================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2002
[ ] 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: 000-23091
J.D. EDWARDS & COMPANY
(exact name of registrant as specified in its charter)
<Table>
DELAWARE 84-0728700
(State or other jurisdiction of incorporation (I.R.S. Employer Identification Number)
or organization)
ONE TECHNOLOGY WAY, DENVER, CO 80237
(Address of principal executive offices) (Zip Code)
</Table>
Registrant's telephone number, including area code: (303) 334-4000
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 [ ]
As of September 10, 2002, there were 119,237,845 shares of the Registrant's
Common Stock outstanding.
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J.D. EDWARDS & COMPANY
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
NO.
----
PART I FINANCIAL INFORMATION
Item 1. Consolidated Balance Sheets as of October 31, 2001 and July 31, 2002 (unaudited)....... 3
Consolidated Statements of Operations for the Three and Nine Months Ended
July 31, 2001 and 2002 (unaudited)................................................... 4
Consolidated Statements of Cash Flows for the Nine Months Ended
July 31, 2001 and 2002 (unaudited)................................................... 5
Notes to Consolidated Financial Statements (unaudited)................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................................ 15
Item 3. Quantitative and Qualitative Disclosure About Market Risk.............................. 25
PART II OTHER INFORMATION
Item 1. Legal Proceedings...................................................................... 26
Item 2. Changes in Securities and Use of Proceeds.............................................. 26
Item 3. Defaults upon Senior Securities........................................................ 26
Item 4. Submission of Matters to a Vote of Security Holders.................................... 26
Item 5. Other Information...................................................................... 26
Item 6. Exhibits and Reports on Form 8-K....................................................... 26
SIGNATURES........................................................................................... 28
CERTIFICATIONS....................................................................................... 29
</Table>
The page numbers in the Table of Contents reflect actual page numbers,
not EDGAR page tag numbers.
J.D. Edwards is a registered trademark of J.D. Edwards & Company. The names of
all other products and services of J.D. Edwards used herein are trademarks or
registered trademarks of J.D. Edwards World Source Company. All other product
and service names used are trademarks or registered trademarks of their
respective owners.
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
J.D. EDWARDS & COMPANY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<Table>
<Caption>
OCTOBER 31, JULY 31,
2001 2002
----------- -----------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................................................. $ 231,952 $ 298,373
Short-term investments.................................................................... 1,515 742
Accounts receivable, net of allowance for doubtful accounts of $17,000 and $12,000 at
October 31, 2001 and July 31, 2002, respectively....................................... 214,621 179,102
Other current assets...................................................................... 31,370 30,499
----------- -----------
Total current assets................................................................. 479,458 508,716
Long-term marketable securities and other investments....................................... 702 5,478
Restricted cash, cash equivalents, and investments.......................................... 15,960 35,995
Property and equipment, net................................................................. 70,021 71,181
Software costs, net......................................................................... 72,821 79,128
Intangible and other assets, net............................................................ 22,170 77,286
----------- -----------
$ 661,132 $ 777,784
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................................................... $ 42,616 $ 31,238
Unearned revenue and customer deposits.................................................... 167,487 194,635
Accrued liabilities....................................................................... 144,163 139,989
----------- -----------
Total current liabilities............................................................ 354,266 365,862
Unearned revenue, net of current portion, and other......................................... 7,807 8,555
----------- -----------
Total liabilities.................................................................... 362,073 374,417
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, $.001 par value; 4,700,000 shares authorized; none outstanding........... -- --
Preferred stock, series A participating, $.001 par value; 300,000 shares authorized; none
outstanding -- --
Common stock, $.001 par value; 300,000,000 shares authorized; 114,193,712 issued and
110,620,096 outstanding as of October 31, 2001; 121,294,328 issued and 119,208,284
outstanding as of July 31, 2002......................................................... 114 121
Additional paid-in capital................................................................ 442,511 493,388
Treasury stock, at cost; 3,573,616 shares and 2,086,044 shares as of October 31, 2001 and
July 31, 2002, respectively............................................................. (72,323) (25,146)
Deferred compensation..................................................................... (32) (2,059)
Accumulated deficit....................................................................... (57,075) (48,208)
Accumulated other comprehensive income (loss): unrealized gains (losses) on
equity securities and foreign currency translation adjustments, net..................... (14,136) (14,729)
----------- -----------
Total stockholders' equity........................................................... 299,059 403,367
----------- -----------
$ 661,132 $ 777,784
=========== ===========
</Table>
The accompanying notes are an integral part of
these consolidated financial statements.
3
J.D. EDWARDS & COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------ ------------------------
2001 2002 2001 2002
--------- --------- --------- ---------
Revenue:
License fees .............................................. $ 50,005 $ 54,918 $ 194,996 $ 152,928
Services .................................................. 159,359 174,038 458,339 504,296
--------- --------- --------- ---------
Total revenue ..................................... 209,364 228,956 653,335 657,224
Costs and expenses:
Cost of license fees (including write-offs of certain third
party product arrangements of $12,762 and $20,566 in the
third quarter and first nine months of fiscal 2001, ..... 21,491 9,297 54,284 23,789
respectively)
Cost of services .......................................... 84,571 79,992 261,001 239,675
Sales and marketing ....................................... 78,437 73,288 224,664 205,923
General and administrative ................................ 21,229 21,840 68,702 66,647
Research and development .................................. 23,916 30,642 74,243 90,205
Amortization of acquired software and other acquired
intangibles and acquisition related deferred compensation 6,614 5,276 18,969 17,983
Acquired in-process research and development .............. -- -- -- 4,600
Restructuring and other related charges ................... 21,737 -- 24,226 1,546
--------- --------- --------- ---------
Total costs and expenses .............................. 257,995 220,335 726,089 650,368
Operating income (loss) ..................................... (48,631) 8,621 (72,754) 6,856
Other income (expense):
Interest and dividend income .............................. 2,996 1,819 11,147 4,722
Losses on equity investments and product line sale ........ (4,112) (459) (6,563) (1,045)
Interest expense, foreign currency gains (losses) and
other, net .............................................. (754) 1,041 (1,783) (217)
--------- --------- --------- ---------
Income (loss) before income taxes ........................... (50,501) 11,022 (69,953) 10,316
Provision for income taxes ................................ 135,400 1,548 127,794 1,449
--------- --------- --------- ---------
Net income (loss) ........................................... $(185,901) $ 9,474 $(197,747) $ 8,867
========= ========= ========= =========
Net income (loss) per common share:
Basic ..................................................... $ (1.65) $ 0.08 $ (1.77) $ 0.08
========= ========= ========= =========
Diluted ................................................... $ (1.65) $ 0.08 $ (1.77) $ 0.07
========= ========= ========= =========
Shares used in computing per share amounts:
Basic ..................................................... 112,353 118,934 111,712 117,999
Diluted ................................................... 112,353 120,061 111,712 120,344
</Table>
The accompanying notes are an integral part of
these consolidated financial statements.
