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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 0-28480
EDIFY CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 77-0250992
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2840 SAN TOMAS EXPRESSWAY
SANTA CLARA, CALIFORNIA 95051
(Address of principal executive offices)
(408) 982-2000
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Title or Class Name of exchange on which registered
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COMMON STOCK, $0.001 PAR VALUE NASDAQ NATIONAL MARKET SYSTEM
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filer pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At February 27, 1998, the aggregate market value of Common Stock held by
non-affiliates of the Registrant was $238,556,424.
As of February 27, 1998, there were 16,785,778 shares of the Registrant's Common
Stock outstanding.
Part III incorporates by reference from the definitive Proxy Statement for the
Registrant's 1998 Annual Meeting of Stockholders to be filed with the Commission
not later than 120 days after the end of the fiscal year covered by this Form.
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TABLE OF CONTENTS
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PART I..............................................................................................1
Item 1. Business..........................................................................1
Item 2. Properties.......................................................................12
Item 3. Legal Proceedings................................................................12
Item 4. Submission of Matters to a Vote of Security Holders..............................12
Item 4A. Executive Officers of the Registrant.............................................13
PART II............................................................................................14
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.........14
Item 6. Selected Financial Data..........................................................15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .............................................17
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.......................24
Item 8. Financial Statements and Supplementary Data......................................24
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure .............................................24
PART III...........................................................................................24
Item 10. Directors and Executive Officers of the Registrant...............................24
Item 11. Executive Compensation...........................................................25
Item 12. Security Ownership of Certain Beneficial Owners and Management...................25
Item 13. Certain Relationships and Related Transactions...................................25
PART IV............................................................................................25
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K..................25
SIGNATURES.........................................................................................41
INDEX TO EXHIBITS..................................................................................42
This Report contains forward-looking statements (within the meaning of Section
27A of the Securities Act of 1933, as amended (the "Securities Act") and Section
21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act")
regarding the Company and its business, financial condition, results of
operations and prospects. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions or variations
of such words are intended to identify forward-looking statements, but are not
the exclusive means of identifying forward-looking statements in this Report.
Additionally, statements concerning future matters such as the features,
benefits and advantages of the Company's products, the development of new
products, enhancements or technologies, business and sales strategies, matters
relating to proprietary rights, competition and facilities needs and other
statements regarding matters that are historical are forward-looking statements.
Forward-looking statements are subject to risks and uncertainties, and actual
results and outcomes may differ materially from the results and outcomes
discussed in the forward-looking statements. Factors that could cause or
contribute to such differences in results and outcomes include without
limitation those discussed in Item 7 under the heading "Business Risks," as well
as those discussed elsewhere in this Report. Readers are urged not to place
undue reliance on these forward-looking statements, which speak only as of the
date of this Report. The Company undertakes no obligation to revise or update
any forward-looking statements in order to reflect any event or circumstance
that may arise after the date of this Report.
Edify and Electronic Workforce are registered trademarks, and Electronic Banking
System and Employee Service System are trademarks, of Edify Corporation. All
other company or product names may be trademarks of their respective owners.
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PART I
ITEM 1. BUSINESS
Edify Corporation ("Edify" or the "Company") is a leading supplier of self
service solutions that enable organizations to deploy automated services
accessed by customers and employees via the Internet, corporate intranets and
the telephone. The Company's software addresses the growing need for
organizations to automate, integrate and personalize interactions with customers
and employees, yielding stronger, more profitable relationships. Edify's self
service solutions also enable organizations to contain costs, to capitalize on
emerging interactive media, and to leverage investments in enterprise systems
and communications infrastructure. Over the past six years, Edify has licensed
its Electronic Workforce application development and runtime platform to over
900 customers for custom development of web and telephone self service
applications such as bank account inquiries and employee benefit enrollments. In
the last two years, the Company introduced two software application products,
the Electronic Banking System ("EBS") and the Employee Service System ("ESY"),
as part of its strategy to establish leadership in the market for self service
applications in the financial services and human resources market segments.
Edify's Electronic Workforce is a full-featured, scalable and flexible
application development and runtime system that enables organizations to create
and deploy custom self service applications through which users can conveniently
and easily obtain access to a broad range of valuable information and services.
Electronic Workforce's object-oriented architecture allows the incorporation of
multiple media, enabling service applications through web browsers, telephones,
facsimiles, electronic mail and alphanumeric pagers. It also facilitates
interaction with information content assembled from a variety of sources,
including mainframe and client-server applications and relational databases.
Electronic Workforce also includes a "visual" development environment that
enables rapid development and adaptation of self service applications without
writing lines of code.
Edify's Electronic Banking System is a software application product which
offers financial institutions the means to deploy a suite of automated banking
services via the World Wide Web (the "web"). The Company's Employee Service
System is a software application product that offers human resources ("HR")
organizations the means to empower employees with direct access to information
and services over corporate intranets. EBS and ESY each offer a fully integrated
application suite, multiple access options including the web and telephone, and
visual customization tools for rapid customization and integration with a wide
range of back office systems. They both are built on Edify's Electronic
Workforce and utilize web browser, Java and other technologies which address the
customization requirements necessary for the application products market.
INDUSTRY BACKGROUND
In today's highly competitive global marketplace, customers and employees are
increasingly demanding faster, more convenient and more interactive access to
information and services. Competitive pressures are driving businesses to
increase the quality of such services while containing costs. The delivery of
richer, more cost-effective services has become critical in differentiating a
company's product or service offerings and expanding its market share. While
traditional information and automation systems have focused primarily on
increasing the efficiency of core business operations, new opportunities exist
to employ available and emerging technologies to automate and enhance an
organization's interactions with its customers and employees.
Organizations traditionally have used trained service representatives to
bridge the gap between customers and employees and the enterprise information
systems that store and process account, employment, shipment or other
information. Service representatives perform multiple functions, including
receiving inquiries from customers or employees, using enterprise software
applications to extract relevant information, implementing company policies and
communicating responses to the inquiries. Reliance on people to perform these
service functions is expensive and has inherent limitations in terms of
scalability, flexibility and reliability. Labor costs tend to grow
proportionately with increased demands for service, and the quality of service
becomes more difficult to maintain as the number of service representatives
increases. In addition, the time required to hire and train service personnel
limits the speed with which organizations can respond to increasing customer
demands or to new competitive service offerings. The solution to these service
demands and challenges is to use technology to enable customers and employees to
serve themselves through automated "self service" applications that provide
direct and interactive access to enterprise information and services.
THE EVOLUTION OF SELF SERVICE
Self service applications have expanded rapidly over the last two decades as
end users have become increasingly comfortable with self service and as new
technologies have broadened end-user access to automated services and
increasingly have enabled the development of full-featured applications. Each
new technology has expanded the scope of self service applications rather than
supplanted the earlier technologies. The evolution of these technologies and
applications can be viewed in phases.
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ACCEPTANCE PHASE. During the 1970s, automated teller machines ("ATMs") were
an initial proving ground for the economic benefits and consumer acceptance of
self service. ATMs not only provide the benefits of better customer service but
also reduce the need for banks to build, staff and maintain expensive branch
offices.
CONVENIENCE PHASE. During the 1980s, the availability of toll-free telephone
service and touch-tone dialing provided an infrastructure that permitted self
service over the telephone. This infrastructure has been exploited using voice
processing technology and standalone interactive voice response ("IVR") systems.
IVR systems, often operating in large call centers, provide convenient 24-hour
access to information and services through touch-tone telephones, facsimile
machines or alphanumeric pagers. Popular telephone self service applications
include telephone banking, employee benefit enrollment, university student
course registration and verification of customer order and shipment status.
While telephone self service has continued to gain acceptance and grow due to
the ubiquity of touch-tone telephones, Edify believes that the inherent user
interface limitations of the telephone, such as the lack of a visual display and
the small number of touch-tone keys, have limited the development of a larger
self service automation market.
In recent years, the development of the web/intranet infrastructure has
enabled users of personal computers operating web browser software to access and
interact with a broad range of information sources, independent of physical
location and underlying computer design. The web/intranet infrastructure shares
many attributes of the telephone: widespread connectivity, widespread access to
service and a simple, easy-to-use interface. Web browsers, however, offer
advantages over the telephone, including a visual user interface, keyboard input
and extensive support for alphanumeric, audio, video and text information types.
Organizations are rapidly adopting web browser and server software for both
external customer communications via the Internet and internal employee
communications via corporate intranets. The proliferation of telephone-based
self service solutions, as well as the emergence of web-based self service
solutions, has provided end users with convenient "anytime, anywhere" access to
information and services, resulting in improved customer service and greater
customer satisfaction.
MASS CUSTOMIZATION PHASE. As technologies continue to advance for both
telephone- and web-based solutions, organizations will be able to deploy
increasingly sophisticated self service applications. For example, organizations
now can provide services for particular users or groups of users, utilizing
information that the organization has accumulated about its individual
customers, employees and suppliers. The Company believes that end users will
demand that these services become increasingly personalized so they can take
ownership of their own service needs. Organizations that offer these
capabilities should be able to build and maintain stronger relationships with
their constituencies.
The evolution from the "convenience" phase to the "mass customization" phase
is complicating the self service infrastructure within the enterprise. Today,
the self service landscape is comprised primarily of disjointed solutions which
provide a single point of access to a single source of data. These point
solutions result in duplicate connections to the enterprise systems in the back
office, inconsistent interfaces for the customer and high maintenance costs.
Point solutions also fail to provide a unified base of customer contact
information with which customer service can be delivered regardless of media and
contact point. There is an increasing need for integrated solutions supporting
multiple media and aggregating data from the many islands of information in the
enterprise. Such solutions enable end users to access any information via any
media and are easier to create and maintain. At the same time, these solutions
must incorporate the necessary flexibility, scalability and reliability to be
capable of supporting sophisticated self service applications.
THE EDIFY SOLUTION
Edify's self service software solutions provide the following benefits:
PERSONALIZED, FEATURE-RICH SELF SERVICE APPLICATIONS. Edify's software
enables organizations to deploy self service applications through which end
users can conveniently and easily obtain access to a broad range of valuable
information and services. Although an application may require access to
information and services on a wide variety of disparate computer systems within
the organization, it retrieves the information and presents the services to the
end user in a unified, intuitive way. In addition, the architecture of Edify's
software enables organizations to provide highly interactive self service
applications that can be customized easily for and by the end user. The runtime
system provides service functions interactively in response to user inquiries
from an on-line personal computer or telephone as well as proactively in
response to pre-set parameters. The Company's architecture also allows companies
to target particular groups of users with specific services through
cross-selling, narrowcasting of content and segmented service by class of user.
These "one-to-one" capabilities enhance the value of the self service
applications for the end user, thereby developing a stronger, more profitable
relationship for the organization.
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ACCESS THROUGH MULTIPLE FRONT-END MEDIA. The object-oriented architecture of
Edify's software is designed to provide self service functions through a broad
range of communications media, including web browsers, telephones, facsimiles,
electronic mail and alphanumeric pagers, either alone or in combination. This
design has enabled the Company to provide end users with multiple points of
entry to the system and to incorporate new communications media, such as the web
browser, as they have emerged to deliver a wider, more useful range of self
service functions. In addition, the Company's software provides better, more
differentiated types of service by supporting multiple combinations of
communications media within the same application. For example, the Company's
software allows web users to initiate a direct telephone link to a customer
service representative ("CSR") in a call center with a mouse click. The current
page being viewed by the user "pops" onto the screen of the CSR, who can shadow
the user's movements, thereby communicating more effectively. Edify's multiple
media approach enables organizations to uniformly manage customer interactions.
BROAD INTEGRATION WITH BACK OFFICE ENTERPRISE SYSTEMS AND COMMUNICATIONS
MEDIA. In contrast to systems that are designed specifically for standalone web
or telephone applications, Edify's software is designed to integrate with a wide
variety of computer and telecommunications technologies and products. These
include mainframe, client-server and personal computer software applications,
relational databases running locally or on distributed networks, web servers,
central offices or private branch exchanges ("COs" and "PBXs") and automated
call distributors ("ACDs"). In addition, the Company has developed or is
developing specific links to systems offered by CheckFree Corporation
("CheckFree"), First Data Corporation, Integrion Financial Network
("Integrion"), Microsoft Corporation ("Microsoft"), M&I Data Services, MSFDC and
NCR Corporation ("NCR") in the financial services market and PeopleSoft Inc.
("PeopleSoft") and SAP AG ("SAP") in the human resources market. This broad
integration capability enables Edify's solutions to access information from
multiple back office systems and to extend the information by assembling rich
combinations of content from diverse sources and making them available to end
users.
HIGHLY ADAPTABLE, "VISUALLY" DEVELOPED APPLICATIONS. Electronic Workforce
includes an object-oriented visual development environment that enables
developers to create and adapt custom self service applications rapidly. By
positioning graphical icons on a workspace grid, a developer can define complete
self service applications without writing lines of code. The visual development
environment allows a developer to build new objects for often-used processes,
such as obtaining and preparing information from a particular source, and then
to reuse these objects in other applications. In addition to reducing the time
to market for new custom applications, the Company believes that the
adaptability of its development environment provides substantial cost savings
over the life of an application. In addition, the visual customization tools for
EBS and ESY enable developers to modify easily the look and feel of the
application, define classes of users, segment functionality by user type and
establish cross-selling rules and notification services.
SCALABILITY, RELIABILITY AND SECURITY. Edify's software architecture is
designed to provide the high capacity and reliability necessary for large-scale
deployment of self service applications. The Company's software operates on one
or more networked computer servers allowing customers to expand capacity as the
number of applications or users increases. The Company has successfully deployed
customer applications with more than 20 networked servers and believes that its
architecture is scalable beyond the size of such installed systems. In addition,
versions of the Company's software optimized for Microsoft's Windows NT
operating system support lightweight threads, message passing and symmetric
multiprocessing (SMP) to achieve greater scalability on a single server.
Electronic Workforce has been designed with separate subsystems that isolate
system faults and can accommodate the loss of one or more networked nodes
without affecting service elsewhere in the system. In addition, Electronic
Workforce manages security and resource contention in providing access to
various enterprise systems and communications media.
THE EDIFY STRATEGY
The Company's objective is to become the leading provider of enterprise self
service software used by organizations to automate, integrate and personalize
interactions with customers and employees, yielding stronger, more profitable
relationships. Edify's strategy includes the following key elements:
DEVELOP AND LEVERAGE LEADING TECHNOLOGIES FOR ENTERPRISE SELF SERVICE
SOLUTIONS. Edify intends to capitalize on its object-oriented software
architecture and visual development technology to extend the capabilities of
Electronic Workforce to automate a wide range of service functions. The system
architecture of Electronic Workforce enables organizations to create and manage
functionally rich, intuitive customer-and employee-oriented services assembled
and delivered through the integration of enterprise computer and
telecommunications systems. The Company plans to continue to enhance the
functionality of its self service solutions and to incorporate new technologies
and standards as they evolve to offer more comprehensive solutions and to
broaden the market acceptance of these solutions.
DEVELOP APPLICATION PRODUCTS FOR SPECIFIC MARKET SEGMENTS. Edify's market
strategy is to apply its technology and experience in self service solutions to
develop application products for certain market segments. As part of this
strategy, the Company has introduced fully integrated application products for
the financial services and human resources markets, the Electronic Banking
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System and the Employee Service System. The Company's application products are
designed to leverage its core Electronic Workforce technology and extend it
utilizing web, Java and other technologies which address the customization
requirements necessary for the applications market. The Company's application
products offer a suite of customizable application modules that provide specific
self service functions for each target market. This modularity enables
organizations to offer the services that meet their particular needs as they
evolve over time. The Company is investing in the ongoing development of
additional application modules for these products.
ESTABLISH LEADERSHIP IN THE FINANCIAL SERVICES AND HUMAN RESOURCES MARKETS.
While the Company markets its products across multiple markets, it emphasizes
two key market segments: customer self service applications within the financial
services industry and HR self service applications across multiple industries.
The Company is focusing on these segments because they represent a large portion
of the self service market and the Company has developed significant expertise
in developing solutions for these segments. The Company focuses a significant
portion of its sales and marketing activities on these two segments, including
the establishment and expansion of distribution or joint marketing relationships
with leading technology providers, outsourcers and integrators in each segment.
In the financial services market, Edify has established relationships with
CheckFree, Hewlett-Packard Company ("HP"), Integrion, Intuit Inc. ("Intuit"),
M&I Data Services, Microsoft, NCR, Price Waterhouse LLC ("Price Waterhouse"),
Tandem, a Compaq Company ("Tandem") and Transaction Systems Architects, Inc.
