, operating results and financial condition would be materially adversely affected.
In addition, steps which the Company has taken or may take in the future to control operating expenses may hamper its development, sales and marketing efforts and, ultimately, its operating results. For instance, the Company aligned its resources through a number of reorganizations during fiscal years 2002 through 2005 to attempt to capitalize on markets that have been consistently successful for it. These reorganizations were intended to streamline the Company’s professional services, customer support and sales organizations by reducing the number of its employees to improve the productivity of each of those organizations as well as by reducing management personnel and other overhead costs in its marketing, development and administrative organizations. However, the loss of key personnel in such restructurings and any severance and other costs incurred in such restructurings could negatively affect the Company’s quarterly operating results and adversely affect its stock price.
The Company derives a significant portion of its revenues from sales to U.S. Government agencies; (for example, for the quarter ended October 31, 2004, total revenues derived from sales to agencies of the U.S. Government represented approximately 47% of the Company’s total revenues); U.S. Government agencies are subject to budget cuts and, consequently, the Company may lose revenues upon which it has historically relied, and a change in the size and timing of the Company’s U.S. Government contracts may materially affect the Company’s operating results
For the quarter ended October 31, 2004, total revenues derived from sales to agencies of the U.S. Government were approximately $2.9 million, representing 47% of total revenues. For the quarter ended October 31, 2003, total revenues derived from sales to agencies of the U.S. Government were approximately $6.7 million, representing 77% of total revenues. While the U.S. Government has recently increased spending on defense and homeland security initiatives, many government agencies have had budget freezes or reductions which may adversely impact their purchasing decisions and timing. The Company is actively pursuing several opportunities for business with certain U.S. Government agencies. While the nature and timing of these opportunities, as well as the ability to complete business transactions related to these opportunities, is subject to certain risks and uncertainties, successful completion of any of these transactions could have a material impact on the Company’s future operating results and financial position. There can be no assurance that the Company will complete any of these potential transactions.
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The Company depends on international sales, particularly in the United Kingdom, Germany and France; (for example, for the quarter ended October 31, 2004, total revenues derived from international sales represented approximately 33% of the Company’s total revenues); any economic downturn, changes in laws, changes in currency exchange rates or political unrest in those countries could have a material adverse effect on the Company’s business
For the quarter ended October 31, 2004, total revenues derived from international sales were approximately $2.0 million, representing approximately 33% of total revenues. For the quarter ended October 31, 2003, revenues derived from international sales were approximately $0.8 million, representing approximately 9% of total revenues. Most of the Company’s international sales are in the United Kingdom, Germany and France. The Company’s international operations have historically exposed it to longer accounts receivable and payment cycles and fluctuations in currency exchange rates. International sales are made mostly from the Company’s foreign subsidiary and are denominated in British pounds or Euros. As of October 31, 2004, approximately 15% and 15% of the Company’s total consolidated accounts receivable were denominated in British pounds or Euros, respectively. Additionally, the Company’s exposure to foreign exchange rate fluctuations arises in part from intercompany accounts in which royalties on the Company’s foreign subsidiary’s sales are charged to the Company’s foreign subsidiary and recorded as intercompany receivables on the books of the Company. The Company is also exposed to foreign exchange rate fluctuations as the financial results of the Company’s foreign subsidiary are translated into U.S. dollars in consolidation. Since exchange rates vary, those results when translated may vary from expectations and adversely impact overall expected profitability.
The Company’s international operations expose it to a variety of other risks that could seriously impede its financial condition and growth. These risks include the following:
| | • | potentially adverse tax consequences; |
| | • | difficulties in complying with regulatory requirements and standards; |
| | • | trade restrictions and changes in tariffs; |
| | • | import and export license requirements and restrictions; and |
| | • | uncertainty of the effective protection of the Company’s intellectual property rights in certain foreign countries |
If any of these risks described above materialize, the Company’s international sales could decrease and its foreign operations could suffer.
The Company is in an extremely competitive market, and if it fails to compete effectively or respond to rapid technological change, the Company’s revenues and market share will be adversely affected
The Company’s business environment and the computer software industry in general are characterized by intense competition, rapid technological changes, changes in customer requirements and emerging new market segments. The Company’s competitors include many companies that are larger and more established and have substantially more resources than the Company does. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the markets which the Company serves. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on the Company’s business, financial condition or results of operations.