4
J.D. EDWARDS & COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
NINE MONTHS ENDED
JULY 31,
------------------------
2001 2002
--------- ---------
Operating activities:
Net income (loss) ........................................................... $(197,747) $ 8,867
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation .............................................................. 23,945 23,189
Amortization and write-offs of capitalized software costs, intangible
assets, and securities premiums or discounts ............................ 26,769 29,045
Provisions for losses and reserves on accounts receivable ................. 3,000 (5,000)
Write-off of acquired in-process research and development ................. -- 4,600
Stock compensation ........................................................ -- 3,339
Loss on sale of a product line ............................................ 1,299 --
Loss on investments in marketable securities .............................. 4,688 1,045
Write-off of software development costs and prepaid reseller royalties .... 20,566 --
Provision for deferred income taxes ....................................... 122,547 --
Other ..................................................................... 2,306 (1,395)
Changes in operating assets and liabilities, net of acquisition:
Accounts receivable ....................................................... 13,675 46,295
Other assets .............................................................. 3,116 1,305
Accounts payable .......................................................... (16,480) (12,469)
Unearned revenue and customer deposits .................................... 37,279 23,010
Accrued liabilities ....................................................... (38,466) (9,467)
--------- ---------
Net cash provided by operating activities .............................. 6,497 112,364
Investing activities:
Purchase of marketable securities and other investments ................... (17,361) (4,850)
Proceeds from sales or maturities of investments in marketable securities . 78,749 --
Purchase of property and equipment, net ................................... (18,237) (20,610)
Cash paid for acquisition of business, net of cash acquired ............... -- (751)
Capitalized software costs ................................................ (31,472) (17,834)
--------- ---------
Net cash provided by (used in) investing activities .................... 11,679 (44,045)
Financing activities:
Proceeds from issuance of common stock .................................... 25,882 16,062
Settlement of common stock repurchase contracts ........................... (67,296) --
Restricted cash, cash equivalents, and investments ........................ (27,649) (19,423)
Release of restricted cash and cash equivalents ........................... 27,649 729
--------- ---------
Net cash used in financing activities .................................. (41,414) (2,632)
Effect of exchange rate changes on cash ..................................... (622) 734
--------- ---------
Net (decrease) increase in cash and cash equivalents ........................ (23,860) 66,421
Cash and cash equivalents at beginning of period ............................ 180,674 231,952
--------- ---------
Cash and cash equivalents at end of period .................................. $ 156,814 $ 298,373
========= =========
Supplemental disclosure of other cash and non-cash investing and financing
transactions:
Retirement savings plan contribution funded with common stock ............. $ 3,697 $ 3,748
Deferred stock compensation for assumed options related to acquisition of
business ................................................................ -- 2,099
Transfer of unrestricted long-term investments in marketable securities to
restricted long-term investments in marketable securities ............... 20,304 --
Reconciliation for acquisition of business:
On November 16, 2001 the company acquired all of the issued and outstanding
stock of YOUcentric, Inc., in exchange for $81.7 million of consideration. In
conjunction with the acquisition, the fair value of assets and liabilities
received were as follows:
Fair value of assets acquired ...................................................... $ 78,684
Common stock issued for acquired company and fair value of options assumed ........ (72,885)
Write-off of acquired in-process research and development ......................... 4,600
Cash paid for acquisition of business, net of cash acquired ....................... (751)
--------
Fair value of liabilities assumed .................................................. $ 9,648
========
</Table>
The accompanying notes are an integral part of
these consolidated financial statements.
5
J.D. EDWARDS & COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Interim Financial Statements. The accompanying consolidated financial
statements of J.D. Edwards & Company (the Company) have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to such rules
and regulations. However, the Company believes that the disclosures are adequate
to make the information presented not misleading. The unaudited consolidated
financial statements included herein have been prepared on the same basis as the
annual consolidated financial statements and reflect all adjustments, which
include only normal recurring adjustments necessary for a fair presentation in
accordance with accounting principles generally accepted in the United States of
America. Certain amounts in the prior periods' consolidated financial statements
have been reclassified to conform to the current period presentation. The
results for the three and nine-month periods ended July 31, 2002 are not
necessarily indicative of the results expected for the full fiscal year. These
consolidated financial statements should be read in conjunction with the audited
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended October 31, 2001.
Use of Estimates. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from those estimates.
(2) REVENUE RECOGNITION
The Company licenses software under non-cancelable license agreements and
provides related services, including consulting, support, and education. The
Company recognizes revenue in accordance with Statement of Position (SOP) 97-2,
"Software Revenue Recognition," as amended and interpreted by SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, with respect to certain
transactions," and follows Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements," as amended, as well as Technical Practice
Aids issued from time to time by the American Institute of Certified Public
Accountants.
The Company recognizes license fee revenue when a non-cancelable,
contingency-free license agreement has been signed, the product has been
delivered, fees from the arrangement are fixed or determinable, and collection
is probable. For license transactions with undelivered elements, the fair value
of the fees associated with those undelivered elements is recorded as deferred
revenue and recognized once such elements are delivered. Typically, the
Company's software licenses do not include significant post-delivery obligations
to be fulfilled by the Company, and payments are due within a 12-month period
from the date of delivery. Where software license contracts call for payment
terms of 12 months or more from the date of delivery, revenue is recognized as
payments become due assuming all other conditions for revenue recognition have
been satisfied. Consulting and education services are separately priced, are
generally available from a number of suppliers, and are typically not essential
to the functionality of the Company's software products. Revenue from these
services is recognized separately from the license fees as the services are
performed. Revenue from agreements for supporting and providing periodic
unspecified upgrades to the licensed software is recorded as unearned revenue
and is recognized ratably over the support service period. Such unearned revenue
includes a portion of the related arrangement fee equal to the fair value of any
bundled support services and unspecified upgrades. Management anticipates that
the majority of our arrangement fees will continue to be recognized as described
above. The Company does not require collateral for receivables; however, an
allowance is maintained for potential losses. In certain instances where the
Company's services are deemed essential to the customer's use of the software,
the entire arrangement is accounted for in accordance with SOP 81-1, "Accounting
for Performance of Construction Type and Certain Production Type Contracts."
(3) EARNINGS PER COMMON SHARE AND STOCK BASED COMPENSATION
Earnings Per Common Share
Basic earnings per share (EPS) excludes the dilutive effect of common stock
equivalents and is computed by dividing net income or loss by the
weighted-average number of shares outstanding during the period. Diluted EPS
includes the dilutive effect of common stock equivalents and is computed using
the weighted-average number of common and common equivalent shares outstanding
during the period. Common stock equivalents consist of stock options and certain
other equity instruments. Diluted loss per share for the three and nine-month
periods ended July 31, 2001 exclude common stock equivalents because the effect
of their inclusion would be anti-dilutive, or would decrease the reported loss
per share. Using the treasury stock method, the weighted-average common stock
equivalents excluded were 1.5 million shares and 2.2 million shares for the
three and nine-month periods ended July 31, 2001,
6
respectively. The weighted-average outstanding shares for the three and
nine-month periods ended July 31, 2001 and 2002 are reflected net of treasury
shares. All shares owned by the Employee Retirement Savings Plans were included
in the weighted-average common shares outstanding for all periods. Options to
purchase stock at exercise prices greater than the average fair market value of
the Company's stock for the periods presented are excluded from the calculation
of diluted income or loss because their inclusion would be anti-dilutive. For
the three and nine months ended July 31, 2001, options to purchase 13.1 million
and 10.5 million shares of common stock, respectively, were excluded from the
diluted income or loss per share calculations. For the three and nine months
ended July 31, 2002, options to purchase 14.5 million and 9.7 million shares of
common stock, respectively, were excluded from the diluted income or loss per
share calculations.