("TSA"), among others. In the HR market, the Company has relationships with
Cambridge Technology Partners ("CTP"), PeopleSoft, SAP and Watson Wyatt
Worldwide ("Watson Wyatt"), among others. In addition, the Company has
introduced application suites for the financial services and human resources
markets, EBS and ESY. The Company intends to invest significantly in these
relationships and products in order to establish leadership in the financial
services and human resources markets.
TARGET LARGE CALL CENTERS. The Company intends to market its Electronic
Workforce software to large call centers for telephone-based customer service
applications, in addition to its traditional focus on medium-sized call centers.
The Company's recently introduced version of Electronic Workforce for the
Windows NT operating system supports symmetric multiprocessing (SMP), allowing
organizations to scale with improved price-performance and smaller footprint.
The Company believes that the increased scalability of Electronic Workforce,
combined with its ability to integrate with a variety of access media and
enterprise information and communications systems, will enable the Company to
more effectively target the large-scale call center market.
EXPAND DOMESTIC AND INTERNATIONAL DISTRIBUTION. To achieve broad adoption of
its self service software, the Company believes that it must continue to pursue
multiple distribution channels worldwide. The Company currently distributes
products through a combination of field sales and indirect sales channels,
including VARs, OEMs, outsourcers and international distributors. In order to
facilitate sales of its application products and to leverage its installed base
and distribution partners, Edify has established dedicated sales positions for
application specialists, major customers and major partners. The Company pursues
VARs with vertical market expertise, systems integration experience and
geographical diversity. The Company's international distribution strategy is to
penetrate key international markets by seeking additional regional distributors
and by further developing its existing distributor relationships. Through its
distributors, the Company currently has a presence in more than 15 countries.
The Company's international expansion currently is focused on Europe, where the
Company is investing resources in sales, marketing and technical personnel.
EXPAND IMPLEMENTATION CAPACITY AND EXPERTISE. The Company seeks to accelerate
customer adoption and deployment of self service solutions by expanding its
professional services consulting organization and leveraging its partnerships
with third party integrators. Through its professional services organization,
the Company has established expertise in assisting and training customers to
perform integrations of diverse computer and communications systems as well as
knowledge of user interface and design and a familiarity with the self service
needs of its targeted market segments. The Company intends to continue to expand
its professional services organization with experienced consultants who combine
technical and application expertise. The Company believes that its professional
services organization facilitates the success of its customers' implementations,
strengthens its customer relationships and generates valuable feedback that the
Company can apply to product enhancements. In addition, the Company has
established relationships with third party integrators such as CTP, HP, Price
Waterhouse and Watson Wyatt to assist customers with the successful
implementation of Edify products. The Company believes these relationships will
enable its customers to achieve efficient implementation of its products while
decreasing the capacity strain on the Company's professional services
organization.
The foregoing statements regarding the Company's strategy and intentions are
forward-looking statements, and actual results may vary substantially depending
upon a variety of factors, including the development of emerging markets for
web-based self service software, intense competition, evolving industry
standards, changing customer needs, any product development delays, and the
ability of the Company to manage any future growth and new distribution
channels.
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MARKETS, CUSTOMERS AND APPLICATIONS
MARKETS
The Company targets large organizations where there is a need to process
substantial numbers of customer or employee service transactions efficiently.
Electronic Workforce is best suited for organizations seeking to offer a variety
of functionally rich services that can be rapidly deployed or modified, accessed
by customers and employees through multiple communications media, and integrated
with existing or new enterprise applications and telecommunications systems. The
Company has successfully installed solutions in the banking, consumer goods,
energy/utilities, financial services, technology, universities, retail,
insurance, telecommunications, healthcare, manufacturing and media sectors,
among others. The Company currently participates in two major self service
areas: customer self service across a number of industries, with an emphasis on
banking and financial services, and employee self service focused on HR
applications.
CUSTOMERS
As of December 31, 1997, Edify had, directly or indirectly through VARs or
distributors, licensed its products to more than 975 customers. The following is
a representative list of the Company's direct and indirect customers as of
December 31, 1997 that accounted for more than $150,000 in revenue to Edify from
January 1, 1996 through December 31, 1997. The Company believes that these
customers are typical of the Company's customer base by virtue of the industries
they represent and the types of applications they implement using the Company's
products. Because the Company generally does not have long-term sales contracts
with its customers, however, there can be no assurance that relationships with
these or other customers will continue. No single customer accounted for more
than 10% of the Company's total revenue in 1997.
BANKING/FINANCIAL SERVICES CONSUMER GOODS INSURANCE/HEALTHCARE
-------------------------- -------------- --------------------
Alaska USA Federal Credit Union Bristol-Meyers Squibb Company Aetna Life & Casualty
BancAmerica Robertson Stephens Eastman Kodak Company American Skandia
Boeing Employees' Credit Union Kraft General Foods, Inc. Empire Blue Cross and Blue Shield
Busey Bank The Upper Deck Company Independence Blue Cross
Capital One Services, Inc. Warner-Lambert Company SAFECO Corporation
Chase Manhattan Bank
Comerica Incorporated MANUFACTURING TECHNOLOGY
Dollar Bank ------------- -----------
Fifth Third Bank
First American National Bank Eastman Chemical Company 3Com Corporation
First National Bank of Omaha Lockheed Martin Corporation Applied Materials, Inc.
First Union Corporation The Perkin-Elmer Corporation Hewlett-Packard Company
FirstBank Data Corporation United Technologies Corporation, Oracle Corporation
Harris Bank Pratt & Whitney Unisys Corporation
Janus Capital Corporation Westinghouse Electric Corporation
Los Alamos National Bank
Mercantile Bank National TELECOMMUNICATIONS UNIVERSITIES
Association ------------------ ------------
NationsBank Corporation
Pennsylvania State Employees Aspect Telecommunications Corp. Stanford University
Credit Union AT&T Corp. University of California, Los Angeles
Scudder, Stevens & Clark, Inc. MCI Communications Corp. University of California, San Diego
Standard Chartered Bank Nextel Communications, Inc. University of Florida
Pacific Telesis Group University and Community College
System of Nevada
CUSTOMER APPLICATIONS
Edify's software can be used in many applications, including the following
representative applications:
HARRIS BANK: WEB AND TELEPHONE CUSTOMER SERVICE APPLICATION. This "top 40"
U.S. bank located in the Midwest first began using the Electronic Banking System
to provide its retail banking customers with home banking services via the web.
The application allows customers to access account balances, review and search
for transactions, transfer funds between accounts, place a stop payment and
communicate with the bank via secure electronic mail. Based on the success of
this application, the bank added the ability for its customers to pay bills via
the web and the telephone.
DHL WORLDWIDE EXPRESS: TELEPHONE CUSTOMER SERVICE APPLICATION. The world's
largest international air express network is using Electronic Workforce to offer
customer self service via the telephone. To service its 635,000 destinations in
227 countries, DHL operates a variety of computerized telecommunications and
call center systems, as well as legacy hosts and corporate networks. Working in
this complex environment, Electronic Workforce enables DHL customers to obtain
information on the status of deliveries, receive confirmations via facsimile,
schedule pickups and, if necessary, be transferred to a customer service
representative. In
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addition, the system proactively tracks shipments of premium customers and
generates electronic mail messages to notify the appropriate representatives of
delayed shipments.
APPLIED MATERIALS: TELEPHONE AND INTRANET HR APPLICATION. The world's largest
supplier of wafer fabrication systems is using the Employee Service System to
provide HR self service via the telephone and intranet for its 15,000 employees.
After several years of using Electronic Workforce for telephone-based employee
self service applications, Applied Materials selected ESY to deploy a web-based
solution. Leveraging Applied Materials' existing PeopleSoft HRMS, ESY enables
employees to access personal information such as address, telephone and
emergency contact and dependent information. Further, new hires can enroll in
benefits and existing employees can register for training courses and
participate in open enrollment.
PRODUCTS
Edify currently offers three self service software products: the Electronic
Workforce, the Electronic Banking System and the Employee Service System.
Electronic Workforce is an integrated development and runtime platform utilized
for the creation and management of custom self service solutions. EBS and ESY
are application products which address the needs of the financial services and
human resources markets, respectively. EBS and ESY are built on top of the
Electronic Workforce and incorporate web, Java and other technologies which
address the customization requirements necessary for the application product
market. Versions through 4.x of Electronic Workforce and 1.x of EBS and ESY
operate on Intel-based hardware platforms using IBM Corporation's ("IBM") OS/2
operating system.
In October 1997, the Company began shipping Electronic Workforce Release 5,
which is optimized for Microsoft's Windows NT operating system. In December
1997, the Company began shipping EBS Release 2 and ESY Release 2, both of which
are optimized for NT. Windows NT versions of these products provide an extended
open architecture, enhanced visual development tools and larger scale deployment
for high-end applications.
ELECTRONIC WORKFORCE
Edify's Electronic Workforce, which began shipping in the first quarter of
1992, is a full-featured, scalable and flexible application development and
runtime system that enables organizations to create and deploy custom self
service applications that automate, integrate and personalize interactions with
customers and employees. Electronic Workforce's object-oriented architecture
allows the incorporation of a broad range of media, enabling self service
applications through web browsers, telephones, facsimiles, electronic mail and
alphanumeric pagers, either alone or in combination. It also facilitates
interaction with information content assembled from a variety of sources,
including mainframe and client-server applications and relational databases, all
in a way that is transparent to the end user. Electronic Workforce comprises
three primary components which are licensed separately:
WORKFORCE OBJECTS. Workforce Objects are advanced, high-function software
objects that provide access to a variety of enterprise information systems
through a broad range of media. Workforce Objects are the core building blocks
of Electronic Workforce applications, enabling them to perform tasks such as
answering a telephone, operating a host application or exchanging information
through web browsers.
WORKFORCE APPLICATION BUILDER. The Workforce Application Builder is an
object-oriented, visual development environment used to assemble and customize
self service applications using Workforce Objects. Workforce Application Builder
provides developers with a visual framework for process automation through which
complex associations of media, information sources and application functions may
be represented in a simple and conceptual way. By positioning graphical icons on
a workspace grid, a developer can define complete self service applications
without writing lines of code.
WORKFORCE APPLICATION SERVER. The Workforce Application Server is a robust,
open runtime environment that schedules resources and activities, manages
resource usage, tracks application status, and reacts and responds to changing
conditions. These features simplify the task of developing self service
applications by eliminating the need to program such functions within each
application. In addition, they give administrators the ability to manage
large-scale systems efficiently where many applications need to be scheduled and
share resources concurrently. Workforce Application Server can be installed on
multiple networked servers and can work in a coordinated fashion to achieve high
levels of service capacity. It is designed to work with the Workforce
Application Builder so that applications can be developed, tested and installed
on-line without interruption of ongoing service.
Electronic Workforce components are licensed according to capacity and
according to functionality. Capacity is determined by the number of concurrent
users on a server. Functionality is determined primarily by the end user
communications media and by the
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9
access methods to a customer's back office systems that are supported by the
software. Typical software licenses with associated maintenance and consulting
contracts begin at approximately $50,000, and large customer contracts can
exceed $1 million.
ELECTRONIC BANKING SYSTEM
The Electronic Banking System, which began shipping in September 1996, is a
software application product which offers financial institutions the means to
deploy a suite of automated banking services via the World Wide Web. EBS is
built on top of the Electronic Workforce and incorporates web, Java and other
technologies which address the customization requirements necessary for the
application product market. EBS is the first product to combine web banking
services with optional electronic banking capabilities that support self service
via telephones, facsimiles and personal financial management software. EBS
comprises three components: a fully integrated application suite for web
banking; multiple electronic delivery options including telephone, facsimile and
personal financial managers; and visual customization tools for rapid
customization and integration with a wide range of back office systems.
The Electronic Banking System's application suite utilizes a user interface
framework that includes a tool set which enables banks to incorporate their
unique brands, logos and product names into the application. EBS currently
includes the following integrated application modules: home banking, bill
payment, dynamic target marketing, personal profile, proactive notification,
message center and customer service teleconferencing. EBS also offers
integration modules for leading technology vendors such as CheckFree and
Integrion for bill payment processing, and offers an OFX integration module for
communication with personal financial management software programs such as
Microsoft Money and Intuit Quicken.
Edify intends to develop additional application modules for EBS to enable
customers to expand the range of services offered through EBS. For example, the
Company currently is developing modules for small business banking and bill
presentment. In addition, EBS has been designed using the visual customization
tools of Electronic Workforce, enabling EBS customers and Edify partners to
develop custom web banking modules that integrate with the EBS web user
interface framework. With this customization capability, financial institutions
can offer differentiated services ahead of their competition while still gaining
the economies of scale traditionally achieved with pre-built solutions. Finally,
use of the Electronic Workforce software provides a scalable and highly reliable
runtime environment, meeting requirements for high-capacity, mission-critical
implementations.
As of December 31, 1997, EBS had been licensed to more than 50 customers. EBS
pricing, including the application and implementation services, begins at
approximately $200,000. Actual pricing varies depending upon the number of
modules desired, the capacity requirements of the system and the level of
customization and integration support.
EMPLOYEE SERVICE SYSTEM
The Employee Service System, which began shipping in June 1997, is a software
application product that offers human resources organizations the means to
empower employees with direct access to information and services over corporate
intranets. ESY addresses the growing need for HR organizations to reduce
administrative costs while expanding the availability and value of employee
services. Similar to EBS, ESY comprises three components: a fully integrated
application suite for employee self service; multiple access options including
web browser, telephone, electronic mail, kiosk and facsimile; and visual
customization tools for rapid customization and integration with a wide range of
back office systems.
ESY offers a suite of integrated application modules that automate the most
common and time-intensive employee transactions managed by HR organizations. ESY
currently includes the following integrated application modules: personal
profile, direct deposit, electronic paystub, W-4, leave status, benefits
summary, employee directory, job posting and training registration.
As with EBS, the Company intends to develop additional application modules,
such as open enrollment, for ESY. In addition, in order to facilitate
integration with human resources information systems, Edify offers a pre-built
integration module for PeopleSoft's HRMS and can provide integration with SAP.
ESY also has been designed using the visual customization tools of Electronic
Workforce, enabling ESY customers and Edify partners to develop custom
application modules that integrate with the ESY web user interface framework. In
addition, ESY includes a visual customization tool which enables easy
customization of the user interface and other graphical elements. Finally, also
similar to EBS, the use of the Electronic Workforce software provides a scalable
and highly reliable runtime environment, meeting requirements for high-capacity,
mission-critical implementations.
As of December 31, 1997, ESY had been licensed to more than 15 customers. ESY
pricing, including the application and implementation services, begins at
approximately $150,000. Actual pricing varies depending upon the number of
modules desired, the capacity requirements of the system and the level of
customization and integration support.
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SALES AND MARKETING
The Company's sales strategy is to pursue opportunities with large
organizations in the United States through its field sales force and
professional services organization, and to penetrate various targeted market
segments through multiple indirect distribution channels, including VARs,
international distributors, OEMs and joint marketing partners. To support its
selling efforts, the Company conducts comprehensive marketing programs which
include direct mail, phone- and web-based lead generation, advertising, trade
shows, an annual users and developers conference, and ongoing customer
communication programs. As of December 31, 1997, the Company's sales and
marketing organization consisted of 118 employees, including 39 quota-carrying
salespeople.
DOMESTIC FIELD SALES FORCE. The Company employs a field sales force to market
its products and services directly in the United States. Field sales
representatives are assigned quotas and are compensated for all Company revenue
resulting from their assigned territory and specialty. While the sales cycle
varies from customer to customer, it typically ranges from one month to over a
year and averages six months. In order to more effectively sell the application
products and to generate increased levels of repeat sales, the Company has
assigned sales representatives to focus on application products and on the
Company's installed base.
VALUE ADDED RESELLERS. VARs license and distribute the Company's software to
build and implement self service solutions for their customers in various market
segments. VARs often provide specialized application or systems integration
expertise in the installation, development and support of self service
applications. The Company maintains an organization to recruit, train and
provide ongoing support for its VARs. As of December 31, 1997, the Company had
more than 40 domestic VARs.
STRATEGIC ACCOUNTS. Over time, some of the Company's customers and channel
partners account for a significant amount of revenue. In 1997, the Company began
identifying certain of these customers and partners as "strategic accounts." The
Company has assigned sales representatives to focus 100% of their efforts on one
or more of these accounts in order to provide increased support for and maximize
revenue from these accounts.
OEMS. The Company has agreements with Aspect Telecommunications Inc.
("Aspect") and NEC America, Inc. ("NEC") under which Aspect and NEC licensed the
Company's software technology to provide solutions to the call center market.