In order for the Company’s strategy to succeed and to remain competitive, the Company must leverage its core technology to develop new product offerings, update existing features and add new components to its current products such as support for new datatypes and taxonomies for specific vertical markets. These development efforts are expensive, and the Company plans to fund these developments with its existing capital resources, and other sources, such as equity issuances and borrowings, which may be available to it. If these developments do not generate substantial revenues, the Company’s business and results of operations will be adversely affected. The Company cannot assure that it will successfully develop any new products, complete them on a timely basis or at all, achieve market acceptance or generate significant revenues with them.
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The Company designs its products to work with certain systems and changes to these systems may render its products incompatible with these systems, and the Company may be unable to sell its products
The Company’s ability to sell its products depends on the compatibility of its products with other software and hardware products. These products may change or new products may appear that are incompatible with the Company’s products. If the Company fails to adapt its products to remain compatible with other vendors’ software and hardware products or fail to adapt its products as quickly as its competitors, the Company may be unable to sell its products.
The Company’s software products are complex and may contain errors that could damage its reputation and decrease sales
The Company’s complex software products may contain errors that people may detect at any point in the products’ life cycles. The Company cannot assure that, despite its testing and quality assurance efforts and similar efforts by current and potential customers, errors will not be found. The discovery of an error may result in loss of or delay in market acceptance and sales.
The Company depends on proprietary technology licensed from third parties; if the Company loses these licenses, it could delay shipments of products incorporating this technology and could be costly
The Company’s products use some of the technology that it licenses from third parties, generally on a nonexclusive basis. The Company believes that there are alternative sources for each of the material components of technology it licenses from third parties. However, the termination of any of these licenses, or the failure of the third-party licensors to adequately maintain or update their products, could delay the Company’s ability to ship these products while it seeks to implement technology offered by alternative sources. Any required replacement licenses could prove costly. Also, any delay, to the extent it becomes extended or occurs at or near the end of a fiscal quarter, could harm the Company’s quarterly results of operations. While it may be necessary or desirable in the future to obtain other licenses relating to one or more of the Company’s products or relating to current or future technologies, the Company cannot assure that it will be able to do so on commercially reasonable terms or at all.
Because of the technical nature of the Company’s business, its intellectual property is extremely important to its business, and adverse changes to the Company’s intellectual property would harm its competitive position
The Company believes that its success depends, in part, on its ability to protect its proprietary rights and technology. Historically, the Company has relied on a combination of copyright, patents, trademark and trade secret laws, employee confidentiality and invention assignment agreements, distribution and OEM software protection agreements and other methods to safeguard the Company’s technology and software products. Risks associated with the Company’s intellectual property, include the following:
| | • | pending patent applications may not be issued; |
| | • | intellectual property laws may not protect the Company’s intellectual property rights; |
| | • | third parties may challenge, invalidate, or circumvent any patent issued to the Company; |
| | • | rights granted under patents issued to the Company may not provide competitive advantages to it; |
| | • | unauthorized parties may attempt to obtain and use information that the Company regards as proprietary despite the Company’s efforts to protect its proprietary rights; |
| | • | others may independently develop similar technology or design around any patents issued to the Company; and |
| | • | effective protection of intellectual property rights may be limited or unavailable in some foreign countries in which the Company operates. |
The Company depends on its key personnel, the loss of whom would adversely affect the Company’s business, and the Company may have difficulty attracting and retaining skilled employees
The Company’s success depends to a significant degree upon the continued contributions of its key management, marketing, technical and operational personnel. The Company generally does not utilize employment agreements for its key employees. The loss of the services of one or more key employees could have a material adverse effect on the Company’s operating results. The Company also believes that its future success will depend in large part upon its ability to attract and retain additional highly skilled management, technical, marketing, product development, operational personnel and consultants. Competition for such personnel, particularly software developers, professional service consultants and other technical personnel, is intense, and pay scales in the software industry have significantly increased. There can be no assurance that the Company will be successful in attracting and retaining such personnel.