The computation of basic and diluted EPS was as follows (in thousands,
except per share amounts):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------ ------------------------
2001 2002 2001 2002
---------- -------- ---------- --------
NUMERATOR:
Net income (loss) .............................. $ (185,901) $ 9,474 $ (197,747) $ 8,867
========== ======== ========== ========
DENOMINATOR:
Basic income (loss) per share - weighted-average
shares outstanding ........................... 112,353 118,934 111,712 117,999
Dilutive effect of common stock equivalents .... -- 1,127 -- 2,345
---------- -------- ---------- --------
Diluted income (loss) per share - adjusted
weighted-average shares outstanding, assuming
conversion of common stock equivalents ....... 112,353 120,061 111,712 120,344
========== ======== ========== ========
Basic net income (loss) per share ................ $ (1.65) $ 0.08 $ (1.77) $ 0.08
========== ======== ========== ========
Diluted net income (loss) per share .............. $ (1.65) $ 0.08 $ (1.77) $ 0.07
========== ======== ========== ========
</Table>
Stock-Based Compensation
The Company has elected to determine the value of stock-based compensation
arrangements under the provisions of Accounting Principles Board (APB) Opinion
No. 25 "Accounting for Stock Issued to Employees;" and the pro forma disclosures
under Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting
for Stock-Based Compensation" are included below. SFAS No. 123 permits the use
of either a fair value based method or the intrinsic value method to measure the
value and expense associated with stock-based compensation arrangements.
Companies that elect to use the method provided in APB No. 25 are required to
disclose, at the end of their fiscal year, the pro forma net income or loss and
earnings per share that would have resulted from the use of the fair value based
method.
The following weighted-average assumptions were used for grants in the third
quarter and first nine months of fiscal 2001 and 2002:
<Table>
<Caption>
STOCK-BASED EXPECTED LIFE EXPECTED RISK-FREE
COMPENSATION (IN YEARS) VOLATILITY INTEREST RATE
------------ ------------- ---------- -------------
Options:
2001 3.38 75% 4.49%
2002 4.59 84% 3.96%
ESPP:
2001 0.50 75% 5.99%
2002 0.50 84% 1.80%
</Table>
The pro forma impact on the Company's net income or loss and net income or
loss per share had compensation expense been recorded as determined under the
fair value method is shown below (in thousands, except per share data):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------------- ---------------------------
2001 2002 2001 2002
----------- --------- ----------- ----------
Net income (loss):
As reported ............................. $ (185,901) $ 9,474 $ (197,747) $ 8,867
Pro forma ............................... $ (197,077) $ 12 $ (223,497) $ (26,833)
Basic and diluted net income (loss) per share:
As reported ............................. $ (1.65) $ 0.08 $ (1.77) $ 0.07
=========== ========= =========== ==========
Pro forma ............................... $ (1.75) $ 0.00 $ (2.00) $ (0.23)
=========== ========= =========== ==========
</Table>
7
(4) OTHER BALANCE SHEET COMPONENTS
Significant components of certain balance sheet line items were as follows
(in thousands):
<Table>
<Caption>
OCTOBER 31, JULY 31,
2001 2002
----------- ---------
ACCOUNTS RECEIVABLE, NET:
Accounts receivable ................. $ 231,621 $ 191,102
--------- ---------
Allowance for doubtful accounts ..... (17,000) (12,000)
--------- ---------
$ 214,621 $ 179,102
========= =========
INTANGIBLES AND OTHER ASSETS, NET:
Deposits ............................ $ 1,464 $ 1,646
Acquired intangible assets .......... 19,972 73,587
Other long-term assets .............. 734 2,053
--------- ---------
$ 22,170 $ 77,286
========= =========
UNEARNED REVENUE AND CUSTOMER DEPOSITS:
Unearned revenue .................... $ 165,933 $ 192,235
Customer deposits ................... 1,554 2,400
--------- ---------
$ 167,487 $ 194,635
========= =========
</Table>
Net accounts receivable decreased $35.5 million from October 31, 2001
primarily due to collection of cash from customers during the second and third
quarter of fiscal 2002. Net intangibles and other assets consist primarily of
intangible assets related to the in-place workforce, customer base, and goodwill
resulting from the Company's business acquisitions. The total $55.1 million
increase in net intangibles and other assets from October 31, 2001 was primarily
related to the Company's first quarter of fiscal 2002 acquisition of YOUcentric,
Inc. (see Note 7). Unearned revenue and customer deposits consist primarily of
annual maintenance contract billings that are recorded as unearned revenue when
invoiced and recognized as revenue over the contract period. The $27.1 million
increase in unearned revenue and customer deposits from October 31, 2001 was
primarily due to annual maintenance contract and renewal billings offset, in
part, by the maintenance revenue recognized during the first nine months of
fiscal 2002.
(5) INVESTMENTS IN MARKETABLE SECURITIES
As of July 31, 2002, the Company's short- and long-term investments totaled
$15.5 million, of which $14.3 million was related to long-term investments
resulting in a gross unrealized gain of $118,000, and $1.2 million was the
remaining aggregate fair value of equity securities in certain publicly traded
or privately held technology companies. During the three and nine-month periods
ended July 31, 2002, the Company recorded losses of $459,000 and $1.0 million,
respectively, for other than temporary declines in fair value of certain equity
investments. During the three and nine-month periods ended July 31, 2001, the
Company recorded losses of $4.1 million and $4.7 million, respectively, for
other than temporary declines in fair value of certain equity investments. These
losses are presented on the accompanying consolidated statement of operations in
other income or expense. As of July 31, 2002, $26.7 million of cash and cash
equivalents and $9.3 million of long-term investments in marketable securities
were restricted pursuant to executed amendments to the security agreements for
the Company's headquarters facilities (see Note 12) and are shown on the
accompanying balance sheet as restricted cash, cash equivalents, and
investments.
(6) STOCKHOLDERS' EQUITY
Preferred Share Rights Purchase Plan. In November 2001, the Company
designated 300,000 shares of its authorized preferred stock as Series A
Preferred Stock with a par value of $0.001 per share, pursuant to a Preferred
Stock Rights Agreement (the Rights Agreement) approved by the Board of
Directors. The Rights Agreement is intended to protect stockholders' rights in
the event of an unsolicited takeover attempt. It is not intended to prevent a
takeover of the Company on terms that are favorable and fair to all stockholders
and will not interfere with a merger approved by the Board of Directors. Upon
becoming exercisable, each right entitles stockholders to buy 1/1000 of a share
of Series A Preferred Stock of the Company at an exercise price of $75.00,
subject to adjustment. The rights will be exercisable only if a person or a
group (an Acquiring Person) acquires or announces a tender or exchange offer to
acquire 15% or more of the Company's common stock. The rights will expire on the
earlier of November 26, 2011 or the date of their redemption or exchange.
In the event that an Acquiring Person acquires 15% or more of the Company's
common stock (a Triggering Event), each right not held by the Acquiring Person
will entitle the holder to purchase for the exercise price that number of shares
of common stock having a market value equal to two times the exercise price. In
addition, if following a Triggering Event, the Company is acquired in a merger
or sells 50% or more of its assets, each right not held by an Acquiring Person
will entitle the holder to purchase for the exercise price that number of shares
of common stock of the acquiring company having a market value equal to two
times the exercise price. The rights are redeemable, at the Company's option, at
a price of $0.001 per right. The Company may also exchange the rights for shares
of common stock under certain circumstances.
8
Warrant Grant. During the first quarter of fiscal 2002, the Company granted,
in exchange for professional services rendered, a warrant to purchase 160,417
and 16,667 shares of the Company's common stock at an exercise price of $15.90
and $.01 per share, respectively. The estimated fair value of the warrant of
$1.6 million was recorded in operating expenses and was determined using a
Black-Scholes pricing model with the following assumptions: volatility factor of
75%, risk free interest rate of 4.49%, expected life of 3.38 years, and a
dividend yield of zero. The warrant expires in January 2005 and, as of July 31,
2002, the warrant was outstanding and fully exercisable.