INTERNATIONAL SALES. International revenues accounted for 5% or less of total
net revenues for each of the years ended December 31, 1997, 1996 and 1995. The
Company maintains distribution relationships with distributors in Canada,
Europe, Asia/Pacific and South America. The Company's ability to expand
internationally its web-based applications is limited by the general acceptance
of the Internet and intranets in other countries. The Company's ability to
expand its telephony applications internationally is limited to those countries
where there is regulatory approval of the third-party telephony hardware
supported by Edify software. Because Edify depends on third-party suppliers to
certify such telephony hardware and obtain regulatory approval on a country by
country basis, there can be no assurance that such approval will exist or
continue to exist in the future.
STRATEGIC RELATIONSHIPS
As part of its objective of establishing leadership in the self service
software market, particularly for financial services and human resources, the
Company has established strategic relationships with leading technology
providers, outsourcers and integrators in these markets. These relationships
enable the Company to interoperate with new technologies, lend the Company
significant visibility and credibility within the self service market and
provide the Company with access to their large customer bases. The Company
intends to leverage these relationships and to develop additional strategic
relationships.
In the financial services market, Edify has established relationships with
CheckFree, Electronic Data Systems, HP, Integrion, Intuit, M&I Data Services,
Microsoft, NCR, Price Waterhouse, Tandem, TSA and Unisys Corporation, among
others. In the HR market, the Company has relationships with Application Group,
CTP, Hunter Group, Restrac, Inc., Resumix, Inc., PeopleSoft, SAP and Watson
Wyatt, among others. In the call center market, the Company has relationships
with Aspect, Fujitsu Limited and NEC.
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PROFESSIONAL SERVICES AND SUPPORT
To be competitive in providing self service software solutions, the Company
believes that it must provide a high level of professional services and support
to its customers. The Company's professional services and technical support
organizations provide customers and distribution partners with fee-based
consulting services, education and technical support. As of December 31, 1997,
the Company had 118 people in its professional services and technical support
organizations. A majority of the Company's customers currently have support
agreements with the Company.
CONSULTING SERVICES. The Company's professional services organization assists
direct sales customers who wish to outsource their software installation and
application development. Through its professional services organization, the
Company has expertise in systems integration, knowledge of user interface and
design, and familiarity with the self service needs of its targeted market
segments. All fees for consulting services are charged separately from the
license fees for the Company's software.
EDUCATION AND TRAINING. The Company offers a comprehensive education and
training program to its customers and distribution partners. Training classes
are offered through in-house facilities at the Company's offices in Santa Clara,
California and Waltham, Massachusetts. The Company also provides on-site
training upon request by customers. Fees for education and training services are
charged separately from the license fees for the Company's software. As of
December 31, 1997, the Company had trained and certified more than 1,100 people
to develop self service applications with its software.
TECHNICAL SUPPORT. The Company offers customer support through its technical
support staff. Support services are available through telephone, facsimile or
the Company's web site. Additional support is available from the Company's VARs,
international distributors and OEMs, which provide first-line support to their
customers. Customers are entitled to new software releases, maintenance updates
and support beyond an initial 90-day warranty period for an annual fee typically
equal to 15% to 20% of the list prices of the products under license to such
customers.
PRODUCT DEVELOPMENT
The statements made herein regarding the Company's products and product
enhancements under development are forward-looking statements, and the actual
results for such products or enhancements could differ materially from those
projected as a result of a variety of factors, including but not limited to,
those contained in this "Product Development" section and elsewhere in this
Report.
The market for Edify's products is characterized by rapid technological
change, changes in customer requirements, frequent new product introductions and
enhancements and emerging industry standards. The Company must continually
change and improve its products in response to changes in operating systems,
application software, computer and telephony hardware, networking software,
programming tools and computer language technology. The introduction of products
embodying new technologies and the emergence of new industry standards can
render existing products obsolete and unmarketable. In particular, the market
for self service application products has only recently begun to develop and is
rapidly evolving. The Company's success will depend upon its ability on a timely
and cost-effective basis to enhance its current products and to develop new
products that meet changing market conditions, which include changing customer
needs, new competitive product offerings, emerging industry standards and
changing technology. There can be no assurance that the Company will be
successful in developing and marketing, on a timely and cost-effective basis or
at all, fully functional and integrated product enhancements or new products
that respond to technological change, updates or enhancements to third party
products used in conjunction with the Company's products, changes in customer
requirements or emerging industry standards, or that the Company's enhanced or
new products will be accepted by customers. Any failure by the Company to
anticipate or respond adequately to changing market conditions, or any
significant delays in product development or introduction, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's software development team is composed of members with
experience in Internet and web technology, financial services and human
resources application software, visual programming design, object-oriented
software development, computer telephony integration, voice processing and
large-scale real-time subsystems. The Company believes this assembly of diverse
technical expertise contributes to the highly integrated functionality of its
products. The Company's ability to attract and retain highly qualified employees
will be the principal determinant of its success in maintaining technological
leadership.
Product development expenses were $10.1 million in 1997, $5.8 million in 1996
and $2.6 million in 1995. To date, all software development costs have been
expensed as incurred. The total product development staff consisted of 69
full-time employees as of December 31, 1997. All of the Company's products have
been developed internally by its product development staff. Product development
expenses have increased over recent quarters as the Company increased product
development staff to develop versions
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12
of its products for the Windows NT platform. The Company believes significant
investments in product development are required to remain competitive. As a
consequence, the Company intends to increase the dollar amount of its product
development expenditures in the future.
The Company's current development efforts are focused on enhancements to the
NT versions of Electronic Workforce, EBS and ESY. These enhancements include
increased scalability for Electronic Workforce and additional application
modules for EBS and ESY. There can be no assurance that these development
efforts will be completed within the Company's anticipated schedules or that,
when completed, they will have the features necessary to make them successful in
the marketplace. Moreover, software as complex as that developed by the Company
may contain undetected errors when first introduced or as new versions are
released. Errors in new products may be found after commencement of commercial
shipments, resulting in loss or delay of market acceptance. Future delays in the
development or marketing of product enhancements or new products, including
presently contemplated new features of the Company's software products for
Windows NT, could result in a material adverse effect on the Company's business,
financial condition and results of operations.
COMPETITION
The market for self service software and services is rapidly evolving,
extremely competitive and subject to rapid technological change. The Company
expects competition to increase in the future from existing competitors and from
companies that may enter the Company's existing or future markets with similar
or substitute solutions that may be less costly or provide better performance or
functionality than the Company's products. Many of the Company's current and
potential competitors have longer operating histories, greater name recognition,
larger installed customer bases and significantly greater financial, technical,
marketing and other resources than the Company. To be successful in the future,
the Company must continue to respond promptly and effectively to the challenges
of changing customer requirements, technological change and competitors'
innovations. Increased competition is likely to result in price reductions,
reduced gross margins and loss of market share, any of which could materially
adversely affect the Company's business, financial condition and results of
operations. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, financial condition and results of operations.
The Company's current and potential competitors include Internet software and
tools vendors, web application vendors, business application vendors and
standalone IVR vendors. In the market for web-based self service solutions, the
Company's primary competition has been from system integrators, potential
customers' internal information systems departments that build applications with
custom code and web development tool vendors. In the future, the Company expects
competition from Netscape Communications Corporation, Microsoft and others to
increase. In addition, the Company expects database vendors such as Oracle
Systems Corporation, Informix Corporation and Sybase, Inc. to provide many of
the capabilities needed in the development of web self service applications. Any
of these companies could use its superior financial resources, market power and
installed base of customers to compete effectively against the Company. The
Company believes that the principal competitive factors in the web self service
market segment are breadth and depth of application functionality, support for
multiple communications media, speed of application development, integration
with mainframe and client-server computer systems, price, reliability and
scalability of product offerings, third-party distribution, company reputation,
application development expertise and customer service and support. Although the
Company believes that its products and services currently compete favorably with
respect to such factors, there can be no assurance that the Company can maintain
its competitive position against current and potential competitors, especially
those with significantly greater financial, marketing, service, support,
technical and other resources. Such competition could materially adversely
affect the Company's ability to sustain current pricing levels and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company expects to encounter increased competition from companies
offering Internet application products that compete with the Company's
application products and custom applications of the Company's software. The
Company's Electronic Banking System competes with solutions from BroadVision,
Inc., IBM and Security First Technologies, among others. The Company believes
that the principal competitive factors in this market are application
functionality, ease-of-use, adaptability of applications, integration with
on-premise enterprise applications, and systems and support for multiple media.
Although the Company believes that its products and services compete favorably
on the basis of these factors, there can be no assurance that the Company can
maintain its competitive position against current and potential competitors.
Web browser and web server technology offers vendors of business application
software a means to extend their products to provide self service capabilities
over the web or intranets. The Company expects that application vendors such as
Baan Company N.V., Oracle, PeopleSoft, SAP and others will market new or
enhanced products offering web-based self service capabilities. These products
could dilute materially the value of the Company's Employee Service System with
customers who use applications licensed
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from such vendors. Such enhanced offerings could materially and adversely affect
the Company's market position, business, financial condition and results of
operations.
For telephone self service solutions, the Company competes principally with
standalone IVR vendors such as Brite Voice Systems, Inc., InterVoice, Inc.,
Lucent Technologies Inc. ("Lucent"), Periphonics Corporation, Syntellect
Technology Corporation ("Syntellect") and TALX Corp. The Company believes that
the principal competitive factors in the telephone self service market segment
are the same as those for the web-based self service market. Although the
Company believes that it competes favorably on the basis of these factors, there
can be no assurance that the Company can maintain its competitive position
against current and potential competitors. Certain of the Company's IVR
competitors have introduced products supporting web applications. Such
competition could materially adversely affect the Company's ability to compete
and could have a material adverse effect on the Company's business, financial
condition and results of operations.
PROPRIETARY RIGHTS
The Company's success is heavily dependent upon its proprietary technology.
The Company relies primarily on a combination of copyright, trade secret and
trademark laws, nondisclosure and other contractual provisions and technical
measures to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials through trade secret and
copyright laws, which provide only limited protection. In addition, the Company
holds one United States patent, has three United States patent applications
pending (two of which have also been filed internationally) and intends to seek
further United States and international patents on its technology. There can be
no assurance that any patents held by the Company will not be challenged and
invalidated, that patents will issue from any of the Company's pending
applications or that any claims allowed from existing or pending patents will be
of sufficient scope or strength or be issued in all countries where the
Company's products can be sold to provide meaningful protection or any
commercial advantage to the Company. As part of its confidentiality procedures,
the Company generally enters into nondisclosure agreements with its employees,
consultants, distributors and corporate partners and limits access to and
distribution of its software, documentation and other proprietary information.
Despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy or otherwise obtain and use the Company's products
or technology that the Company considers proprietary, and third parties may
attempt to develop similar technology independently. In particular, the Company
provides its existing and potential distribution partners with access to its
product architecture and other proprietary information underlying the Company's
licensed software. Policing unauthorized use of the Company's products is
difficult, and, while the Company is unable to determine the extent to which
piracy of its software products exists, software piracy can be expected to be a
persistent problem. In addition, effective protection of intellectual property
rights may be unavailable or limited in certain countries. Accordingly, there
can be no assurance that the Company's means of protecting its proprietary
rights will be adequate or that the Company's competitors will not independently
develop similar technology.
In March 1996, the Company received a letter from Syntellect inviting the
Company to negotiate a license of certain of Syntellect's patents. Since then,
Syntellect has called additional Syntellect patents to the Company's attention.
Based on its investigation of the patents referenced in Syntellect's March 1996
letter, the Company believes that it has substantial arguments that it does not
violate any valid claims of such Syntellect patents.
In April 1996, the Company received a letter from Lucent inviting the Company
to negotiate a license of Lucent's patents. Since then, Lucent has asserted that
it believes that certain of the Company's products infringe certain of Lucent's
patents and has offered to license those patents to the Company for a
substantial payment. In November 1997, the Company received a letter from Lucent
in which Lucent made similar assertions with respect to other patents it holds.
The Company believes that it has substantial arguments that its current products
do not violate any valid claims of the Lucent patents referenced in the April
1996 letter and is in the process of investigating the patents referenced in the
November 1997 letter. The Company has had several discussions with Lucent
regarding the potential licensing of the patents referenced in Lucent's letters
and is currently engaged in such discussions. Based on these discussions, it
appears that obtaining a license from Lucent may require the payment of a
substantial license fee and possibly ongoing royalties, which could have a
material adverse effect on the Company's results of operations in the periods
when such payments are made, although the Company does not believe that such
payments would have a material adverse effect on the Company's financial
condition or liquidity. In the event that the Company cannot come to an
agreement with Lucent, the Company may be drawn into litigation with Lucent.
Such litigation could be protracted and expensive, and the outcome cannot be
predicted. There can be no assurance that the costs associated with
participating in or settling such litigation would not have a material adverse
effect on the Company's business, financial condition or results of operations.
In the future, the Company may receive additional communications from these
or other parties asserting that the Company's products, trademarks or other
proprietary rights require a license of intellectual property rights or
infringe, or may infringe, on their property rights. As the number of software
products in the industry increases, and the functionality of these products
further overlaps,
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the Company believes that software developers may become increasingly subject to
infringement claims. Any such claims, with or without merit, could be time
consuming, result in costly litigation, cause product shipment delays or require
the Company to enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, may not be available on terms acceptable to
the Company, or at all, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
In addition, the Company may initiate claims or litigation against third
parties for infringement of the Company's proprietary rights or to establish the
validity of the Company's proprietary rights. Litigation to determine the
validity of any claims could result in significant expense to the Company and
divert the efforts of the Company's technical and management personnel from
productive tasks, whether or not such litigation is determined in favor of the
Company. In the event of an adverse ruling in any such litigation, the Company
may be required to pay substantial damages, discontinue the use and sale of
infringing products, expend significant resources to develop non-infringing
technology or obtain licenses to infringing technology. The failure of the
Company to develop or license a substitute technology could have a material
adverse effect on the Company's business, financial condition and results of
operations.
EMPLOYEES
As of December 31, 1997, the Company had a total of 349 employees, including
69 in product development, 118 in sales and marketing, 118 in professional
services and customer support, and 44 in administration and finance. Of these,
one employee was located in Hong Kong, one was in Spain, three were in the
United Kingdom and the remainder were located in the United States. The
Company's future performance depends to a significant degree upon the continued
contributions of members of the Company's senior management and other key
research and development, sales and marketing personnel and its continuing
ability to identify, attract, train and retain other highly skilled managerial,
engineering, sales and marketing and professional services personnel.
Competition for highly qualified personnel is intense, and there can be no
assurance that the Company will be successful in attracting, assimilating and
retaining the necessary personnel in the future. None of the Company's employees
is represented by a labor union. The Company has not experienced any work
stoppages and considers its relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing and product
development facility occupies approximately 95,000 square feet of leased space
in Santa Clara, California. In addition, the Company leases offices in Waltham,
Massachusetts, Dallas, Texas, and London, England. The Company believes that its
existing facilities, together with certain options to expand its existing
facilities, are adequate for its current needs but that it may need to seek
additional space in the future. The Company believes that suitable additional
space or alternative space will be available in the future, as needed, on
commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
NAME AGE POSITION
---- --- --------
Jeffrey M. Crowe........... 41 President, Chief Executive Officer and
Director
Charles H. Jolissaint...... 54 Vice President and Chief Technical Officer
Stephanie A. Vinella....... 43 Vice President of Finance and
Administration, Chief Financial
Officer and Secretary
Thomas M. Glassanos........ 42 Vice President of Marketing
Alvin S. Begun............. 53 Vice President of Professional Services
Patricia A. Tomlinson...... 40 Vice President of Human Resources
Mr. Crowe has been President, Chief Executive Officer and a director of the
Company since co-founding the Company in 1990. From 1982 to 1990, he held
various management and marketing positions at Rolm Corporation ("Rolm"), a
telecommunications equipment manufacturing company, most recently as General
Manager. Mr. Crowe received a Bachelor of Arts degree in History from Dartmouth
College in 1978 and a Masters degree in Business Administration from Stanford
University in 1982.
Dr. Jolissaint has been Vice President and Chief Technical Officer of the
Company since co-founding the Company in 1990. From 1978 to 1990, he held
various engineering management positions at Rolm. In October 1989, he was
elected a Senior Member of the Technical Staff at Rolm. Dr. Jolissaint received
a Bachelor of Science degree in Electrical Engineering from Louisiana State
University in 1965 and Master of Science and Ph.D. degrees in Electrical
Engineering from Stanford University in 1966 and 1972, respectively.