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The Company may not be able to use net operating loss carryforwards
As of January 31, 2004, the Company had net operating loss carryforwards of approximately $154 million. The deferred tax assets representing the benefits of these carryforwards have been offset completely by a valuation allowance due to the Company’s lack of an earnings history. The realization of the benefits of these carryforwards depends on sufficient taxable income in future years. Lack of future earnings could adversely affect the Company’s ability to utilize these carryforwards. Additionally, past or future changes in the Company’s ownership and control could limit the ability to utilize these carryforwards. Despite the carryforwards, the Company may have income tax liability in future years due to the application of the alternative minimum tax rules of the United States Internal Revenue Code.
As of October 31, 2004, the Company’s balances of cash, cash equivalents and short-term investments were approximately $22.7 million. While the Company believes it will have sufficient funds for its operations for at least the next twelve months, it is possible that the Company will need additional capital during or after that time. The Company may need additional capital in the future, and it may not be available on acceptable terms, or at all, and if the Company does not receive any necessary additional capital, it could harm the Company’s financial condition and future prospects
As of October 31, 2004, the Company’s balances of cash, cash equivalents and short-term investments were approximately $22.7 million. The Company believes its current balance of cash, cash equivalents and short-term investments, combined with any funds generated from its operations will be sufficient to meet its working capital and capital expenditure requirements for at least the next twelve months based upon its estimates of funds required to operate its business during such period. However, during or after that time, the Company may need to raise additional funds for the following purposes:
| | • | to fund the Company’s operations; including sales, marketing and research and development programs including the Web initiative; |
| | • | to fund any growth the Company experiences; |
| | • | to enhance and/or expand the range of products and services the Company offers; for example, the Company may upgrade its existing products or develop new products, including products capable of searching and/or indexing the Web, and the Company may expand its training and other professional services for its products; |
| | • | to increase the Company’s promotional and marketing activities; or |
| | • | to respond to competitive pressures and/or perceived opportunities, such as investment, acquisition and international expansion activities. |
The Company cannot assure that if it needs any additional capital that it will be available, and if so, on terms beneficial to the Company. Historically, the Company has obtained external financing entirely from sales of its common stock. To the extent the Company raises additional capital by issuing equity securities, its shareholders may experience substantial dilution. If the Company is unable to obtain additional capital, it may then attempt to preserve its available resources by various methods including deferring the creation or satisfaction of commitments, reducing expenditures on its research and development programs or otherwise scaling back its operations. If the Company were unable to raise such additional capital or defer certain costs as described above, that inability would have an adverse effect on the Company’s financial position, results of operations and prospects
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The Company’s stock price may fluctuate which may make it difficult to resell shares of the Company’s stock
The market price of the Company’s common stock has been highly volatile. For example, in the first nine months of fiscal year 2005, the market price per share of the Company’s common stock ranged from $2.16 to $5.40. This volatility may adversely effect the price of the Company’s common stock, and its stockholders may not be able to resell their shares of common stock following periods of volatility because of the market’s adverse reaction to this volatility. The Company anticipates that this volatility, which frequently affects the stock of software companies, will continue. Factors that could cause such volatility include:
| | • | future announcements concerning the Company or its competitors; |
| | • | quarterly variations in the Company’s operating results; |
| | • | actual or anticipated announcements of technical innovations or new product developments by the Company or its competitors; |
| | • | general conditions in the Company’s industry; |
| | • | proprietary or other litigation; and |
| | • | worldwide economic and financial conditions. |
On occasion, the equity markets, and in particular the markets for software companies, have experienced significant price and volume fluctuations. These fluctuations have affected the market price for many companies’ securities even though the fluctuations are often unrelated to the companies’ operating performance.
The Company’s amended and restated certificate of incorporation, bylaws, ownership and Delaware law contain provisions that could discourage a third party from acquiring the Company and consequently decrease the market value of an investment in the Company’s stock
Some provisions of the Company’s amended and restated certificate of incorporation and bylaws and of Delaware law could delay or prevent a change of control or changes in the Company’s management that a stockholder might consider favorable. Any delay or prevention of a change of control or change in management could cause the market price of the Company’s common stock to decline.
Allen Holding Inc. and related parties exercise voting control of the Company, and the Company’s other shareholders will not have an effective say in any matters upon which its shareholders vote
Allen Holding Inc., together with Allen & Company Incorporated, Herbert A. Allen and certain related parties, beneficially owns more than 50% of the Company’s voting power, and would therefore be able to control the outcome of matters requiring a stockholder vote. These matters could include offers to acquire the Company and elections of directors. Allen Holding Inc., Mr. Allen and Allen & Company may have interests which are different than the interests of the Company’s other stockholders.