(7) ACQUISITION
On November 16, 2001, J.D. Edwards & Company completed its acquisition of
YOUcentric, Inc. (YOUcentric), a Charlotte, N.C. provider of Java-based customer
relationship management (CRM) software. The completion of the acquisition
allowed the Company to position itself in the CRM applications market and
integrate the CRM product into its suite of product offerings. J.D. Edwards
acquired all of the issued and outstanding capital stock of YOUcentric, for
$81.7 million (excluding $11.6 million held in escrow, which is discussed
below). The YOUcentric stockholders received $6.0 million in cash, and J.D.
Edwards issued approximately 7.7 million shares of its common stock valued at
$10.91 per share. The value of stock issued was determined in accordance with
Emerging Issues Task Force (EITF) Issue No. 99-12, "Accounting for Formula
Arrangements under EITF Issue No. 95-19, "Determination of the Measurement Date
for the Market Price of Securities Issued in a Purchase Business Combination.""
In addition, certain vested and unvested options to purchase YOUcentric capital
stock under YOUcentric's stock option plans were assumed by J.D. Edwards. The
intrinsic value related to the unvested portion of the options that was recorded
as deferred compensation was $2.1 million. The fair value of the vested options
assumed and the excess of the fair value over intrinsic value of the unvested
options assumed, which was included in the purchase price, amounted to $700,000.
Option fair values were determined using a Black Scholes option pricing model
with an expected life of 2.75 years, expected volatility of 75%, and a risk free
interest rate of 2.78%.
All assumed options, vested and unvested, were converted into options to
purchase shares of J.D. Edwards common stock based upon the acquisition share
exchange ratio. Additionally, the purchase price recorded by the Company
included $2.8 million of direct acquisition costs.
The Agreement and Plan of Reorganization (Agreement) included an escrow
arrangement, under which J.D. Edwards may claim reimbursement of certain losses
through an escrow fund that is administered by an independent escrow agent.
There are 1.1 million shares, of the total 7.7 million shares issued, that are
currently held in escrow that were valued at $11.6 million. The $11.6 million
has been excluded from the purchase price in these financial statements as the
outcome of any claims against the escrow is currently not determinable. The
shares held in escrow will be transferred to the former YOUcentric stockholders
in September 2002 to the extent that such shares are not required to be held to
satisfy any claims that J.D. Edwards may make against the escrow fund. The
Company plans to notify the escrow agent of claims against the escrow fund by
September 16, 2002. Management expects that the claims will not have a material
impact on the purchase price, the Company's results of operations, financial
position, or cash flows. Upon release of shares in the escrow fund to the
YOUcentric stockholders, the purchase price and related goodwill will be
increased.
Pursuant to the Agreement, YOUcentric became a wholly owned subsidiary of
J.D. Edwards. The acquisition was accounted for as a purchase and, accordingly,
the total purchase price was allocated to the tangible and intangible assets
acquired and liabilities assumed at fair value. The excess of purchase price
paid (net of in-process research and development (IPR&D)) over the fair value of
assets and liabilities acquired was recorded as goodwill during the first
quarter of fiscal 2002. The Company paid a premium over the fair market value of
the net assets and intangibles identified as part of the purchase in order to
invest in the CRM applications market and integrate the CRM product into its
suite of product offerings. Additionally, IPR&D in the amount of $4.6 million
was written-off during the first quarter of fiscal 2002. YOUcentric results of
operations subsequent to the consummation date of the acquisition are included
on the accompanying consolidated financial statements for the third quarter and
first nine months of fiscal 2002.
The Company retained an independent appraiser to assist with determining
the estimated fair values of the intangible assets acquired in the acquisition.
The valuations were based on methodologies that most closely related the fair
market value assignment with the economic benefits provided by each asset and
the risks associated with the assets. In valuing the software costs, an
income-based approach was determined to best quantify the economic benefits and
risks. The economic benefits were quantified using projections of net cash flows
and the risks by applying an appropriate discount rate. The estimated fair value
assigned to software costs was $8.0 million and non-compete agreements were
$200,000. The software costs and non-compete intangible assets will be amortized
over their estimated useful lives of three years. Goodwill of approximately
$61.4 million was recorded as a result of the acquisition and pursuant to SFAS
No.142, "Goodwill and Other Intangible Assets" (see Note 15) is subject to an
annual impairment test and will not be amortized. None of the goodwill is
expected to be deductible for tax purposes, as the historical cost will be used
as the tax basis.
The estimated value of $4.6 million assigned to acquired IPR&D was
determined by identifying research projects for which technological feasibility
has not been established and there is no alternative future use. The fair value
of acquired IPR&D include
9
revisions to the YOUrelate Platform V4.X, High Tech Application V4.5, High Tech
Application V5.0, and FinServ Application V4.5. The value was determined by a
hypothetical royalty receipts method, a variation of the discounted cash flow
method. Using this method, a hypothetical royalty rate was applied to the
after-tax cash flows of the IPR&D application projects that leverage Platform
V4.X. A royalty rate ranging from 5% to 20% was used to discount the cash flows
varying in relation to the increased reliance on Platform V4.X and decreased
reliance on the core technology. The estimated net cash flows generated by the
products over a 3-year period were discounted at rates ranging from 35% to 60%
in relation to the stage of completion and the risks associated with achieving
technological feasibility. The net cash flows for such projects were based on
management's estimates of revenue, expenses, asset requirements, and the core
technology royalty rate.
The allocation of the purchase price to the net assets acquired, excluding
the amount in the escrow fund, as of November 16, 2001 is presented below (in
millions):
<Table>
Net Assets Acquired:
Assets:
Total current assets ...................................... $12.1
Certificate of deposit (restricted) ....................... 1.3
Property and equipment, net ............................... 3.7
-----
Total assets acquired .............................. $17.1
-----
Liabilities:
Total current liabilities ................................. $ 9.4
Unearned revenue, net of current portion, and other ....... 0.2
-----
Total liabilities assumed .......................... $ 9.6
-----
Net assets acquired ........................................... $ 7.5
=====
Purchase Price Components:
Net assets acquired ............................................ $ 7.5
Identified Intangibles:
Acquired in-process research and development .............. 4.6
Software development costs and other identified intangibles 8.2
-----
Total identified intangibles ....................... $12.8
Goodwill ....................................................... 61.4
-----
Total purchase price ............................... $81.7
=====
</Table>
The following unaudited pro forma combined financial information is
presented as if the Company and YOUcentric had been combined as of the beginning
of the periods presented. This information is presented for illustrative
purposes only and is not necessarily indicative of the results that actually
would have been realized had the entities been a single entity during the
periods presented. The pro forma results of operations as though the companies
had combined at the beginning of fiscal 2002 would not be materially different
from the reported results and therefore have been omitted. Unaudited pro forma
results of operations for the third quarter and first nine months of fiscal 2001
are as follows (in thousands, except per share amounts):
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED ENDED
------------ -----------
JULY 31, 2001
---------------------------
PRO FORMA RESULTS OF OPERATIONS:
Revenue ............................ $ 217,125 $ 667,937
Net loss ........................... $(200,369) $(219,108)
Basic and diluted net loss per share $ (1.68) $ (1.85)
</Table>
(8) RESTRUCTURINGS AND OTHER RELATED CHARGES
Fiscal 2001 Restructuring
Overview. During fiscal 2001, the Company's Board of Directors approved a
two-phased global restructuring plan (referred to as the fiscal 2001
restructuring plan) precipitated by the Company's operating losses, lower
employee productivity levels, and the general economic downturn. Actions
included the elimination of 398 employee positions in order to reduce the total
workforce and the computer equipment either owned or leased for employee use,
and the closure or consolidation of some operating facilities. The fiscal
10
2001 restructuring plan consisted of two phases (Phase I and Phase II),
initiated during the second and third quarter of fiscal 2001, respectively.