Ms. Vinella has been Chief Financial Officer of the Company since August
1990, Vice President of Finance and Administration since August 1994 and
Secretary since February 1996. Prior to joining the Company, she served as
Director of Finance at Lumisys, Inc., a medical equipment company, from 1988 to
1990, and as Director of Finance and Chief Financial Officer at Spectra Logic
Corporation, a disk and tape controller manufacturer, from 1982 to 1987. Ms.
Vinella received a Bachelor of Science degree in Accounting from the University
of San Francisco in 1976 and a Masters degree in Business Administration from
Stanford University in 1982.
Mr. Glassanos has been Vice President of Marketing of the Company since
October 1992. From February 1992 to July 1992, he was Vice President of Product
Marketing, and from July 1989 to February 1992, he was Director of Marketing, at
NetFRAME Systems, Inc., a network server company. Mr. Glassanos received a
Bachelor of Arts degree in Political Science and Bachelor of Science and Master
of Science degrees in Electrical Engineering from Tufts University in 1978, 1978
and 1980, respectively, and a Masters degree in Business Administration from
Harvard University in 1982.
Mr. Begun has been Vice President of Professional Services of the Company
since April 1995. From March 1992 to April 1995, he was the President and Chief
Executive Officer of Wyatt Software Services, Inc., a human resources software
development company and a subsidiary of The Wyatt Company, a benefits and
compensation consulting company. Mr. Begun also served as President of the David
Corporation, a subsidiary of The Wyatt Company, from January to April 1995. From
October 1988 to March 1992, he was an Administrative Systems Practice Leader and
a senior systems consultant at The Wyatt Company. Mr. Begun received a Bachelor
of Science degree in Chemistry from Cornell University in 1966.
Ms. Tomlinson joined the Company as Vice President of Human Resources in
April 1996. From March 1995 to April 1996, she was Vice President of Human
Resources for the Desktop Document Systems Division of Xerox Corporation. Ms.
Tomlinson also served as Director of Human Resources for Synopsys, Inc. from
June 1992 to March 1995. From July 1983 to June 1992, she held human resource
management positions with Apple Computer, Inc. Ms. Tomlinson received a Bachelor
of Arts degree in Sociology from Pomona College in 1979.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's stock has been traded on the Nasdaq National Market since the
Company's initial public offering on May 2, 1996 under the Nasdaq symbol EDFY.
The following table sets forth, for the periods indicated, the high and low
closing sales prices for the Company's common stock as reported by Nasdaq:
High Low
---- ---
Year Ended December 31, 1996
----------------------------
Second Quarter (since May 2, 1996) 54 24 3/4
Third Quarter 26 1/4 17 1/4
Fourth Quarter 19 1/4 13 1/2
Year Ended December 31, 1997
----------------------------
First Quarter 16 10 1/4
Second Quarter 14 3/4 9 1/4
Third Quarter 17 7/16 12 3/4
Fourth Quarter 21 1/4 14 1/2
As of December 31, 1997, there were approximately 241 holders of record of
the Company's common stock.
The Company has never paid cash dividends on its common stock. The Company
currently intends to retain earnings, if any, for use in its business and does
not anticipate paying any cash dividends in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements and notes thereto included elsewhere in
this Report.
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net revenues:
License................................. $2,704 $6,274 $ 10,774 $20,134 $34,081
Services and other...................... 1,339 2,089 5,229 12,883 22,971
------ ------ ------- ------- -------
Total net revenues.................... 4,043 8,363 16,003 33,017 57,052
Cost of license revenues.................. 225 267 503 450 889
Cost of services and other revenues....... 1,161 2,225 3,865 10,635 17,576
------ ------ ------- ------- -------
Gross profit.......................... 2,657 5,871 11,635 21,932 38,587
------ ------ ------- ------- -------
Operating expenses:
Product development..................... 2,253 2,189 2,627 5,801 10,066
Sales and marketing..................... 4,493 4,696 8,015 15,371 21,565
General and administrative.............. 586 762 1,163 2,946 4,613
------ ------ ------- ------- -------
Total operating expenses.............. 7,332 7,647 11,805 24,118 36,244
------ ------ ------- ------- -------
Income (loss) from operations......... (4,675) (1,776) (170) (2,186) 2,343
------ ------ ------- ------- -------
Interest income........................... 215 113 143 1,598 2,078
Interest expense.......................... (76) (59) (58) (123) (125)
------ ------ ------- ------- -------
Interest, net......................... 139 54 85 1,475 1,953
------ ------ ------- ------- -------
Income (loss) before income taxes..... (4,536) (1,722) (85) (711) 4,296
Provision for income taxes................ 7 22 19 44 344
------ ------- ------- ------- -------
Net income (loss)..................... $(4,543) $(1,744) $ (104) $ (755) $ 3,952
======= ======= ======= ======= =======
Basic net income (loss) per share (1)..... $ (0.05) $ (0.07) $ 0.24
Shares used in computing basic net income
(loss) per share (1)................ 2,283 10,686 16,398
Diluted net income (loss) per share (1)... $ (0.05) $ (0.07) $ 0.22
Shares used in computing diluted net income
(loss) per share (1)................ 2,283 10,686 18,063
DECEMBER 31,
---------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments.............................. $4,410 $2,587 $ 7,154 $44,840 $43,161
Working capital............................ 3,856 2,128 8,992 43,870 48,954
Total assets............................... 7,393 6,214 15,372 60,721 68,480
Capital lease obligations, excluding current
installments............................. 332 148 510 707 340
Total stockholders' equity................. 4,800 3,063 10,419 49,187 55,808
(1) See Notes 2 and 3 of notes to financial statements for an explanation of
the determination of the number of shares used in computing per share data
and the restatement of prior year amounts to reflect the adoption of
Statement of Financial Accounting Standards No. 128.
15
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The following tables set forth certain unaudited statement of operations data
for each of the four quarters in 1996 and 1997, as well as the percentage of the
Company's total net revenues represented by each item. The unaudited financial
statements have been prepared on the same basis as the audited financial
statements contained herein and include all adjustments (consisting only of
normal recurring adjustments) that the Company considers necessary for a fair
presentation of such information when read in conjunction with the Company's
financial statements and notes thereto appearing elsewhere in this Report. In
view of the Company's recent growth and other factors, the Company believes that
quarter-to-quarter comparisons of its financial results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
QUARTER ENDED
--------------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
------- -------- -------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Net revenues:
License .................. $ 3,902 $ 4,274 $ 5,356 $ 6,602 $ 7,132 $ 7,807 $ 8,742 $ 10,400
Services and other ....... 1,915 2,639 3,705 4,624 5,178 5,730 5,478 6,585
------- -------- -------- --------- --------- --------- --------- ---------
Total net revenues .. 5,817 6,913 9,061 11,226 12,310 13,537 14,220 16,985
Cost of license revenues ... 90 110 138 112 131 205 162 391
Cost of services and other
revenues ................. 1,747 2,195 3,026 3,667 4,377 4,274 4,136 4,789
------- -------- -------- --------- --------- --------- --------- ---------
Gross profit ........ 3,980 4,608 5,897 7,447 7,802 9,058 9,922 11,805
------- -------- -------- --------- --------- --------- --------- ---------
Operating expenses:
Product development ...... 1,135 1,335 1,527 1,804 2,098 2,511 2,721 2,736
Sales and marketing ...... 2,955 3,473 4,022 4,921 4,521 4,953 5,329 6,762
General and administrative 506 629 845 966 1,027 1,155 1,160 1,271
------- -------- -------- --------- --------- --------- --------- ---------
Total operating
expenses ........... 4,596 5,437 6,394 7,691 7,646 8,619 9,210 10,769
------- -------- -------- --------- --------- --------- --------- ---------
Income (loss) from
operations ......... (616) (829) (497) (244) 156 439 712 1,036
------- -------- -------- --------- --------- --------- --------- ---------
Interest income ............ 91 369 571 567 525 529 508 515
Interest expense ........... (40) (18) (37) (28) (33) (27) (32) (32)
------- -------- -------- --------- --------- --------- --------- ---------
Interest, net ....... 51 351 534 539 492 502 476 483
------- -------- -------- --------- --------- --------- --------- ---------
Income (loss) before
income taxes ....... (565) (478) 37 295 648 941 1,188 1,519
Provision for income taxes . 2 6 -- 36 53 76 95 120
------- -------- -------- --------- --------- --------- --------- ---------
Net income (loss) ... $ (567) $ (484) $ 37 $ 259 $ 595 $ 865 $ 1,093 $ 1,399
======= ======== ======== ========= ========= ========= ========= =========
PERCENT OF TOTAL NET
REVENUES:
Net revenues:
License .................. 67.1% 61.8% 59.1% 58.8% 57.9% 57.7% 61.5% 61.2%
Services and other ....... 32.9 38.2 40.9 41.2 42.1 42.3 38.5 38.8
------- -------- -------- --------- --------- --------- --------- ---------
Total net revenues .. 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of license revenues ... 1.6 1.6 1.5 1.0 1.1 1.5 1.1 2.3
Cost of services and
other revenues ........... 30.0 31.7 33.4 32.7 35.6 31.6 29.1 28.2
------- -------- -------- --------- --------- --------- --------- ---------
Gross profit ........ 68.4 66.7 65.1 66.3 63.4 66.9 69.8 69.5
------- -------- -------- --------- --------- --------- --------- ---------
Operating expenses:
Product development ...... 19.5 19.3 16.9 16.1 17.0 18.6 19.1 16.1
Sales and marketing ...... 50.8 50.3 44.4 43.8 36.7 36.6 37.5 39.8
General and administrative 8.7 9.1 9.3 8.6 8.3 8.5 8.2 7.5
------- -------- -------- --------- --------- --------- --------- ---------
Total operating
expenses .......... 79.0 78.7 70.6 68.5 62.1 63.7 64.8 63.4
------- -------- -------- --------- --------- --------- --------- ---------
Income (loss) from
operations ........ (10.6) (12.0) (5.5) (2.2) 1.3 3.2 5.0 6.1
------- -------- -------- --------- --------- --------- --------- ---------
Interest income ............ 1.6 5.3 6.3 5.1 4.3 3.9 3.6 3.0
Interest expense ........... (0.7) (0.2) (0.4) (0.3) (0.3) (0.2) (0.2) (0.2)
------- -------- -------- --------- --------- --------- --------- ---------
Interest, net ....... 0.9 5.1 5.9 4.8 4.0 3.7 3.4 2.8
------- -------- -------- --------- --------- --------- --------- ---------
Income (loss) before
income taxes ....... (9.7) (6.9) 0.4 2.6 5.3 7.0 8.4 8.9
Provision for income taxes . -- 0.1 -- 0.3 0.4 0.6 0.7 0.7
------- -------- -------- --------- --------- --------- --------- ---------
Net income (loss) ... (9.7)% (7.0)% 0.4% 2.3% 4.8% 6.4% 7.7% 8.2%
======= ======== ======== ========= ========= ========= ========= =========
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results
of Operations includes forward-looking statements that reflect the Company's
current views with respect to future matters such as revenue sources, levels and
growth, spending levels, international operations, gross profit and capital
needs. Actual results may differ materially from the results and outcomes
discussed in the forward-looking statements. Factors that could cause or
contribute to such differences in results and outcomes include without
limitation those discussed below as well as those discussed elsewhere in this
Report.
OVERVIEW
The Company develops, markets and supports self service software products
that enable organizations to deploy automated services accessed by customers and
employees via the Internet, corporate intranets and the telephone. The Company
commenced operations in May 1990 to address the issues facing organizations
needing to provide more and better service through a broad range of interactive
media while containing costs. The Company was engaged principally in research
and development through the first quarter of 1992, when it made its initial
product shipments of its principal product, Electronic Workforce. Since that
time, the Company has released new versions of Electronic Workforce at least
annually.
The Company derives revenues from licenses of its software products and fees
for services related thereto. The Company currently markets Electronic Workforce
across multiple industries, emphasizing customer self service applications
within the financial services industry and employee self service applications
deployed by human resources organizations. In addition, in the last two years,
the Company has introduced two software application products for web-based self
service applications in the financial services and human resources markets, the
Electronic Banking System and the Employee Service System, both of which are
built on Electronic Workforce and incorporate web, Java and other technologies
which address the customization requirements necessary for the application
products market. The Company began shipping EBS in September 1996 and began
shipping ESY in June 1997.
The Company markets its products through its own field sales force, as well
as through VARs and OEMs, and markets its services directly to its customers and
distribution partners. The typical size of a direct transaction (including
software licenses and services) ranges from $100,000 to $200,000 and can be over
$1,000,000 for large applications. Most indirect licenses are smaller and do not
include a service component, resulting in substantially lower revenues per
transaction to the Company. In 1997, the Company derived approximately 60% of
its revenues from software licenses and 40% from fees for services. The Company
generally recognizes revenue from the licensing of software products upon
shipment and revenue from service contracts ratably over the contract period or
as the services are performed.
As of December 31, 1997, the Company had an accumulated deficit of $10.6
million. The Company intends to make ongoing investments in its sales,
marketing, research and development, customer support and administrative
infrastructure over the near term. Operating results for future periods are
subject to numerous uncertainties, and there can be no assurance that the
Company will sustain profitability on an annual or quarterly basis. The
Company's prospects must be considered in light of the risks encountered by
companies in new and rapidly evolving markets. Although the Company has
experienced significant percentage growth in revenues, it does not believe that
prior percentage growth rates are sustainable or indicative of future growth.
The ability of the Company to achieve revenue growth and profitability in the
future will depend on a number of factors, many of which are outside of the
Company's control. In particular, growth and profitability will depend on the
Company's success in marketing versions of and developing enhancements to its
products that run on the Windows NT platform as well as the Company's success in
marketing its new application products. The Company's inability to implement
these key elements of its growth strategy would result in a material adverse
effect on its business, financial condition and results of operations.
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20
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of total net revenues,
statement of operations data for the periods indicated:
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------ ------ ------
Net revenues:
License......................... 59.7% 61.0% 67.3%
Services and other.............. 40.3 39.0 32.7
------ ------ ------
Total net revenues........... 100.0 100.0 100.0
Cost of license revenues.......... 1.6 1.4 3.1
Cost of services and other revenues 30.8 32.2 24.2
------ ------ ------
Gross profit................. 67.6 66.4 72.7
------ ------ ------
Operating expenses:
Product development............. 17.6 17.6 16.4
Sales and marketing............. 37.8 46.5 50.1
General and administrative...... 8.1 8.9 7.3
------ ------ ------
Total operating expenses..... 63.5 73.0 73.8
------ ------ ------
Income (loss) from operations 4.1 (6.6) (1.1)
------ ------ ------
Interest income................... 3.6 4.8 0.9
Interest expense.................. (0.2) (0.4) (0.4)
------ ------ ------
Interest, net................ 3.4 4.4 0.5
------ ------ ------
Income (loss) before income
taxes...................... 7.5 (2.2) (0.6)
Provision for income taxes........ 0.6 0.1 0.1
------ ------ ------
Net income (loss)............ 6.9% (2.3)% (0.7)%
====== ====== ======
NET REVENUES
Total net revenues were $57.1 million, $33.0 million, and $16.0 million in
1997, 1996, and 1995, respectively, representing increases of 72.8% from 1996 to
1997 and 106.3% from 1995 to 1996. The Company's revenues are principally
derived from software licenses and fees for services, which are generally
charged separately. Revenues are recorded net of reserves for potential product
returns, neither of which have been significant to date. No single customer
exceeded 10% of total net revenues in 1997, 1996 or 1995. In each of 1997, 1996
and 1995, 5% or less of the Company's total net revenues were derived from
international sales. Over time, the Company intends to expand its operations
outside the United States and enter additional international markets.
International operations entail a number of risks including those associated
with product customization and regulatory compliance, and there can be no
assurance that such expansion will be successful.
LICENSE REVENUES. Revenues from licenses were $34.1 million, $20.1 million
and $10.8 million in 1997, 1996, and 1995, respectively, representing increases
of 69.3% from 1996 to 1997 and 86.9% from 1995 to 1996. The increases in license
revenues from 1995 to 1997 were attributable to several factors, including an
increase in unit volume as a result of the market's growing awareness and
acceptance of Electronic Workforce, the addition of web capabilities to this
product in the fourth quarter of 1995, the introduction of the Electronic
Banking System in September 1996, the introduction of the Employee Service
System in June 1997, and expansion of the Company's field sales force and
indirect distribution channels. The prices of the Company's Electronic Workforce
licenses have remained relatively constant from 1995 to 1997. The Company does
not believe that the historical growth rates of license revenues will be
sustainable or are indicative of future results.
SERVICES AND OTHER REVENUES. Services and other revenues consist primarily of
fees from consulting, post-contract customer support and, to a lesser extent,
training and installation services. Services and other revenues were $23.0
million, $12.9 million and $5.2 million in 1997, 1996 and 1995, respectively,
representing increases of 78.3% from 1996 to 1997 and 146.4% from 1995 to 1996.