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Item 3. Quantitative and Qualitative Disclosure About Market Risk
The Company’s market risk is principally confined to changes in foreign currency exchange rates and potentially adverse effects of differing tax structures. International revenues from CTIL, the Company’s foreign sales subsidiary located in the United Kingdom, along with entities established in Paris, France and Munich, Germany, were approximately 33% of total revenues in the three months ended October 31, 2004. International sales are made mostly from the Company’s foreign subsidiary and are typically denominated in British pounds or Euros. As of October 31, 2004, approximately 15% and 15% of total consolidated accounts receivable were denominated in British pounds and Euros, respectively. Additionally, the Company’s exposure to foreign exchange rate fluctuations arises in part from intercompany accounts in which royalties on CTIL sales are charged to CTIL and recorded as intercompany receivables on the books of the U.S. parent company. The Company is also exposed to foreign exchange rate fluctuations as the financial results of CTIL are translated into U.S. dollars in consolidation. As exchange rates vary, those results when translated may vary from expectations and adversely impact overall expected profitability.
As of October 31, 2004, 3% of the Company’s cash and cash equivalents balance was included in the Company’s foreign subsidiaries. Cash equivalents consist of funds deposited in money market accounts with original maturities of three months or less. The Company’s short-term investment consists of certificate of deposit pledged as collateral for an office lease. Given the relatively short maturity periods of cash equivalents and short-term investments, the Company’s exposure to fluctuations in interest rates is limited.
Item 4. Controls and Procedures
The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in making known to them, on a timely basis, material information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act. In addition, there have been no changes in the Company’s internal control over financial reporting during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II — OTHER INFORMATION
| Item 1. | Legal Proceedings | None. |
| Item 2. | Changes in Securities | None. |
| | On September 16, 2004, the Company completed a private placement of 3,433,333 newly-issued shares (the “Shares”) of its common stock to several investors, including affiliates of Allen & Company Incorporated, a significant stockholder of Convera, and certain directors. The shares were priced on September 7, 2004 at $3.00 per share, representing a premium to the $2.80 closing market price on such date, and are subject to a six-month lock-up. The private placement resulted in gross proceeds of $10.3 million. The shares issued in the private placement were issued pursuant to the exemption from registration provided by Section 4(2) and Rule 506 under the Securities Act of 1933, as amended. The Company plans to use the net proceeds to finance ongoing operations and for general corporate purposes, including potential acquisitions. |
| Item 3. | Defaults upon Senior Securities | None. |
| Item 4. | Submission of Matters to Vote of Security Holders | None. |
| Item 5. | Other Information | None. |
| Item 6. | Exhibits and Reports on Form 8-K | |
| | 10.18 | Office Lease (1921 Gallows Road, Vienna Virginia) commencing October 6, 2004 |
| | 31.1 | Certification of Chief Executive Officer pursuant to Securities Exchange Act of 1934 Rules 13a-14(a) and 15d-14(a) |
| | 31.2 | Certification of Chief Financial Officer pursuant to Securities Exchange Act of 1934 Rules 13a-14(a) and 15d-14(a) |
| | 32.1 | Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | 32.2 | Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | On September 16, 2004, the Company filed a Form 8-K for Item 3, announcing that the Company had completed a private placement of 3,433,333 newly-issued shares of its common stock to several investors, including affiliates of Allen & Company Incorporated, a significant stockholder of Convera, and certain directors. |
| | On August 18, 2004, the Company filed a Form 8-K for Item 12, attaching and incorporating a press release of the Company dated August 18, 2004, reporting the Company’s financial results for the fiscal quarter ended July 31, 2004. |
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| | On August 9, 2004, the Company filed a Form 8-K for Item 9, announcing that the Company had embarked on an advanced development effort focused on applying the Company’s existing technology to assist customers in locating contextually relevant information on the World Wide Web (the “Web”). |
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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.
December 14, 2004 | | CONVERA CORPORATION
By: /s/ Patrick C. Condo
——————————————
Patrick C. Condo
President and Chief Executive Officer
(Principal Executive Officer) |
December 14, 2004 | |
By: /s/ John R. Polchin
——————————————
John R. Polchin
Chief Financial Officer
(Principal Financial and Accounting Officer) |
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