Restructuring and related charges primarily consisted of severance related costs
for the involuntarily terminated employees, operating lease termination
payments, and office closure costs.
All actions related to Phase I were completed by the fourth quarter of
fiscal 2001 and Phase II actions were completed by April 30, 2002. At July 31,
2002, the outstanding accrual was $7.7 million and consisted of remaining lease
obligations for office and training facilities closed or consolidated which will
be paid over the remaining lease terms through 2007 and unsettled employee
termination costs.
Fiscal 2001 restructuring costs. The following table summarizes the
components of the Phase I and Phase II restructuring charge, the payments made
during the periods presented, and the remaining accrual as of July 31, 2002:
<Table>
<Caption>
Summary of fiscal 2001 restructuring Employee Total
charge and payments (in thousands): Severance & Operating Restructuring Asset Disposal Restructuring
Termination Office Lease Costs Losses and and Related
Costs Closures Buyouts Subtotal Other Costs Charges
----------- -------- --------- ------------- -------------- -------------
Fiscal 2001 consolidated charge, before
adjustments......................... $ 9,401 $ 10,896 $1,537 $ 21,834 $ 2,339 $ 24,173
Fiscal 2001 cash payments and other
reductions.......................... (8,972) (1,742) (1,181) (11,895) (2,339) (14,234)
Fiscal 2001 adjustments................ (161) 190 (50) (21) -- (21)
------- -------- ------ --------- -------- --------
Accrual balance, October 31, 2001... 268 9,344 306 9,918 -- 9,918
Fiscal 2002 cash payments and other
reductions.......................... (319) (3,318) (65) (3,702) -- (3,702)
Fiscal 2002 adjustments................ 114 1,585 (241) 1,458 1,458
------- -------- ------- -------- -------- --------
Accrual balance, July 31, 2002...... $ 63 $ 7,611 $ -- $ 7,674 $ -- $ 7,674
======= ======== ======= ======== ======== ========
</Table>
The accrual will continue to be reduced until all remaining obligations
have been settled by 2007. The Company recorded adjustments to increase the
restructuring accrual from the original estimate by approximately $1.5 million
during fiscal 2002. The adjustments primarily represent an increase in the
employee termination and severance accrual due to unsettled employee termination
costs, an increase in the office closure costs, which are expected to be higher
than originally estimated due to higher vacancy rates and lower sublease rates,
which serve to decrease the period of time over which the Company will receive
sublease income, and a decrease in the final amount of operating lease buyouts.
Any cost true-ups subsequent to April 30, 2002 related to the fiscal 2001
restructuring were recorded through operating expense with no impact to the
restructuring charge.
Fiscal 2000 Restructuring
Overview. During fiscal 2000, the Company's Board of Directors approved a
global restructuring plan to reduce the Company's operating expenses and
strengthen both its competitive and financial positions. Management effected the
restructuring plan during the third quarter of fiscal 2000 by eliminating 775
employee positions, reducing office space and related overhead expenses, and
modifying the Company's approach for providing certain services for customers.
Restructuring and related charges primarily consisted of severance related costs
for the involuntarily terminated employees, operating lease termination
payments, and office closure costs.
The Company has completed all actions related to this restructuring as of April
30, 2001. An outstanding accrual of $1.9 million remained at July 31, 2002
primarily consisting of lease obligations for office and training facilities
closed and consolidated which will be paid over the remaining lease terms and
unsettled employee termination costs.
<Table>
<Caption>
Summary of fiscal 2000 restructuring Employee Total
accrual activity (in thousands): Severance & Operating Restructuring Asset Disposal Restructuring
Termination Office Lease Costs Losses and and Related
Accrual Closures Buyouts Subtotal Other Costs Charges
----------- -------- --------- ------------- -------------- -------------
July 31, 2000 consolidated charge,
before adjustments.................. $16,683 $ 12,667 $ 647 $ 29,997 $ 116 $ 30,113
Fiscal 2000 cash payments and other
reductions.......................... (15,487) (4,154) (223) (19,864) 384 (19,480)
Fiscal 2000 adjustments............... (342) (2,696) -- (3,038) -- (3,038)
------- -------- ------- -------- ------ --------
Accrual balance, October 31, 2000... 854 5,817 424 7,095 500 7,595
Fiscal 2001 cash payments and other
reductions.......................... (617) (2,693) (237) (3,547) (500) (4,047)
Fiscal 2001 adjustments............... (134) (306) (187) (627) -- (627)
------- -------- ------- ------- ------ -------
Accrual balance, October 31, 2001... 103 2,818 -- 2,921 -- 2,921
Fiscal 2002 cash payments and other
reductions.......................... (91) (947) -- (1,038) -- (1,038)
------- -------- ------- -------- ------ ---------
Accrual balance, July 31, 2002...... $ 12 $ 1,871 $ -- $ 1,883 $ -- $ 1,883
======= ======== ======= ======== ====== =========
</Table>
11
The accrual will continue to be reduced until all remaining obligations have
been settled in 2007. The Company recorded adjustments to decrease the
restructuring accrual by $627,000 during fiscal 2001. The adjustments primarily
represent operating lease buyouts being reduced from the original estimate and
successful elimination of rental obligations on office closures earlier in the
fiscal year. Additionally, the provision was reduced resulting from favorable
negotiations and reduced obligations surrounding employee termination costs. Any
cost true-ups subsequent to April 30, 2001 related to the fiscal 2000
restructuring were recorded through operating expense with no impact to the
restructuring charge.
(9) OTHER COMPREHENSIVE INCOME OR LOSS
Other comprehensive income or loss includes unrealized gains or losses on
equity securities and foreign currency translation gains or losses that have
been reflected as a component of stockholders' equity and have not impacted net
income or loss. The following table summarizes the components of total other
comprehensive income or loss as of the balance sheet dates indicated (in
thousands):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------ ------------------------
2001 2002 2001 2002
--------- --------- --------- ---------
Net income (loss) ...................................... $(185,901) $ 9,474 $(197,747) $ 8,867
Change in unrealized gains (losses) on equity securities (5,080) 85 (14,589) 193
Change in foreign currency translation adjustments ..... (1,111) (1,382) (1,072) (786)
--------- --------- --------- ---------
Total comprehensive income (loss), net .............. $(192,092) $ 8,177 $(213,408) $ 8,274
========= ========= ========= =========
</Table>
(10) DERIVATIVE INSTRUMENTS AND FOREIGN CURRENCY EXPOSURE
At July 31, 2002, the Company had approximately $97.4 million of gross U.S.
dollar equivalent forward foreign exchange contracts outstanding to mitigate the
exposure to monetary assets and liabilities denominated in foreign currency.
Included in other income and expense were net foreign exchange losses of
$429,000 for the third quarter of fiscal 2001 and losses of $780,000 for the
first nine months of fiscal 2001, and gains of $654,000 for the third quarter of
fiscal 2002 and losses of $522,000 million for the first nine months of fiscal
2002.