Services and other revenues increased as a percentage of total net revenues to
40.3% in 1997 from 39.0% in 1996 and 32.7% in 1995. These increases in services
and other revenues occurred primarily due to increased demand for consulting
services, as well as increases in post-contract customer support, training and
installation services associated with the increased volume of licenses of the
Company's software. Consulting services primarily are contracted for under time
and material arrangements. The Company does not expect historical growth rates
of its services revenues to be sustainable in the future. To the extent services
and other revenues increases as a percentage of total net revenues, overall
gross profit margins may be adversely impacted.
18
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COST OF REVENUES
COST OF LICENSE REVENUES. Cost of license revenues consists primarily of the
cost of product media, product duplication, documentation and royalties paid to
third parties under technology licenses. Cost of license revenues was $889,000,
$450,000 and $503,000 in 1997, 1996 and 1995, respectively, representing 2.6%,
2.2% and 4.7% of the related license revenues for the respective years. The
increase in the dollar amount and the cost of license revenues as a percentage
of license revenues from 1996 to 1997 was due to increases in shipments of the
Company's software products and the costs of third-party technology used for a
particular customer. The decrease in the dollar amount from 1995 to 1996 was due
primarily to decreased overhead costs. The decrease in cost of license revenues
as a percentage of license revenues from 1995 to 1996 was due to increased
license revenues coupled with decreased material and overhead costs. If the
Company were required to obtain licenses from third parties under patent or
other intellectual property rights, the cost of license revenues could increase
significantly.
COST OF SERVICES AND OTHER REVENUES. Cost of services and other revenues
consists primarily of personnel-related costs and fees for third-party
consultants incurred in providing consulting, post-contract customer support,
training and installation services to customers. Cost of services and other
revenues was $17.6 million, $10.6 million and $3.9 million in 1997, 1996 and
1995, respectively, representing 76.5%, 82.6% and 73.9% of the related services
and other revenues for the respective years. The increases in absolute dollars
were due primarily to increases in personnel-related costs as the Company
continued to expand its consulting, customer support, training and installation
services organizations. The cost of services and other revenues as a percentage
may vary between periods due to the mix of services provided by the Company and
to varying levels of expenditures required to build the services organizations.
Any significant decline in the demand for the Company's consulting services
would have a material adverse impact on the Company's revenues and, as a result
of the under-utilization of consulting personnel, on the Company's gross profit
and results of operations.
OPERATING EXPENSES
PRODUCT DEVELOPMENT. Product development expenses were $10.1 million, $5.8
million and $2.6 million, or 17.6%, 17.6% and 16.4% of total net revenues, in
1997, 1996 and 1995, respectively. Product development expenses consist
primarily of salaries and other related expenses for research and development
personnel, as well as the cost of facilities and depreciation of capital
equipment. The increases in absolute dollars from 1995 to 1997, as well as the
increase in product development expenses as a percentage of total net revenues
from 1995 to 1996, were attributable primarily to increased staffing related to
development of application products, the development of versions of Electronic
Workforce to run on Windows NT and ongoing enhancements to Electronic Workforce.
The Company believes that significant investments in product development are
required to remain competitive. As a result, the Company expects that product
development expenses will increase in absolute dollars in the future and will
not decline significantly as a percentage of total net revenues from their
current levels.
In accordance with Statement of Financial Accounting Standards No. 86, the
Company expects to capitalize eligible computer software development costs upon
the achievement of technological feasibility, subject to net realizable value
considerations. The Company has defined technological feasibility as completion
of a working model. To date, the Company believes its process for developing
software was essentially completed concurrently with the establishment of
technological feasibility, and, accordingly, no software development costs have
been capitalized in the accompanying statements of operations.
SALES AND MARKETING. Sales and marketing expenses were $21.6 million, $15.4
million and $8.0 million, or 37.8%, 46.5% and 50.1% of total net revenues, in
1997, 1996 and 1995, respectively. Sales and marketing expenses consist
primarily of salaries and commissions earned by sales and marketing personnel
and promotional expenses. The increases in absolute dollars in sales and
marketing expenses for 1996 and 1997 were due primarily to the expansion of the
Company's field and indirect sales operations and increased marketing
activities. The reductions in sales and marketing expenses as a percentage of
total net revenues were due primarily to the growth in total net revenues. The
Company expects to continue to expand its field sales and marketing efforts, its
third-party VAR distribution channel and its operations outside the United
States and, therefore, anticipates that sales and marketing expenditures will
increase in absolute dollars in the future. In addition, sales and marketing
expenses as a percentage of total net revenues may fluctuate between periods due
to varying levels of expenditures to build the sales and marketing
organizations.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $4.6
million, $2.9 million and $1.2 million, or 8.1%, 8.9% and 7.3% of total net
revenues, in 1997, 1996 and 1995, respectively. General and administrative
expenses consist primarily of salaries and other related expenses of
administrative, executive and financial personnel and outside professional fees.
The increases in absolute dollars from 1995 to 1997 were attributable primarily
to the addition of staff, increased costs associated with expansion of
information systems to support the growth of the Company's business and
increased costs to take on the additional responsibilities associated with being
a public company. The reduction in general and administrative expenses as a
percentage of total net revenues
19
22
from 1996 to 1997 was due primarily to the growth in total net revenues. The
increase in general and administrative expenses as a percentage of total net
revenues from 1995 to 1996 was due primarily to the aforementioned factors. The
Company expects to continue to expand its staffing, information systems and
other items related to infrastructure and, therefore, anticipates that general
and administrative expenses will increase in absolute dollars in the future.
INTEREST
INTEREST INCOME. Interest income was $2.1 million, $1.6 million and $143,000
in 1997, 1996 and 1995, respectively. The increases from 1995 to 1997 were due
primarily to increases in average investment balances from the proceeds of the
Company's initial public offering.
INTEREST EXPENSE. Interest expense, which relates primarily to capital lease
obligations, was $125,000, $123,000 and $58,000 in 1997, 1996 and 1995,
respectively. The increases from 1995 to 1997 were due primarily to an increase
in property and equipment acquired under capital lease obligations.
PROVISION FOR INCOME TAXES
The provision for income taxes was $344,000, $44,000 and $19,000 in 1997,
1996 and 1995, respectively. No provision for federal income taxes was required
through 1996, as the Company had not been profitable on an annual basis from its
inception through 1996. As of December 31, 1997, the Company had federal net
operating loss carryforwards of approximately $4.2 million. The net operating
loss carryforwards expire in years 2005 through 2010. As of December 31, 1997,
the Company also had federal and state research and development tax credit
carryforwards of approximately $903,000 and $676,000, respectively.
The Company's accounting for deferred taxes under Statement of Financial
Accounting Standards No. 109 involves the evaluation of a number of factors
concerning the realizability of the Company's deferred tax assets. To support
the Company's conclusion that a 100% valuation allowance was required,
management primarily considered such factors as the Company's history of
operating losses, the nature of the Company's deferred tax assets, the lack of
significant firm sales backlog, no significant excess of appreciated asset value
over the tax basis of the Company's net assets and the absence of taxable income
in prior carryback years. Although management's operating plans assume taxable
and operating income in future periods, management's evaluation of all the
available evidence in assessing the realizability of the deferred tax assets
indicates that such plans are not considered sufficient to overcome the
available negative evidence.
LIQUIDITY AND CAPITAL RESOURCES
From inception through April 1996, the Company financed its operations and
met its capital expenditure requirements primarily through private sales of
preferred stock, totaling $24.1 million. On May 2, 1996, the Company completed
its initial public offering of 2,875,000 shares of its Common Stock at a price
of $15.00 per share. Proceeds to the Company from this offering were
approximately $38.9 million, net of underwriting discounts and other offering
costs. At December 31, 1997, the Company's cash, cash equivalents, and
short-term investments totaled $43.2 million.
At December 31, 1997, the Company also had available an $8.0 million
unsecured revolving bank line of credit agreement which expires in December 1998
and contains certain financial covenants, with which the Company was in
compliance. Borrowings accrue interest at the bank's prime rate. As of December
31, 1997, there were no borrowings outstanding under this line of credit.
In 1997, $643,000 of cash was provided by operating activities, resulting
primarily from net income, depreciation and amortization and increases in
accrued expenses and unearned revenue, offset by an increase in accounts
receivable due to an increase in revenues and average days sales outstanding. In
1996, $3.9 million of cash was provided by operating activities, resulting
primarily from depreciation and amortization and increases in accrued expenses
and unearned revenue, partially offset by an increase in accounts receivable. In
1995, $1.5 million of cash was used in operating activities, resulting primarily
from increases in accounts receivable associated with the increases in revenues,
partially offset by increases in accrued expenses and unearned revenue.
In 1997, 1996 and 1995, the Company's investing activities have consisted
primarily of purchases and sales of short-term investments and purchases of
property and capital equipment. Capital expenditures, including equipment
acquired under capital leases, were $4.4 million, $5.5 million and $1.7 million
in 1997, 1996 and 1995, respectively, primarily for expansion of the Company's
facilities and purchases of computer and network equipment for the Company's
growing employee base. The Company expects that its capital expenditures will
increase as the Company's employee base grows. The Company's principal
commitments
20
23
consist primarily of leases on its headquarters facilities and its equipment. In
1997, net cash generated from financing activities of $2.0 million was related
primarily to proceeds from the issuance of the Company's common stock through
its Employee Stock Purchase Plan and stock option exercises.
At December 31, 1997, the Company's working capital was $49.0 million. In
1998, the Company expects to incur costs in excess of $500,000 associated with
the implementation of a new financial system to replace its current system. The
Company has no other significant capital spending or purchase commitments other
than normal purchase commitments and commitments under facilities and capital
leases. The Company believes that its working capital, together with its bank
line of credit and anticipated cash flows from operations, if any, will be
sufficient to meet its working capital and capital expenditure requirements for
at least the next 12 months.
BUSINESS RISKS
This section on "Business Risks" includes forward-looking statements that
reflect the Company's current views with respect to future matters such as
factors that can affect the Company's operating results, technological change,
the markets for the Company's products, the Company's sales channels and the
stability and availability of compatible technology. This section also contains
cautionary statements that identify important factors, including certain risks
and uncertainties, that could cause actual results or outcomes to differ
materially from those in the forward-looking statements in this section and
elsewhere in this Report.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's revenues, margins
and operating results have fluctuated in the past, and are expected to continue
to fluctuate in the future, on an annual and quarterly basis as a result of a
number of factors, such as demand for the Company's products, including new
products and product enhancements, the mix of products and services sold, the
mix of distribution channels through which the Company's products are sold,
customer order deferrals in anticipation of new products or product
enhancements, purchasing patterns of value added resellers and customers,
Company decisions regarding hiring and other expenses and competitive conditions
in the industry. In particular, the Company plans to increase its operating
expenses to expand its sales and marketing operations, expand its distribution
channels, expand its international operations, fund greater levels of product
development, broaden its consulting services and customer support capabilities
and increase its administrative infrastructure. A relatively high percentage of
the Company's expenses is fixed in the short term as the Company's expense
levels are based, in part, on its expectations as to future revenues. If
revenues fall below expectations, expenditure levels could be disproportionately
high as a percentage of total net revenues, and operating results would be
immediately and adversely affected.
The Company historically has operated with little backlog because its
products are generally shipped as orders are received. As a result, license
revenues in any quarter depend on the volume and timing of, and the Company's
ability to fill, orders received in that quarter. Individual orders for the
Company's products typically are for relatively large dollar amounts. The
Company also believes the purchase of its products is relatively discretionary
and generally involves a significant commitment of capital resources. Therefore,
any downturn in any potential customer's business, or any loss or delay of
individual orders for any reason, would have a significant impact on the
Company's revenues and quarterly results. In addition, because the Company
typically recognizes a substantial portion of its total revenue from
transactions booked and shipped in the last weeks, or even days, of the quarter,
the magnitude of quarterly fluctuations may not become evident until very late
in a particular quarter. Revenues are difficult to forecast because the market
for the Company's products is rapidly evolving. The Company's sales cycle,
including initial order, provision of services and follow-on sales, averages six
months, but varies substantially from customer to customer and can range from
one month to over one year from initial contact. Furthermore, the Company
expects that sales derived through indirect channels, which are harder to
predict and may have lower margins than direct sales, will increase as a
percentage of total net revenues. In addition, as a result of recently issued
guidance on software revenue recognition, license agreements entered into during
a quarter may not meet the Company's revenue recognition criteria. Therefore,
even if the Company meets or exceeds its forecast of aggregate licensing and
other contracting activity, it is possible that the Company's revenues would not
meet expectations. Although the Company's revenue growth has made it difficult
to determine whether the Company's business has been subject to seasonal
variations, the Company believes that some of its customers tend to make product
purchase decisions in the fourth quarter as a result of purchase cycles related
to expiration of budgetary authorizations. Based upon all of the foregoing, the
Company believes that its quarterly revenues, expenses and operating results
could vary significantly in the future, and that period-to-period comparisons
should not be relied upon as indications of future performance. The Company may
also choose to reduce prices or increase spending in response to competition or
to pursue new market opportunities. If new competitors, technological advances
by existing competitors or other competitive factors require the Company to
invest significantly greater resources in research and development efforts, the
Company's operating results in the future may be adversely affected. There can
be no assurance that the Company will be able to grow in future periods or that
it will be able to sustain its level of total revenues or its rate of revenue
growth on a quarterly or annual basis. It is likely that, in some future
quarters, the Company's operating results will be below the expectations of
stock market analysts and investors. In such event, the price of the Company's
common stock could be materially adversely affected.
21
24
RISKS OF EXPANSION TO WINDOWS NT OPERATING SYSTEM. The Company's future
success will depend on its ability to design, develop, test, sell and support
new software products and enhancements of current products on a timely basis in
response to changing customer needs, competition, technological developments and
emerging industry standards. Versions through 4.x of Electronic Workforce and
1.x of EBS and ESY run on IBM's OS/2 operating system. In October 1997, the
Company released its first version of Electronic Workforce Release 5 for the
Windows NT operating system. In December 1997, the Company released initial
versions of EBS and ESY for NT. Because these products have been recently
released, many customers licensing these versions have not yet fully deployed
the product and undetected errors may remain in these versions. The existence of
any such errors may delay the release of future versions and adversely affect
the acceptance of these products, either of which could have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, certain features of the OS/2 versions of the Company's software are
not available on currently available NT-based versions. Accordingly, the Company
is devoting significant engineering and development resources to develop
enhancements to the versions of its products that run on the Microsoft Windows
NT operating system. It is possible that the newness of or lack of features on
the Windows NT-based versions of its products will cause potential customers to
defer or forgo purchases of current or future versions of these products, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company's future success will depend
upon the timely and successful introduction of new versions of its Windows
NT-based products. There can be no assurance that the Company will be successful
in developing, on a timely basis or at all, fully featured Windows NT-based
versions of its products or that such versions, if developed, will achieve
customer acceptance. Failure by the Company to develop new Windows NT-based
versions successfully and in a timely manner would have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company intends to invest a significant majority of its product
development resources on products and product enhancements for the Windows NT
operating system. The Company must manage the effect on its existing OS/2
customers of this focus on the Windows NT operating system. There can be no
assurance that updates to and enhancements for the Company's OS/2-based products
will be sufficient to encourage its OS/2 customers to continue to purchase
additional software or services from the Company. In addition, the Company must
provide its customers with an economically reasonable and technologically
feasible migration path from the OS/2-based products to the NT-based products.
There can be no assurance that the Company's OS/2 customers will migrate to the
Company's NT-based products. The failure of a significant number of its existing
OS/2 customers to purchase additional software or services from the Company, for
any reason, would have a material adverse effect on the Company's business,
operating results and financial condition.
EMERGING MARKET; UNPROVEN ACCEPTANCE OF THE COMPANY'S APPLICATION PRODUCTS.
Certain of the Company's products and features have been introduced only
recently. In September 1996, the Company began shipping the Electronic Banking
System, its first application product. In June 1997, Edify began shipping its
Employee Service System. The emerging self service application products markets
are rapidly changing and are characterized by an increasing number of new
entrants whose products compete with those of the Company. Demand for and market
acceptance of these products and services are subject to a high level of
uncertainty. Moreover, much of the industry software and infrastructure
supporting the use of the Company's products in these markets is new and
unproven. It is difficult to predict with any assurance whether the web will
prove to be a viable commercial marketplace, or whether demand for web or
intranet related products and services will increase in the future. In addition,
portions of the markets for the Company's products and services are new and
evolving, and it is difficult to predict the future growth of this market. There
can be no assurance that a viable market for self service application products
will develop or be sustainable. If the market fails to develop, develops more
slowly than expected or becomes saturated with competitors, or if the Company's
products and services do not achieve or sustain market acceptance, the Company's
business, financial condition and results of operations would be materially
adversely affected.