(11) SEGMENT INFORMATION
Operating segments are defined as components of an enterprise for which
discrete financial information is available and is reviewed regularly by the
chief operating decision-maker, or decision-making group, to evaluate
performance and make operating decisions. The Company identified its chief
operating decision-makers as three key executives - the Chief Executive Officer,
Chief Operating Officer, and Chief Financial Officer. These executives review
the revenue and overall results of operations by geographic regions. The
accounting policies of the operating segments presented below are the same as
those described in the summary of significant accounting policies included in
the Company's Annual Report on Form 10-K for the fiscal year ended October 31,
2001. Total revenue from each country outside of the United States was less than
10 percent of the Company's consolidated revenue for all periods presented. The
groupings presented below represent an aggregation of financial information for
countries meeting certain criteria, including economic characteristics, similar
customers, and the same products, services, and distribution methods (in
thousands):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------- ------------------------
2001 2002 2001 2002
---------- ---------- ---------- ---------
REVENUES:
United States........................................... $ 128,912 $ 139,672 $ 418,149 $ 405,961
Europe, Middle East, and Africa......................... 45,209 49,155 129,487 139,693
Canada, Asia, and Latin America......................... 35,243 40,129 105,699 111,570
---------- ---------- ---------- ----------
Consolidated............................................ $ 209,364 $ 228,956 $ 653,335 $ 657,224
========== ========== ========== ==========
INCOME (LOSS) FROM OPERATIONS:
United States........................................... $ (24,772) $ (14,362) $ (50,065) $ (39,899)
Europe, Middle East, and Africa......................... 9,200 18,813 26,312 43,309
Canada, Asia, and Latin America......................... 8,054 9,446 14,760 27,575
Amortization of acquired software and other acquired
intangibles and other acquisition related charges..... (6,614) (5,276) (18,969) (17,983)
Write-off of certain third party product arrangements... (12,762) - (20,566) -
Acquired in-process research and development............ - - - (4,600)
Restructuring and other related charges................. (21,737) - (24,226) (1,546)
----------- ----------- ---------- ----------
Consolidated........................................ $ (48,631) $ 8,621 $ (72,754) $ 6,856
========== ========== ========== ==========
</Table>
12
(12) COMMITMENTS AND CONTINGENCIES
Leases. The Company's corporate headquarters were constructed on land owned
by the Company and are leased under operating leases. The lessor (a wholly owned
subsidiary of a bank) and a syndication of banks financed $121.2 million in
purchase and construction costs through a combination of debt and equity. The
Company guarantees the residual value of each building up to approximately 85%
of its original cost. Management does not believe that the residual guarantee
will be exercised to satisfy any of the Company's financial obligations under
the leases. The Company's lease obligations are based on a return on the
lessor's costs. Management can elect to reduce the interest rate used to
calculate lease expense by collateralizing the financing arrangements with
investments consistent with the Company's investment policy. At October 31,
2001, investments totaling $67.2 million were designated as collateral for these
leases. During the third quarter of fiscal 2002, management elected to increase
the total amount of investments designated as financing collateral to $117.6
million in order to reduce the Company's interest rate used to calculate lease
expense. The majority of investments designated as collateral are included in
cash and cash equivalents on the accompanying consolidated balance sheets.
During the fourth quarter of fiscal 2001, the Company obtained a covenant
compliance waiver related to the profitability covenant from one of the
syndicate banks. In connection with the waiver, the Company designated $16.0
million of existing collateral as restricted cash and cash equivalents. During
the first quarter of fiscal 2002, management executed amendments to the security
agreements on the remaining leased buildings and designated an additional $19.4
million of the collateral as restricted cash and cash equivalents. The lease
collateral represents substantially all of the $36.0 million restricted cash,
cash equivalents, and investments on the accompanying consolidated balance
sheets. The Company may withdraw the funds used as collateral, excluding the
restricted amounts, at Management's sole discretion provided that the Company is
not in default under the lease agreements. At July 31, 2002, the Company was in
compliance with the covenants, representations, and warranties required under
the lease agreements.
Litigation. The Company is involved in certain disputes and legal actions
arising in the ordinary course of its business. In management's opinion, none of
such disputes and legal actions is expected to have a material impact on the
Company's consolidated financial position, results of operations, or cash flows.
(13) LINE OF CREDIT
In June 2002, the Company elected to permanently reduce the commitment under
the bank line of credit to $50 million from $100 million. In July 2002, the $50
million revolving line of credit was renewed. The line of credit is secured by
the Company's accounts receivable and expires in July 2003. The primary purpose
of this line of credit is for general corporate use and to increase the
Company's financial flexibility. Advances under the line of credit require the
Company's compliance with certain affirmative and negative covenants and
representations and warranties. At July 31, 2002, the Company was in compliance
with these covenants, representations, and warranties.
(14) RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142, "Goodwill and Other Intangible Assets," which is effective for the
Company's fiscal year 2003. Certain provisions shall also be applied to
acquisitions initiated subsequent to June 30, 2001. SFAS No. 142 supersedes APB
Opinion No. 17 "Intangible Assets," and requires, among other things, the
discontinuance of amortization related to goodwill and indefinite lived
intangible assets. These assets will then be subject to an impairment test at
least annually. In addition, the standard includes provisions upon adoption for
the reclassification of certain intangibles to goodwill, reassessment of the
useful lives of intangibles, and reclassification of certain intangibles out of
previously reported goodwill.
The Company will adopt SFAS No. 142 no later than November 1, 2002. When
the Company adopts SFAS No. 142, it will result in the Company no longer
amortizing existing goodwill. In addition, the Company will be required to
measure goodwill for impairment as part of the transition provisions. Any
impairment resulting from these transition tests will be recorded and recognized
as the cumulative effect of a change in accounting principle. Management
anticipates that the adoption of SFAS No. 142 will not have
13
a material impact on the Company's business acquisitions completed prior to June
30, 2001, as the majority of remaining goodwill and intangibles related to those
acquisitions will be fully amortized by November 1, 2002. Goodwill in the amount
of $61.4 million related to the YOUcentric acquisition will be subject to the
annual impairment test and is not being amortized under SFAS No. 142. Management
cannot determine the future extent of impairment, if any, until the completion
of such impairment review.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which is effective for fiscal years beginning after
June 15, 2002. SFAS No. 143 requires, among other things, that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are then capitalized as part of the carrying
amount of the long-lived asset. The Company will adopt SFAS No. 143 no later
than November 1, 2002. Management anticipates that the adoption of SFAS No. 143
will not have a material impact on the Company's consolidated financial
statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long Lived Assets," which is effective for fiscal
years beginning after December 15, 2001. SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. The Company will adopt SFAS No. 144
no later than November 1, 2002. Management anticipates that the adoption of SFAS
No. 144 will not have a material impact on the Company's consolidated financial
statements.
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
as of April 2002," which is effective for certain transactions occurring after
May 15, 2002 and for financial statements issued on or after May 15, 2002. SFAS
No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt," and an amendment of that statement, SFAS No. 64, "Extinguishments of Debt
Made to Satisfy Sinking-Fund Requirements." SFAS No. 145 also rescinds SFAS No.
44, "Accounting for Intangible Assets of Motor Carriers." SFAS No. 145 amends
SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. This statement also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The adoption
of SFAS No. 145 on May 15, 2002 did not have a material impact on the Company's
consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit of
Disposal Activities." This statement addresses the recognition, measurement, and
reporting of costs associated with exit and disposal activities. SFAS No. 146 is
applicable to restructuring activities and costs related to terminating a
contract that is not a capital lease and one time benefit arrangements received
by employees who are involuntarily terminated. SFAS 146 supercedes EITF 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)."
Under SFAS No. 146 the cost associated with an exit or disposal activity is
recognized in the periods in which it is incurred rather than at the date the
Company committed to the exit plan. This statement is effective for exit or
disposal activities initiated after December 13, 2002 with earlier adoption
encouraged. Previously issued financial statements will not be restated. The
provisions of EITF 94-3 shall continue to apply for exit plans initiated prior
to the adoption of SFAS No. 146. Accordingly, the adoption of SFAS No. 146 will
not have a material impact on the Company's financial position, results of
operations, or cash flows.
During the second quarter of fiscal 2002, the Company adopted EITF Issue No.
01-14, "Income Statement Characterization of Reimbursements Received for 'Out-of
Pocket' Expenses Incurred." EITF Issue No. 01-14 requires reimbursements
received for out-of-pocket expenses to be reported as revenue in the statement
of operations. Prior to adoption of EITF Issue No. 01-14, the Company recorded
revenue and operating expenses net of reimbursable expenses. The Company's
financial results of operations for prior periods have been reclassified to
conform to the new presentation. In accordance with EITF Issue No. 01-14,
reimbursable expenses of $5.2 million and $14.8 million for the third quarter
and first nine months of fiscal 2001, respectively, and $4.7 million and $14.1
million for the third quarter and first nine months of fiscal 2002,
respectively, are now reflected as revenue and cost of revenue. This change had
no effect on operating income or net income for any period presented.
14
ITEM 2. 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 CONTAINS FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADE PURSUANT
TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THESE
FORWARD-LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES, AND
PROJECTIONS ABOUT J.D. EDWARDS' INDUSTRY, MANAGEMENT'S BELIEFS, AND CERTAIN
ASSUMPTIONS MADE BY J.D. EDWARDS' MANAGEMENT. SUCH FORWARD-LOOKING STATEMENTS
INCLUDE, BUT ARE NOT LIMITED TO, OUR EXPECTATIONS REGARDING OUR OPERATING
MARGINS IN OUR FOURTH FISCAL QUARTER, J.D. EDWARDS 5, MAINTENANCE REVENUE,
EDUCATION REVENUE, GROSS MARGINS ON SERVICE REVENUE, CAPITALIZATION OF RESEARCH
AND DEVELOPMENT COSTS, RENT EXPENSE FOR OUR HEADQUARTERS IN OUR FOURTH FISCAL
QUARTER, AND SHORT- AND LONG-TERM CASH NEEDS. IN SOME CASES, WORDS SUCH AS
"ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," "BELIEVES," "SEEKS," "ESTIMATES,"
OR VARIATIONS OF SUCH WORDS, AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY
SUCH FORWARD-LOOKING STATEMENTS. THE STATEMENTS ARE NOT GUARANTEES OF FUTURE
PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES, AND ASSUMPTIONS
THAT ARE DIFFICULT TO PREDICT; THEREFORE, ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE EXPRESSED OR FORECASTED IN ANY SUCH FORWARD-LOOKING STATEMENTS. SUCH
RISKS AND UNCERTAINTIES INCLUDE THOSE SET FORTH IN THE COMPANY'S ANNUAL REPORT
ON FORM 10-K FOR THE FISCAL YEAR ENDED OCTOBER 31, 2001 UNDER "RISK FACTORS" ON
PAGES 11 THROUGH 21. UNLESS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO
OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A
RESULT OF NEW INFORMATION, FUTURE EVENTS, OR OTHERWISE. HOWEVER, READERS SHOULD
CAREFULLY REVIEW THE RISK FACTORS SET FORTH IN OTHER REPORTS OR DOCUMENTS THE
COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION,
PARTICULARLY THE QUARTERLY REPORTS ON FORM 10-Q AND ANY CURRENT REPORT ON FORM
8-K.
RESULTS OF OPERATIONS
J.D. Edwards is a leading provider of agile, collaborative enterprise
software solutions. For 25 years, we have developed, marketed, and supported
innovative, flexible solutions that help run small- to multinational-sized
organizations. Our customer base includes approximately 6,500 companies of
various sizes. We deliver integrated, collaborative software for supply chain
management, procurement, and customer relationship management (CRM), in addition
to Enterprise Resource Planning (ERP), and other functional support. To help
customers achieve benefits from our software, we provide implementation and
education services through our own direct services organization and business
partners. We distribute, implement, and support our software worldwide through
59 offices and approximately 200 third-party business partners. In May 2002, we
released J.D. Edwards 5, which consists of our integrated product lines
including ERP, CRM, supply chain management, supplier relationship management,
business intelligence, collaboration and integration solutions, and tools and
technology.
Our financial results for the third quarter and first nine months of fiscal
2002 reflected net income of $9.5 million, or $0.08 per share, and net income of
$8.9 million, or $0.07 per share, respectively, compared to net losses of $185.9
million, or $1.65 per share, and $197.7 million, or $1.77 per share for the same
periods last year, respectively. The third quarter and first nine months of
fiscal 2002 reflected operating income of $8.6 million and $6.9 million,
respectively, compared to operating losses of $48.6 million and $72.8 million
for the third quarter and first nine months of fiscal 2001, respectively. We are
focusing on delivering consistent, profitable growth and continue to make
progress with our improved execution and financial performance. The improvement
in financial performance from last year was primarily the result of increased
services revenue and decreased operating expenses resulting from improved
operating efficiencies throughout our organization and continued focus on cost
reductions. Our cash flows from operations increased significantly to $112.4
million for the nine months ended July 31, 2002 from $7.0 million for the nine
months ended July 31, 2001. Our days sales outstanding (DSO) improved to 71 days
as of July 31, 2002, compared to 80 days as of October 31, 2001, and 99 days as
of July 31, 2001 primarily due to successful collections of cash from customers
and a lower weighted-average number of days granted under customer payment terms
during the third quarter of fiscal 2002.
Operating income for the third quarter of fiscal 2002 included $5.3 million
of charges related to the amortization of acquired software, other acquired
intangibles, and acquisition related deferred compensation, $4.0 million of
revenue related to the reduction of the allowance for doubtful accounts
receivable no longer required given the successful collection activities and a
$2.3 million reduction of the accrual for employee vacations. We have adopted a
new vacation policy in certain geographic locations whereby employees must take
their vacations before the end of the fiscal year or forfeit any remaining
vacation balances. It is expected that in the fourth quarter of fiscal 2002 an
additional reduction of the vacation accrual will be taken as a result of the
release of the remaining affected employee vacation accruals due to this new
policy. The operating loss for the third quarter of fiscal 2001 included $6.6
million of charges related to the amortization of acquired software and other
acquired intangibles, restructuring and related charges of $21.7 million, and a
$12.8 million write-off associated with the exit of certain third-party product
arrangements. The first nine months of fiscal 2002 included $18.0 million of
charges related to the amortization of acquired software, other acquired
intangibles, and acquisition related deferred compensation, a charge of $4.6
million for acquired IPR&D resulting from our YOUcentric, Inc. (YOUcentric)
acquisition, restructuring and related charges of $1.5 million, $5.0 million of
revenue related to the reduction of the allowance for doubtful accounts
receivable, and a $2.3 million reduction in the accrual for employee vacations.
The first nine months of fiscal 2001 included $19.0 million of charges related
to amortization of acquired software and other acquired intangibles,
15
restructuring and related charges of $24.2 million, and a $20.6 million
write-off of prepaid royalties associated with the exit of certain third-party
product arrangements.
During November 2001, we completed our acquisition of YOUcentric, a provider
of Java-based CRM software, including applications for sales force automation,
campaign management, contact center management, and partner relationship
management. Most of YOUcentric's employees have remained with J.D. Edwards. This
acquisition was accounted for as a purchase and, accordingly, operating expenses
were impacted in the third quarter and first nine months of fiscal 2002
subsequent to the consummation date of the acquisition, primarily as a result of
a write-off of in-process research and development (IPR&D) and amortization of
acquired intangible assets and acquisition related deferred compensation.