LENGTHY SALES CYCLE. The licensing of Edify's software is often an
enterprise-wide decision by prospective customers and generally requires the
Company to engage in a lengthy sales cycle and to provide a significant level of
education to prospective customers regarding the use and benefits of its
software. Due in part to the mission-critical nature of certain of the Company's
software applications and the associated hardware, software and consulting
expenditures, potential customers tend to be cautious in making product
acquisition decisions. In addition, the licensing of the Company's software
involves a significant commitment of capital and the attendant delays frequently
associated with approving large capital expenditures and reviewing new
technologies that affect key operations. For these and other reasons, the sales
cycle for the Company's products can range from one month to over one year,
averages six months, and is subject to a number of significant risks, including
customers' budgetary constraints and internal acceptance reviews, over which the
Company has little or no control. Consequently, if sales forecasted from a
specific customer for a particular quarter are not realized in that quarter, the
Company is unlikely to be able to generate revenue from alternate sources in
time to compensate for the shortfall. As a result, and due to the relatively
large size of a typical order, a lost or delayed sale could have a material
adverse effect on the Company's quarterly operating results. Moreover, to the
extent that significant sales occur earlier than expected, operating results for
subsequent quarters may be adversely affected.
22
25
DEPENDENCE UPON DEVELOPMENT OF MARKETING CHANNELS. An integral part of the
Company's strategy is to develop multiple distribution channels, including a
field sales force, VARs and OEMs. The Company intends to increase its reliance
on third-party distribution partners in the future. The Company is expending and
intends to continue to expend significant resources to develop the VAR channel.
VARs are not, however, subject to any minimum purchase or resale requirements
and can cease marketing the Company's products at any time. Certain VARs also
offer competing products that they produce or that are produced by third
parties. There can be no assurance that the Company's existing VARs will
continue to provide the level of services and technical support necessary to
provide a complete self service solution to the Company's customers or that they
will not emphasize their own or third-party products to the detriment of the
Company's products. The loss of VARs, the failure of such parties to perform
under agreements with the Company, or the inability of the Company to attract
and retain new VARs with the technical, industry and application expertise
required to market the Company's products successfully in the future could have
a material adverse effect on the Company's business, financial condition and
results of operations. To the extent that the Company is successful in
increasing its sales through VARs, those sales will be at discounted rates, and
revenue to the Company for each such sale will be less than if the Company had
licensed the same products to the customer directly.
The Company plans to expand its field sales force and its marketing
organization. The Company's future success depends upon the increased
productivity of its existing field sales force and the ability of the Company to
integrate and train new sales personnel. There can be no assurance that the
Company's efforts will be successful, that the cost of such efforts will not
exceed the revenue generated, or that the Company's sales and marketing
organization will be able to compete successfully against the significantly more
extensive and well-funded sales and marketing operations of many of the
Company's current or potential competitors. The Company's inability to manage
its internal expansion effectively could have a material adverse effect on the
Company's business, financial condition and results of operations.
MANAGEMENT OF A RAPIDLY CHANGING BUSINESS. The rapid development of an
infrastructure necessary for the Company to exploit the market opportunities for
its products requires an effective planning and management process. The Company
has recently experienced changes in its operations that have placed significant
demands on the Company's administrative, operational and financial resources. In
1997, the Company increased its staff from 279 to 349 employees and its total
net revenues by 73%. The Company is expanding its sales and marketing
organizations, developing its distribution channels to penetrate different and
broader markets, funding increasing levels of research and development, and
growing its support organization to accommodate the increasing installed base of
products. The growth in the Company's customer base has placed, and any future
growth is expected to continue to place, a significant strain on the Company's
management and operations, including its sales, customer support, research and
development, finance and administrative operations. The Company's officers as a
whole have had limited experience in managing large or rapidly growing business
organizations. The Company's ability to compete effectively and its future
growth, if any, will require the Company to continually improve its financial
and management controls, reporting systems and procedures on a timely basis,
implement new systems as necessary, and expand, train and manage its employee
workforce. There can be no assurance that the Company's controls, systems or
procedures will be adequate to support the Company's operations. The failure of
the Company's management to respond effectively to changing business conditions
could have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL. The Company's
future performance depends to a significant degree upon the continued
contributions of members of the Company's senior management and other key
research and development, sales and marketing personnel. The Company currently
has open positions for Vice President of Sales and Vice President of
Engineering. The failure of the Company to fill these positions with qualified
persons in a timely fashion, or the loss of any other key persons, could have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company does not have employment agreements with any
of its key personnel. In addition, the Company believes that its future success
will depend upon its continuing ability to identify, attract, train and retain
other highly skilled managerial, engineering, sales and marketing and
professional services personnel. Competition for such personnel is intense.
There can be no assurance that the Company will be successful in attracting,
assimilating and retaining the necessary personnel, and the failure to do so
could have a material adverse effect on the Company's business, financial
condition and results of operations.
RELIANCE ON STABILITY AND AVAILABILITY OF THIRD-PARTY SOFTWARE AND HARDWARE.
The Company's products involve integration with products and systems developed
by third parties. Substantially all of the Company's installed base of products
run on the OS/2 operating system, and the Company is therefore dependent upon
the continued viability of the OS/2 operating system and upon IBM's continuing
support for the OS/2 operating system. In the fourth quarter of 1997, the
Company released Windows NT-based versions of its products and intends to focus
future product development efforts on NT. Accordingly, the Company also is
dependent upon the continued viability of that operating environment. In
addition, the current versions of the Company's products are designed to
function only with Natural MicroSystems Corporation's voice hardware cards and
software drivers and Intersolv Inc.'s QELib for database connectivity. If any of
these third-party products should become unavailable for any reason, fail under
operation with the
23
26
Company's products, or fail to be supported by their respective vendors, it
would be necessary for the Company to redesign its products. There can be no
assurance that any redesign could be accomplished in a cost-effective or timely
manner. The Company or its customers could also experience difficulties
integrating the Company's products with other hardware and software.
Furthermore, should new releases of these operating systems, voice hardware
cards and software drivers or database connectivity software occur before the
Company develops products compatible with such new releases, any resulting
decline in demand for the Company's products could have a material adverse
effect on the Company's business, financial condition and results of operations.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and software
products are coded to accept two digit entries in the date code field. These
date code fields will need to accept four digit entries to distinguish 21st
century dates from 20th century dates. As a result, in less than two years,
computer systems and software used by many companies may need to be upgraded to
comply with such "Year 2000" requirements. Although the Company's products are
Year 2000 compliant, the Company believes that the purchasing patterns of
customers and potential customers may be affected by Year 2000 issues as
companies expend significant resources to correct or patch their current
software systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase software products such as those offered by
the Company, which could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, even if
the Company's products are Year 2000 compliant, other systems or software used
by the Company's customers may not be Year 2000 compliant. The failure of such
noncompliant third-party software or systems could affect the perceived
performance of the Company's products, which could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, the Company is in the process of identifying operating and
application software challenges related to the Year 2000. While the Company
expects to resolve Year 2000 compliance issues substantially through normal
replacement and upgrades of software, there can be no assurance that there will
not be interruption of operations or other limitations of system functionality
or that the Company will not incur substantial costs to avoid such limitations.
Any failure to effectively monitor, implement or improve the Company's
operational, financial, management and technical support systems could have a
material adverse effect on the Company's business, financial condition and
results of operations.
IMPLEMENTATION OF NEW FINANCIAL SYSTEM. The Company has decided to replace
its existing financial system as part of its ongoing effort to increase
operational efficiency. The failure of the Company to implement successfully the
new system and to manage effectively the transition from its current system to
the new system could have a material adverse effect on the Company's business,
financial condition and results of operations.
For a discussion of additional business risks, see "Business--Product
Development," "--Competition," "--Proprietary Rights" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Overview."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements of the Company required by this item are set
forth at the pages indicated at Item 14(a). The Supplementary Data required by
this item are incorporated by reference from Item 6 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item with respect to the directors of
the Company is incorporated by reference from the definitive proxy statement for
the Company's 1998 annual meeting of stockholders to be filed with the
Commission pursuant to
24
27
Regulation 14A not later that 120 days after the end of the fiscal year covered
by this report (the "Proxy Statement") under the caption "PROPOSAL NO.
1--ELECTION OF DIRECTORS." The information relating to the executive officers of
the Company is set forth in Part I of this report under the caption "Item 4A.
Executive Officers of the Registrant."
Information required by this item with respect to compliance with
Section 16(a) of the Securities Exchange Act of 1934 is incorporated by
reference from the Proxy Statement under the caption "SECTION 16(a) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from
the Proxy Statement under the captions "EXECUTIVE COMPENSATION," "PROPOSAL NO.
1--ELECTION OF DIRECTORS--DIRECTOR COMPENSATION" and "COMPENSATION COMMITTEE
INTERLOCKS AND INSIDER PARTICIPATION."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from
the Proxy Statement under the captions "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from
the Proxy Statement under the caption "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form:
PAGE
----
1. Financial Statements
Independent Auditors' Report.......................................... 26
Balance Sheets as of December 31, 1997 and 1996....................... 27
Statements of Operations for the three years ended December 31, 1997.. 28
Statements of Stockholders' Equity for the
three years ended December 31, 1997 ................................ 29
Statements of Cash Flows for the three years ended December 31, 1997.. 30
Notes to Financial Statements......................................... 31
2. Financial Statement Schedule for the years ended
December 31, 1997, 1996 and 1995
Schedule II - Valuation and Qualifying Accounts....................... 40
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes
thereto.
3. Exhibits: See Index to Exhibits on page 42. The Exhibits listed in the
accompanying Index to Exhibits are filed or incorporated by reference
as part of this report.
(b) Reports on Form 8-K:
None.
25
28
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Edify Corporation:
We have audited the accompanying balance sheets of Edify Corporation (the
"Company") as of December 31, 1997 and 1996, and the related statements of
operations, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1997. In connection with our audits of the
financial statements, we have also audited the financial statement schedule as
listed in the accompanying index. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Edify Corporation as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the years in the three-year period ended December 31, 1997, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
Mountain View, California KPMG PEAT MARWICK LLP
January 22, 1998
26
29
EDIFY CORPORATION
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
----------------------
1997 1996
-------- --------
ASSETS
Current assets:
Cash and cash equivalents .................................. $ 31,790 $ 33,704
Short-term investments ..................................... 11,371 11,136
Accounts receivable, net of allowance for returns and
doubtful accounts of $1,629 and $583, respectively ....... 16,668 8,837
Prepaid expenses and other current assets .................. 1,457 1,020
-------- --------
Total current assets ................................ 61,286 54,697
Property and equipment, net .................................. 6,953 5,790
Other assets ................................................. 241 234
-------- --------
Total assets ........................................ $ 68,480 $ 60,721
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................... $ 1,062 $ 1,544
Current installments of capital lease obligations .......... 424 404
Accrued expenses ........................................... 6,265 5,128
Unearned revenue ........................................... 4,581 3,751
-------- --------
Total current liabilities ........................... 12,332 10,827
-------- --------
Capital lease obligations, excluding current installments .... 340 707
Commitments and contingencies (Note 8)
Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized shares - 5,000,000
Issued and outstanding - none ............................ -- --
Common stock, $0.001 par value:
Authorized shares - 55,000,000
Issued and outstanding - 16,607,327 (16,101,607 in 1996) 17 16
Additional paid-in capital ................................. 66,624 64,208
Deferred compensation ...................................... (181) (428)
Note receivable from stockholder ........................... (12) (17)
Accumulated deficit ........................................ (10,640) (14,592)
-------- --------
Total stockholders' equity .......................... 55,808 49,187
-------- --------
Total liabilities and stockholders' equity .......... $ 68,480 $ 60,721
======== ========
See accompanying notes to financial statements.
27
30
EDIFY CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
-------- -------- --------
Net revenues:
License ...................................... $ 34,081 $ 20,134 $ 10,774
Services and other ........................... 22,971 12,883 5,229
-------- -------- --------
Total net revenues ................... 57,052 33,017 16,003
Cost of license revenues ....................... 889 450 503
Cost of services and other revenues ............ 17,576 10,635 3,865
-------- -------- --------
Gross profit ......................... 38,587 21,932 11,635
-------- -------- --------
Operating expenses:
Product development .......................... 10,066 5,801 2,627
Sales and marketing .......................... 21,565 15,371 8,015
General and administrative ................... 4,613 2,946 1,163
-------- -------- --------
Total operating expenses ............. 36,244 24,118 11,805
-------- -------- --------
Income (loss) from operations ........ 2,343 (2,186) (170)
-------- -------- --------
Interest income ................................ 2,078 1,598 143
Interest expense ............................... (125) (123) (58)
-------- -------- --------
Interest, net ........................ 1,953 1,475 85
-------- -------- --------
Income (loss) before income taxes .... 4,296 (711) (85)
Provision for income taxes ..................... 344 44 19
-------- -------- --------
Net income (loss) .................... $ 3,952 $ (755) $ (104)
======== ======== ========
Basic net income (loss) per share .............. $ 0.24 $ (0.07) $ (0.05)
======== ======== ========
Shares used in computing basic net income (loss)
per share ................................... 16,398 10,686 2,283
======== ======== ========
Diluted net income (loss) per share ............ $ 0.22 $ (0.07) $ (0.05)
======== ======== ========
Shares used in computing diluted net income
(loss) per share ............................ 18,063 10,686 2,283
======== ======== ========
See accompanying notes to financial statements.
28
31
EDIFY CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
PREFERRED STOCK COMMON STOCK ADDITIONAL DEFERRED
------------------- ----------------------- PAID-IN COMPENSATION
SHARES AMOUNT SHARES AMOUNT CAPITAL (NOTE 5)
------ -------- ----------- -------- ------- ----------
Balances as of
December 31, 1994............. 8,985,000 $ 16,751 2,255,823 $ 2 $ 43 $ --
Issuance of Series D
preferred stock, net .... 1,091,481 7,328 -- -- -- --
Stock options exercised ... -- -- 79,695 -- 14 --
Sale of common stock to
employees, directors and
consultants ............. -- -- 95,625 -- 33 --
Series A preferred stock
warrants exercised ...... 33,750 42 -- -- -- --
Deferred compensation
related to grant of stock
options ................. -- -- -- -- 601 (601)
Amortization of deferred
compensation ............ -- -- -- -- -- 60
Net loss .................. -- -- -- -- -- --
------------ -------- ----------- -------- --------- ---------
Balances as of
December 31, 1995 ....... 10,110,231 24,121 2,431,143 2 691 (541)
Conversion of preferred
stock to common stock ... (10,110,231) (24,121) 10,110,231 10 24,111 --
Sale of common stock,
net of issuance costs
of $1,204 ............... -- -- 2,875,000 3 38,875 --
Stock options exercised ... -- -- 622,303 1 228 --
Net exercise of stock
warrants ................ -- -- 62,930 -- -- --
Deferred compensation
related to grant of stock
options ................. -- -- -- -- 303 (303)
Amortization of deferred
compensation ............ -- -- -- -- -- 416
Net loss .................. -- -- -- -- -- --
------------ -------- ----------- -------- --------- ---------
Balances as of
December 31, 1996 ....... -- -- 16,101,607 16 64,208 (428)
Stock options exercised,
including tax benefit ... -- -- 315,281 1 358 --
Stock purchased under
Employee Stock Purchase
Plan .................... -- -- 190,439 -- 2,058 --
Payment on note receivable
from stockholder ........ -- -- -- -- -- --
Amortization of deferred
compensation ............ -- -- -- -- -- 247
Net income ................ -- -- -- -- -- --
------------ -------- ----------- --------- --------- ------------
Balances as of
December 31, 1997 ....... -- $ -- 16,607,327 $ 17 $ 66,624 $ (181)
============ ======== =========== ======== ========= ============
NOTE
RECEIVABLE TOTAL
FROM ACCUMULATED STOCKHOLDERS
STOCKHOLDER DEFICIT EQUITY
-------- -------- --------
Balances as of
December 31, 1994 ........ $ -- $(13,733) $ 3,063
Issuance of Series D
preferred stock, net .... -- -- 7,328
Stock options exercised ... -- -- 14
Sale of common stock to
employees, directors and
consultants ............. (17) -- 16
Series A preferred stock
warrants exercised ...... -- -- 42
Deferred compensation
related to grant of stock
options ................. -- -- --
Amortization of deferred
compensation ............ -- -- 60
Net loss .................. -- (104) (104)
-------- -------- --------
Balances as of
December 31, 1995 ....... (17) (13,837) 10,419
Conversion of preferred
stock to common stock ... -- -- --
Sale of common stock,
net of issuance costs
of $1,204 ............... -- -- 38,878
Stock options exercised ... -- -- 229
Net exercise of stock
warrants ................ -- -- --
Deferred compensation
related to grant of stock
options ................. -- -- --
Amortization of deferred
compensation ............ -- -- 416
Net loss .................. -- (755) (755)
-------- -------- --------
Balances as of
December 31, 1996 ....... (17) (14,592) 49,187
Stock options exercised,
including tax benefit ..... -- -- 359
Stock purchased under
Employee Stock Purchase
Plan .................... -- -- 2,058
Payment on note receivable
from stockholder ........ 5 -- 5
Amortization of deferred
compensation ............ -- -- 247
Net income ................ -- 3,952 3,952
-------- -------- --------
Balances as of
December 31, 1997 ....... $ (12) $(10,640) $ 55,808
======== ======== ========
See accompanying notes to financial statements.
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EDIFY CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
-------- -------- --------
Cash flows from operating activities:
Net income (loss) ................................................ $ 3,952 $ (755) $ (104)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization .................................. 3,227 1,563 903
Provision for returns and doubtful accounts, net of
write-offs and recoveries .................................... 1,046 408 138
Amortization of deferred compensation .......................... 247 416 60
Changes in operating assets and liabilities:
Accounts receivable .......................................... (8,877) (3,245) (3,784)
Prepaid expenses and other current assets .................... (437) (739) (91)
Accounts payable ............................................. (482) 742 479
Accrued expenses ............................................. 1,137 3,257 833
Unearned revenue ............................................. 830 2,290 81
-------- -------- --------
Net cash provided by (used in)
operating activities ....................................... 643 3,937 (1,485)
-------- -------- --------
Cash flows from investing activities:
Purchases of property and equipment, net ......................... (4,355) (4,875) (970)
Purchases of short-term investments .............................. (15,684) (24,520) (5,972)
Sales and maturities of short-term investments ................... 15,449 19,356 500
Other assets ..................................................... (7) (119) (67)
-------- -------- --------
Net cash used in investing activities ...................... (4,597) (10,158) (6,509)
-------- -------- --------
Cash flows from financing activities:
Principal payments under capital lease obligations ............... (382) (364) (311)
Proceeds from line of credit and repayment of
shareholder note ............................................... 5 -- 300
Repayments of line of credit ..................................... -- -- (300)
Proceeds from issuance of common stock .......................... 2,417 39,107 30
Proceeds from exercise of preferred stock warrants ............... -- -- 42
Proceeds from sale of preferred stock ............................ -- -- 7,328
-------- -------- --------
Net cash provided by financing activities .................. 2,040 38,743 7,089
-------- -------- --------
Increase (decrease) in cash and cash equivalents ................... (1,914) 32,522 (905)
Cash and cash equivalents at beginning of year ..................... 33,704 1,182 2,087
-------- -------- --------
Cash and cash equivalents at end of year ........................... $ 31,790 $ 33,704 $ 1,182
======== ======== ========
Supplemental schedule of cash flow information:
Cash paid during the year for interest ........................... $ 125 $ 123 $ 57
Cash paid during the year for taxes .............................. $ 96 $ 29 $ 18
Supplemental schedule of noncash investing and financing activities:
Property and equipment acquired under capital lease
obligations .................................................. $ 35 $ 656 $ 720
Accrual of stock option deferred compensation .................. $ -- $ 303 $ 601
Note receivable issued for common stock ........................ $ -- $ -- $ 17
See accompanying notes to financial statements.
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EDIFY CORPORATION
NOTES TO FINANCIAL STATEMENTS
(1) THE COMPANY
Edify Corporation (the "Company") was incorporated on October 19, 1989. The
Company develops and markets self service software and provides application
development consulting, installation and post-contract customer support
services. The principal markets for the Company's products are i) human resource
and customer service departments for a wide variety of companies, and ii)
banking and financial services companies. In April 1996, the Company
reincorporated as a Delaware corporation.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid instruments with a maturity of three
months or less at the time of purchase to be cash equivalents. Cash equivalents
consist of commercial paper and money market deposits.
Short-Term Investments
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" requires entities to classify
investments in debt and equity securities with readily determinable fair values
as "held-to-maturity," "available-for-sale" or "trading," and establishes
accounting and reporting requirements for each classification. In accordance
with SFAS No. 115, the Company has classified its investments in certain debt
securities as available-for-sale. The cost of securities sold is based upon the
specific identification method.
Credit Risk Concentrations and Fair Values of Financial Instruments
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of cash investments and
accounts receivable. The Company's cash investments generally consist of
commercial paper, money market deposits, bankers' acceptances, certificates of
deposit, and corporate bonds. Concentrations of credit risk with respect to
accounts receivable are limited due to the large number of customers comprising
the Company's customer base.
The carrying amounts of cash, cash equivalents, accounts receivable, accounts
payable and accrued liabilities approximate fair value due to the short maturity
of those instruments. The fair value of capital leases is not estimated, but
reflects the contractual present value owed to non-related parties.
Property and Equipment
Property and equipment are stated at cost. Equipment under capital leases is
stated at the lower of fair value or the present value of the minimum lease
payments at the inception of the lease.
Depreciation of property and equipment is computed on a straight-line basis
over the estimated useful lives of the respective assets, generally three years
for equipment and office furniture and the shorter of the useful life of the
asset or the remaining lease term for leasehold improvements. Equipment under
capital leases is amortized on a straight-line basis, generally 42 months.
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Software Development Costs
Product development costs include costs related to software products that are
expensed as incurred until the technological feasibility of the product has been
established. After technological feasibility is established, any additional
software development costs would be capitalized in accordance with SFAS No. 86.
Through December 31, 1997, the Company believes its process for developing
software was essentially completed concurrently with the establishment of
technological feasibility, and, accordingly, no software development costs have
been capitalized to date.
Revenue Recognition
Revenue on the licensing of software products is generally recognized upon
shipment, net of estimated allowances for product returns. Software license
revenues are recognized upon shipment only if no significant vendor obligations
remain and collection of the resulting receivables is deemed probable. In
certain contracts, shipment is defined as delivery of a product master for
noncancelable product licensing arrangements under which the customer has
certain software reproduction and distribution rights. Revenue on post-contract
customer support and service contracts is recognized ratably over the contract
period and as the services are performed, respectively. Fixed price consulting
contract revenues are recognized based on the percentage of completion method.
Estimated losses are recorded in the period in which they become known. Time and
materials contracts are recognized as services are performed.
In October 1997, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA") issued Statement of Position
("SOP") No. 97-2, "Software Revenue Recognition." SOP No. 97-2 is effective for
fiscal years beginning after December 15, 1997, and provides guidance on
applying generally accepted accounting principles in recognizing revenue on
software transactions. SOP No. 97-2 supersedes SOP No. 91-1, Software Revenue
Recognition, and requires revenue recognized from software arrangements to be
allocated to each element of the arrangement based on the relative fair values
of the elements, such as software products, consulting, training, installation,
or post contract customer support. Fair values are based upon vendor specific
objective evidence. If evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist, or until all elements of the
arrangement are delivered. Application of SOP No. 97-2 is not anticipated to
materially impact the Company's revenue.
Net Income (Loss) Per Share
The Company adopted SFAS No. 128, "Earnings Per Share" in 1997 and restated
all comparative per share amounts for prior periods. SFAS No. 128 requires the
presentation of basic earnings per share and, for companies with potentially
dilutive securities, such as options, diluted earnings per share.
Basic earnings per share is computed using the weighted average number of
shares of common stock outstanding. Diluted earnings per share is computed using
the weighted average number of shares of common stock and, when dilutive,
convertible preferred stock outstanding and common equivalent shares from
options to purchase common stock and warrants outstanding using the treasury
stock method.
In February 1998, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 98 which changes the calculation of earnings per
share in periods prior to initial public offerings as previously applied under
SAB No. 83. When a registrant issued common stock, warrants, options, or other
potentially dilutive instruments for consideration or with exercise prices below
the initial public offering price within a one year period prior to the initial
filing of a registration statement relating to an initial public offering, SAB
No. 83 required such equity instruments to be treated as outstanding for all
periods presented in the filing using the anticipated initial public offering
price and the treasury stock method. Under SAB No. 98, when common stock option,
warrants, or other potentially dilutive instruments have been issued for nominal
consideration during the periods covered by income statements in the filing,
those nominal issuances are to be reflected in earnings per share calculations
for all periods presented. Based on the Company's current understanding of the
definition of "nominal consideration," the Company has concluded that during all
periods prior to the Company's initial public offering, no equity instruments
were issued for nominal consideration. Per share results for periods prior to or
including the Company's initial public offering have been restated in accordance
with SAB No. 98.
Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation." SFAS No. 123 is effective for
fiscal years beginning after December 15, 1995, and requires that the Company
either recognize in its financial statements costs related to its employee
stock-based compensation plans, such as stock option and stock purchase plans,
or make pro forma disclosures of such costs in a footnote to the financial
statements.
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35
The Company has elected to continue to use the intrinsic value-based method
of Accounting Principles Board Opinion No. 25, as allowed under SFAS No. 123, to
account for all of its employee stock-based compensation plans. Therefore, the
Company has made the required pro forma disclosures in Note 7 to these financial
statements.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting and displaying comprehensive income and its components in financial
statements. It does not, however, require a specific format for the statement,
but requires the Company to display an amount representing total comprehensive
income for the period in that financial statement. The Company is in the process
of determining its preferred format. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997.
Business Segments
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 establishes standards for the way public business enterprises are to report
information about operating segments in annual financial statements and requires
those enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. The Company is in the process
of evaluating its disclosure requirements under this standard. SFAS No. 131 is
effective for annual financial statements for periods beginning after December
15, 1997 and for interim periods after the first year of adoption.
Income Taxes
The Company accounts for income taxes under the asset and liability method of
accounting. Under the asset and liability method, deferred tax assets and
liabilities are recognized based on the future tax consequences attributable to
differences between the financial statement carrying amount of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of
changes in tax rates is recognized in operating results in the period that
includes the enactment date.
(3) NET INCOME (LOSS) PER SHARE
The Company has adopted SFAS No. 128, "Earnings Per Share." In accordance
with SFAS No. 128, primary net income (loss) per share has been replaced with
basic net income (loss) per share, and fully diluted net income (loss) per share
has been replaced with diluted net income (loss) per share which includes
potentially dilutive securities such as outstanding options and convertible
securities, using the treasury stock method. Prior periods have been restated to
conform with SFAS No. 128 and SAB No. 98. Accordingly, the number of shares used
and the resulting net loss per share amounts for 1996 and 1995 differ from those
amounts previously presented.
The following table sets forth the computation of net income (loss) per share
(in thousands, except per share data):
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
------- --------- -------
Net income (loss) .............................. $ 3,952 $ (755) $ (104)
======= ========= =======
Basic:
Weighted average common shares outstanding
used in computing basic net income (loss) per
share ....................................... 16,398 10,686 2,283
======= ========= =======
Basic net income (loss) per share ............ $ 0.24 $ (0.07) $ (0.05)
======= ========= =======
Diluted:
Weighted average common shares outstanding ... 16,398 10,686 2,283
Dilutive options outstanding ................. 1,665 -- --
------- --------- -------
Shares used in computing diluted net income
(loss) per share ............................ 18,063 10,686 2,283
======= ========= =======
Diluted net income (loss) per share .......... $ 0.22 $ (0.07) $ (0.05)
======= ========= =======
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(4) BALANCE SHEET COMPONENTS
Investments
Under the provisions of SFAS No. 115, debt and equity securities classified
as available-for-sale securities for which cost approximated market value as of
December 31, 1997 and 1996 with maturities generally within one year, consisted
of the following (in thousands):
DECEMBER 31,
-------------------
1997 1996
------- -------
Government agency securities $11,207 $ 8,374
Commercial paper ........... 10,634 8,172
Corporate bonds ............ -- 4,058
------- -------
$21,841 $20,604
======= =======
These investments were classified on the balance sheet as follows (in
thousands):
DECEMBER 31,
--------------------------
1997 1996
------- -------
Cash equivalents ............. $10,470 $ 9,468
Short-term investments ....... 11,371 11,136
------- -------
$21,841 $20,604
======= =======
Gains and losses from sales of available-for-sale securities were not
significant for the years ended December 31, 1997, 1996 or 1995.
Property and Equipment
A summary of property and equipment is as follows (in thousands):
DECEMBER 31,
---------------------
1997 1996
------- -------
Computer equipment .......... $11,011 $ 7,518
Office furniture and fixtures 2,273 1,548
Leasehold improvements ...... 880 708
------- -------
14,164 9,774
Less accumulated depreciation
and amortization .......... 7,211 3,984
------- -------
$ 6,953 $ 5,790
======= =======
Property and equipment as of December 31, 1997 and 1996 includes equipment
under capital leases of approximately $1,652,000 and $1,617,000, respectively,
and related accumulated amortization of approximately $1,010,000 and $583,000,
respectively.
Accrued Expenses
A summary of accrued expenses is as follows (in thousands):
DECEMBER 31,
--------------------
1997 1996
------ ------
Accrued commissions and bonuses .... $2,372 $1,541
Accrued payroll and related items .. 2,145 2,224
Other liabilities .................. 1,748 1,363
------ ------
$6,265 $5,128
====== ======
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Note Receivable from Stockholder
In September 1995, the Company received a note for $17,500 in exchange for
50,000 shares of restricted common stock. The note is to be repaid semiannually
based on the vesting terms of the underlying shares, which are dependent on
certain performance milestones. The note is due no later than March 2002, with
interest at 8% compounding semiannually.
(5) INCOME TAXES
The provision for income taxes in 1997, 1996 and 1995 was as follows (in
thousands):
1997 1996 1995
---- ---- ----
Current:
Federal ............................. $194 $-- $--
State ............................... 64 17 2
Foreign ............................. 40 27 17
---- ---- ----
Total current ................... 298 44 19
Charge in lieu of taxes attributable to
employer stock option plans ........ 46 -- --
---- ---- ----
Total tax provision ................... $344 $ 44 $ 19
==== ==== ====
Total income tax expense differs from expected income tax expense (computed
by applying the U.S. federal corporate income tax rate of 34% to profit (loss)
before taxes) as follows (in thousands):
1997 1996 1995
------- ------- -------
Income tax expense (benefit) at federal
statutory rate ...................... $ 1,461 $ (242) $ (29)
State income tax, net of federal benefit 54 11 2
Unutilized net operating loss .......... -- -- 29
Change in beginning of year valuation
allowance ........................... (1,514) 184 --
Alternative minimum tax ................ 99 -- --
Other, net ............................. 244 91 17
------- ------- -------
$ 344 $ 44 $ 19
======= ======= =======
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities as of December 31, 1997 and 1996
are presented below (in thousands):
1997 1996
---------- ---------
Deferred tax assets:
Capitalized start-up costs....................... $ -- $ 106
Deferred research expenses....................... 428 859
Accrued expenses and reserves.................... 2,346 1,835
Property and equipment depreciation.............. 15 90
Net operating loss carryforwards................. 1,441 2,515
Research credit carryforwards.................... 1,722 906
---------- --------
Total gross deferred tax assets.......... 5,952 6,311
Less valuation allowance......................... 5,952 6,311
---------- --------
Net deferred tax assets.................. $ -- $ --
========== ==========
The net change in the total valuation allowance for the year ended December
31, 1997 was a decrease of $359,000. The Company's accounting for deferred taxes
under Statement of Financial Accounting Standards No. 109 involves the
evaluation of a number of factors concerning the realizability of the Company's
deferred tax assets. To support the Company's conclusion that a 100% valuation
allowance was required, management primarily considered such factors as the
Company's history of operating losses, the nature of the Company's deferred tax
assets, the lack of significant firm sales backlog, no significant excess of
appreciated asset value over the tax basis of the Company's net assets and the
absence of taxable income in prior carryback years. Although management's
operating plans assume taxable and operating income in future periods,
management's evaluation of all the available evidence in assessing the
realizability of the deferred tax assets indicates that such plans are not
considered sufficient to overcome the available negative evidence.
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The Company has net operating loss carryforwards for federal purposes of
approximately $4.2 million. These carryforwards expire in years 2005 through
2010. The Company also has research and development tax credit carryforwards of
approximately $903,000 and $676,000 for federal and state tax purposes,
respectively. The federal research and development tax credit carryforwards
expire in years 2005 through 2012. There is no expiration provision for
California research and development tax credit. In addition, the Company has
foreign tax credits and alternative minimum tax credit of $77,000 and $66,000,
respectively. The foreign tax credits expire in years 2001 through 2002. There
is no expiration provision for the alternative minimum tax credit. Included in
gross deferred tax assets above is approximately $574,000 related to stock
option compensation for which the benefit, when realized, will be recorded to
equity.
The Internal Revenue Code of 1986, and applicable state tax laws, impose
substantial restrictions on the ability of the Company to utilize net operating
loss and research and development tax credit carryforwards in the event of an
"ownership change." During 1992, the Company underwent an ownership change. As a
result of the change of ownership, the federal tax losses incurred through that
date, approximately $3.1 million, are subject to an estimated annual limitation
of approximately $550,000. In addition, federal research and development tax
credit carryovers of approximately $150,000 are also subject to this annual
limitation on a tax converted basis; however, they cannot be utilized until the
restricted net operating loss carryforwards have been utilized. In the event
that additional ownership changes occur, there may be additional restrictions on
the future use of research and development tax credits and net operating loss
carryforwards existing at that date.
(6) STOCKHOLDERS' EQUITY
Preferred Stock
The Board of Directors has authority to issue up to 5,000,000 shares of
preferred stock in one or more series and to fix the powers, designations,
preferences and rights of each series and any qualifications, limitations or
restrictions thereon without any further vote or action by the stockholders.
Common Stock
The Company has periodically sold shares of common stock to its employees,
directors, and other individuals under Restricted Stock Purchase Agreements (the
"Agreements") at prices not less than the fair market value of such stock at the
date of issuance as determined by the Board of Directors. Pursuant to the
Agreements, the Company has the option to repurchase the unvested common stock
at the original purchase price in the event that an individual ceases to be an
employee or director of the Company. The stock generally vests either (a) to the
extent of 20% of the shares upon the first 12-month anniversary of the
employee's hire date and an additional 1/48 of the unvested shares ratably over
the following 48 months or (b) to the extent of 25% of the shares upon the first
12-month anniversary of the employee's hire date and an additional 1/36 of the
unvested shares ratably over the following 36 months. As of December 31, 1997,
49,000 shares were subject to repurchase.
(7) INCENTIVE AND BENEFIT PLANS
1996 Directors Stock Option Plan
In March 1996, the Company adopted the 1996 Directors Stock Option Plan (the
"Directors Plan") and reserved 100,000 shares of common stock for issuance under
this plan. Each eligible director was automatically granted an initial option to
purchase 7,500 shares. Each eligible director who first becomes a member of the
Board thereafter will automatically be granted an option to purchase 15,000
shares upon joining the Board. At each Annual Meeting of Stockholders of the
Company, each eligible director will automatically be granted an additional
option to purchase 7,500 shares if such director has served continuously as a
member of the Board since the date of grant of such director's initial option.
All options issued under the Directors Plan vest as to 1/48 of the shares per
month, provided the optionee continues as a member of the Board or as a
consultant to the Company. As of December 31, 1997, 60,000 shares at a weighted
average exercise price of $13.92 had been granted under the Directors Plan, and
13,053 shares were exercisable.
1996 Equity Incentive Plan and 1990 Stock Option Plan (the "Incentive Plans")
The Company's 1996 Equity Incentive Plan became effective on May 2, 1996 and
serves as the successor to the Company's 1990 Stock Option Plan. The 1996 Equity
Incentive Plan provides for the grant of stock options and stock bonuses and the
issuance of
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39
restricted stock by the Company to its employees, officers, directors,
consultants, independent contractors and advisers. Under the 1990 Stock Option
Plan, options were granted to employees, officers, directors, consultants,
independent contractors and advisers to purchase common stock at not less than
the fair market value of the Company's common stock at the grant date (for
incentive stock options) or 85% of the fair market value of such common stock
(for nonqualified stock options). Shares under options for both plans generally
become exercisable to the extent of 25% upon the first 12-month anniversary of
the grant date and an additional 1/36 of the unvested shares vesting ratably
over the following 36 months, and expire 10 years from the grant date. At the
May 1997 Annual Meeting of Stockholders of the Company, 1,300,000 additional
shares were authorized for the Incentive Plans. At December 31, 1997, the
Company had reserved 4,423,698 shares of common stock for issuance under these
plans and 1,484,073 shares remained available for grant.
A summary of activity under the Directors Plan and the Incentive Plans is as
follows:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
1997 1996 1995
------------------------ ----------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
- ----------------------------------------------------------------------------------------------------
Outstanding - beginning
of year.................... 2,373,989 $ 3.96 2,380,516 $ 0.68 1,780,774 $ 0.25
Granted....................... 1,158,305 13.54 670,796 12.26 739,915 1.64
Exercised..................... (315,281) 0.99 (622,303) 0.23 (79,695) 0.18
Canceled...................... (217,388) 9.04 (55,020) 5.78 (60,478) 0.32
- ----------------------------------------------------------------------------------------------------
Outstanding - end of year..... 2,999,625 7.61 2,373,989 3.96 2,380,516 0.68
- ----------------------------------------------------------------------------------------------------
Weighted average fair value
of options granted,
calculated under SFAS No. 123
(see below).................. $ 7.22 $ 6.29 $ 1.17
The Company has recorded deferred compensation of $0, $303,000 and $601,000
for the difference between the grant price and the deemed fair value of the
common stock underlying certain options granted in 1997, 1996 and 1995,
respectively. These amounts are being amortized over the vesting period of the
individual options, generally four years. Amortization of deferred compensation
was approximately $247,000, $416,000 and $60,000 for the years ended December
31, 1997, 1996 and 1995, respectively.
The following table summarizes information as of December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- ----------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISE EXERCISE
EXERCISE PRICES NUMBER LIFE PRICE NUMBER PRICE
- ------------------ -------------- -------------- -------------- ------------- --------------
$ 0.10 - $ 0.35 1,065,998 6.31 $ 0.30 757,075 $ 0.29
$ 3.00 - $ 8.00 533,742 8.05 4.47 254,381 4.31
$ 9.38 - $14.38 666,195 9.44 12.12 59,495 11.67
$14.50 - $23.25 733,690 9.31 16.42 98,179 17.50
- ------------------ -------------- -------------- -------------- ------------- --------------
$ 0.10 - $23.25 2,999,625 8.05 $ 7.61 1,169,130 $ 3.19
1996 Employee Stock Purchase Plan
In March 1996, the Company adopted the 1996 Employee Stock Purchase Plan (the
"Purchase Plan") and reserved 300,000 shares of common stock for issuance under
this plan. At the May 1997 Annual Meeting of Stockholders of the Company,
300,000 additional shares were authorized for the Purchase Plan. The Purchase
Plan permits eligible employees to acquire shares of the Company's common stock
through payroll deductions of between 2% and 10% of their compensation, up to an
aggregate total payroll deduction not to exceed $21,250 in any calendar year.
Each offering under the Purchase Plan is for a period of twenty-four months, and
each
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offering period consists of four purchase periods, each six months in length.
The purchase price for the Company's common stock purchased under the Purchase
Plan is 85% of the lesser of the fair market value of the Company's common stock
on the first day of the applicable offering period or on the last day of the
respective purchase period. As of December 31, 1997, 190,439 shares had been
issued under the Purchase Plan at an average purchase price of $10.78.
Retirement and Savings Program
The salary deferral "401(k)" plan allows employees to defer up to 20% of
their salary subject to certain limitations. The Company may make discretionary
contributions to the plan; however, no employer contributions have been made
since inception.
Accounting for Stock-Based Compensation Under SFAS No. 123
The Company applies APB Opinion 25, "Accounting for Stock Issued to
Employees," and related interpretations in accounting for options granted to
employees under its stock plans. Had compensation cost for the Company's three
stock plans been determined based on the fair value at the grant dates for
awards under those plans consistent with the method prescribed under SFAS No.
123, "Accounting for Stock-Based Compensation," the Company's operating results
and results per share would have changed to the pro forma amounts indicated
below (in thousands, except per share amounts):
1997 1996 1995
-------- --------- ----------
Net income (loss) - as reported........... 3,952 $ (755) $ (104)
Net income (loss) - pro forma............. 564 $ (1,412) $ (82)
Basic net income (loss) per share - as
reported.................................. $ 0.24 $ (0.07) $ (0.05)
Basic net income (loss) per share - pro
forma..................................... $ 0.03 $ (0.13) $ (0.04)
Diluted net income (loss) per share - as
reported.................................. $ 0.22 $ (0.07) $ (0.05)
Diluted net income (loss) per share - pro
forma..................................... $ 0.03 $ (0.13) $ (0.04)
The fair value of each option grant and Purchase Plan share issuable during
1997, 1996 and 1995 is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions:
1997 1996 1995
--------- --------- ---------
Expected dividend yield.................... 0% 0% 0%
Expected stock price volatility............ 63% 43% 0%
Risk-free interest rate.................... 6.26% 6.26% 6.08%
Expected life of options................... 4 years 4 years 4 years
Expected life of Purchase Plan rights...... 6 months 6 months 6 months
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions, including the expected stock price volatility.
Because the Company's employee and director stock options and shares issuable
under the Purchase Plan have characteristics significantly different from those
of traded options, and because changes in subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee and director stock options and shares issuable pursuant to the
Purchase Plan.
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(8) COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its principal office under a noncancelable operating lease
agreement that expires in September 1999. The Company leases certain equipment
under capital leases. As of December 31, 1997, minimum lease payments under all
noncancelable lease agreements were as follows (in thousands):
YEARS ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
------- --------
1998.............................................. $ 535 $ 2,223
1999.............................................. 269 1,651
2000.............................................. 21 42
------- --------
Total minimum lease payments...................... 825 $ 3,916
========
Less amount representing interest................. 61
-------
Present value of minimum lease payments........... 764
Less current portion.............................. 424
-------
Long-term capital lease obligations............... $ 340
=======
Rent expense was approximately $2,012,000, $1,149,000 and $534,000 for the
years ended December 31, 1997, 1996 and 1995, respectively.
Contingencies
In April 1996, the Company received a letter from Lucent inviting the Company
to negotiate a license of Lucent's patents. Since then, Lucent has asserted that
it believes that certain of the Company's products infringe certain of Lucent's
patents and has offered to license those patents to the Company for a
substantial payment. In November 1997, the Company received a letter from Lucent
in which Lucent made similar assertions with respect to other patents it holds.
The Company believes that it has substantial arguments that its current products
do not violate any valid claims of the Lucent patents referenced in the April
1996 letter and is in the process of investigating the patents referenced in the
November 1997 letter. The Company has had several discussions with Lucent
regarding the potential licensing of the patents referenced in Lucent's letters
and is currently engaged in such discussions. Based on these discussions, it
appears that obtaining a license from Lucent may require the payment of a
substantial license fee and possibly ongoing royalties, which could have a
material adverse effect on the Company's results of operations in the periods
when such payments are made, although the Company does not believe that such
payments would have a material adverse effect on the Company's financial
condition or liquidity. In the event that the Company cannot come to an
agreement with Lucent, the Company may be drawn into litigation with Lucent.
Such litigation could be protracted and expensive, and the outcome cannot be
predicted. There can be no assurance that the costs associated with
participating in or settling such litigation would not have a material adverse
effect on the Company's business, financial condition or results of operations.
The Company is party to various other matters arising in the ordinary course
of its business. In the opinion of management, these proceedings will not have a
material adverse effect on the Company's financial position or results of
operations.
(9) LINE OF CREDIT
The Company has an $8 million line of credit which expires in December 1998,
bears interest at the bank's prime rate (8.50% as of December 31, 1997) and
contains certain financial covenants. The Company was in compliance with those
covenants at December 31, 1997. As of December 31, 1997 and 1996, there were no
borrowings outstanding under this line of credit.
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EDIFY CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
ADDITIONS
--------------------
BALANCE AT CHARGED TO CHARGED BALANCE
BEGINNING COSTS AND TO OTHER AT END
CLASSIFICATION OF YEAR EXPENSES ACCOUNTS(1) DEDUCTIONS(2) OF YEAR
-------------- ------- -------- --------- ------------- -------
Allowance for returns and doubtful accounts
Year ended December 31, 1995 ........... $ 37 $ 465 $ 123 $ (450) $ 175
====== ====== =========== ====== ======
Year ended December 31, 1996 ........... $ 175 $ 710 $ -- $ (302) $ 583
====== ====== =========== ====== ======
Year ended December 31, 1997 ........... $ 583 $1,456 $ 220 $ (630) $1,629
====== ====== =========== ====== ======
- ----------
(1) Includes charges to unearned revenue.
(2) Includes write-offs of accounts and credits issued.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Edify Corporation
Date: March 27, 1998 /s/ Stephanie A. Vinella
------------------------
Stephanie A. Vinella
Chief Financial Officer (Principal
Financial Officer)
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Jeffrey M. Crowe and / or Stephanie A. Vinella as his
or her attorney-in-fact, with the power of substitution, for him or her in any
and all capacities, to sign any amendments to this Report on Form 10-K, and to
file same, with exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he or she might
or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or his or her or their substitute
or substitutes, may lawfully do or cause to be done or by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on March 27, 1998 by the following persons on behalf of
the registrant and in the capacities on the date indicated.
Signature Title
- ------------------------ -----------------------------------------------
/s/ Jeffrey M. Crowe President, Chief Executive Officer and Director
- ------------------------ (Principal Executive Officer)
(Jeffrey M. Crowe)
/s/ Stephanie A. Vinella Vice President of Finance and Administration,
- ------------------------ Chief Financial Officer
(Stephanie A. Vinella) (Principal Financial Officer and Principal
Accounting Officer)
/s/ Stephen M. Berkley Director
- ------------------------
(Stephen M. Berkley)
/s/ Kelly D. Conway Director
- ------------------------
(Kelly D. Conway)
/s/ Tench Coxe Director
- ------------------------
(Tench Coxe)
/s/ Donald R. Hollis Director
- ------------------------
(Donald R. Hollis)
/s/ Stewart A. Schuster Director
- ------------------------
(Stewart A. Schuster)
41
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INDEX TO EXHIBITS
3.03.1 Restated Certificate of Incorporation. (1)
3.04.2 Bylaws. (2)
4.01 Second Amended and Restated Registration Rights Agreement, dated as of
October 26, 1995. (3)
10.01 Registrant's 1990 Stock Option Plan, as amended and related documents.
(4) *
10.02 Registrant's 1996 Equity Incentive Plan and related documents. (5) *
10.03 Registrant's 1996 Directors Stock Option Plan and related documents.
(6) *
10.04 Registrant's 1996 Employee Stock Purchase Plan and related documents.
(7) *
10.05 First Amendment to Loan Documents dated December 29, 1997 between
Registrant and Imperial Bank (amending Credit Terms and Conditions and
related documents) and related documents.
10.06 Form of Indemnification Agreement entered into by Registrant with
each of its directors and executive officers. (4) *
10.07 Office Lease Agreement dated June 11, 1990 between San Tomas No. 1
Limited Partnership and Registrant, as amended. (4)
10.08 Sublease dated August 14, 1995 between Advantest America, Inc. and the
Registrant. (4)
10.09 Master Lease Agreement dated May 15, 1992 between Comdisco, Inc. and
Registrant, as amended and related documents. (4)
10.10 Credit Terms and Conditions dated December 30, 1996 between Registrant
and Imperial Bank and related documents. (8)
23.01 Consent of Independent Auditors.
24.01 Power of Attorney (see page 41 of this report).
27.01 Financial Data Schedule.
27.02 Restated Financial Data Schedule (1996 restated to reflect adoption of
SFAS No. 128).
- ----------
* Management contract or compensatory arrangement.
(1) Incorporated by reference to Exhibit 3.03.1 to Registrant's Form 10-K for
the year ended December 31, 1996 (the "1996 10-K").
(2) Incorporated by reference to Exhibit 3.04 to Registrant's Registration
Statement on Form S-1 (No. 333-02020), declared effective on May 2, 1996
(the "Form S-1").
(3) Incorporated by reference to Exhibit 4.02 to the Form S-1.
(4) Incorporated by reference to the Exhibit of the same number to the Form S-1.
(5) Incorporated by reference to Exhibit 4.03 to Registrant's Registration
Statement on Form S-8 (No. 333-31833) filed on July 22, 1997 (the "Form
S-8").
(6) Incorporated by reference to Exhibit 10.03 to Registrant's Form 10-Q for the
quarter ended June 30, 1997.
(7) Incorporated by reference to Exhibit 4.04 to the Form S-8.
(8) Incorporated by reference to Exhibit 10.10 to the 1996 10-K.
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