Historically we have experienced and expect to continue to experience a high
degree of seasonality in our business operations which is primarily the result
of both the efforts of our direct sales force to meet or exceed fiscal year-end
sales quotas and the tendency of certain customers to finalize sales contracts
at or near the end of our fiscal year. Because our operating expenses are
somewhat fixed in the near term, our operating margins have historically been
significantly higher in our fourth fiscal quarter than in other quarters, and we
expect this to continue in future fiscal years.
While we have made progress towards our goal of consistent, profitable
growth in spite of a difficult global economy, the maturity of the traditional
enterprise resource planning market, challenges of entering new markets, the
continued slowdown in global economic conditions, strong competitive forces, and
potential negative effects from organizational and management changes could
reduce revenue and reduce or eliminate improvements in operating margins. These
uncertainties have made projections of future revenue and operating results
particularly challenging. There can be no assurance of the level of revenue
growth and profitability that will be achieved, if any, or that our financial
condition, results of operations, cash flows, and market price of our common
stock will not be adversely affected by the aforementioned factors.
The following table sets forth, for the periods indicated, certain items
from our consolidated statements of operations as a percentage of total revenue
(except for gross margin data):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------- -------------------
2001 2002 2001 2002
----- ----- ----- -----
Revenue:
License fees................................... 23.9% 24.0% 29.8% 23.3%
Services....................................... 76.1 76.0 70.2 76.7
----- ----- ----- -----
Total revenue............................... 100.0 100.0 100.0 100.0
Costs and expenses:
Cost of license fees (including write-offs of
certain third-party product
arrangements)................................. 10.3 4.1 8.3 3.6
Cost of services .............................. 40.4 34.9 39.9 36.5
Sales and marketing............................ 37.5 32.0 34.4 31.3
General and administrative..................... 10.1 9.5 10.5 10.1
Research and development....................... 11.4 13.4 11.4 13.7
Amortization of acquired software and other
acquired intangibles and acquisition related
deferred compensation......................... 3.1 2.3 2.9 2.7
Acquired in-process research and development... -- -- -- 0.7
Restructuring and other related charges........ 10.4 -- 3.7 0.2
----- ----- ----- -----
Total costs and expenses.................... 123.2 96.2 111.1 98.8
Operating income (loss).......................... (23.2) 3.8 (11.1) 1.2
Other income (expense), net...................... (0.9) 1.0 0.4 0.4
----- ----- ----- -----
Income (loss) before income taxes................ (24.1) 4.8 (10.7) 1.6
Provision for income taxes..................... 64.7 0.7 19.6 0.3
----- ----- ----- -----
Net income (loss)................................ (88.8)% 4.1% (30.3)% 1.3%
===== ===== ===== =====
Gross margin on license fee revenue (including
write-offs of certain third-party product
arrangements).................................. 57.0% 83.1% 72.2% 84.4%
Gross margin on license fee revenue (excluding
write-offs of certain third-party product
arrangements).................................. 82.5% 83.1% 82.7% 84.4%
Gross margin on service revenue.................. 46.9% 54.0% 43.1% 52.5%
</Table>
16
Total revenue. Our total revenue for the third quarter of fiscal 2002
increased 9% to $229.0 million compared to $209.4 million for the third quarter
of fiscal 2001 and increased 1% to $657.2 million for the first nine months of
fiscal 2002 from $653.3 million for the first nine months of fiscal 2001. The
revenue mix between license fees and services was 24.0% and 76.0%, respectively,
for the third quarter of fiscal 2002 compared to 23.9% and 76.1%, respectively,
for the third quarter of fiscal 2001, and was 23.3% and 76.7%, respectively, for
the first nine months of fiscal 2002 compared to 29.8% and 70.2%, respectively,
for the first nine months of fiscal 2001. The increase in total revenue for the
third quarter of fiscal 2002 compared to the third quarter of fiscal 2001 was
primarily due to the increase in maintenance and consulting revenue resulting
from our growing installed base of customers and our focus on generating more
direct consulting service engagements. The relatively flat total revenue and the
change in revenue mix between license fees and services for the first nine
months of fiscal 2002 compared to the first nine months of fiscal 2001 was
primarily a result of declining license fee revenue due to the general downturn
in the global economy which was offset by an increase in consulting services
revenue and our growing installed base of customers, as discussed above.
Additionally, total revenue for the third quarter and first nine months of
fiscal 2002 includes $4.0 million and $5.0 million, respectively, of revenue
related to the reduction of the allowance for doubtful accounts receivable no
longer required given the successful collection activities during fiscal 2002.
A portion of our total revenue is derived from international sales and is
therefore subject to the related risks, including general economic conditions in
each country, the strength of international competitors, different tax
structures, complexity of managing an organization spread over various
countries, changes in regulatory requirements, compliance with a variety of
foreign laws and regulations, longer payment cycles, and the volatility of
currency exchange rates in certain countries. A portion of our business is
conducted in currencies other than the U.S. dollar. For the third quarter of
fiscal 2001 and 2002, the geographic areas defined as the U.S., Europe, the
Middle East, and Africa (EMEA), and the rest of the world accounted for 61%,
22%, and 17% of total revenue. For the first nine months of fiscal 2002, the
geographic areas defined as the U.S., EMEA, and the rest of the world accounted
for 62%, 21%, and 17% of total revenue, respectively, compared to 64%, 20%, and
16%, respectively, for the first nine months of fiscal 2001. Changes in the
value of major foreign currencies relative to the U.S. dollar positively
affected our total revenue by less than 3% based on a comparison of foreign
exchange rates in effect at the beginning of our fiscal year to actual rates for
the third quarter and first nine months of fiscal 2002. Comparatively, changes
in the value of major foreign currencies relative to the U.S. dollar positively
affected our total revenue by less than 1% for the third quarter and first nine
months of fiscal 2001, based on a comparison of foreign exchange rates in effect
at the beginning of fiscal 2001. Fluctuations in foreign currency exchange rates
will continue to affect our total revenue, results of operations, cash flows and
financial position depending on the U.S. dollar strengthening or weakening
relative to foreign currencies. For any period, changes in each country's
general economic and political environment or foreign exchange rates may also
have a material impact on our total revenue, results of operations, cash flows,
and financial position.
License fees. License fee revenue increased 10% to $54.9 million for the
third quarter of fiscal 2002 from $50.0 million for the third quarter of fiscal
2001, and declined 22% to $152.9 for the first nine months of fiscal 2002 from
$195.0 million for the first nine months of fiscal 2001. For the third quarter
of fiscal 2002, the number of license transactions exceeding $1.0 million
remained flat at 9 transactions compared to the prior year quarter, representing
$20.6 million or 38% of license fee revenue compared to $15.5 million or 31% of
license fee revenue, for the third quarter of fiscal 2001. Our overall average
sales price was up 14% in the third quarter of fiscal 2002 over the prior year
quarter attributing to the overall increase. For the first nine months of fiscal
2002, we had 27 transactions over $1 million, down from 47 for the prior year
period, representing $55.3 million or 37% of license fee revenue compared to
$86.7 million or 43% of license fee revenue for the first nine months of fiscal
2001. Our overall average sales price for the first nine months was down 13%
over the prior year period. The decrease in license fee revenue for the first
nine months of fiscal 2002 was primarily due to the downturn of global economic
conditions and lower customer spending on ERP than the first nine months of
fiscal 2001. Revenue resulting from reseller arrangements for the third quarter
and first nine months of fiscal 2002 and the same periods for fiscal 2001 was
less than 5% of total license fee revenue.
We increased our total number of customers to approximately 6,500 at July
31, 2002, which represents a 3% increase compared to the end of the third
quarter of fiscal 2001. The percentage of license fee revenue from existing
customers increased to 55% for the third quarter of fiscal 2002 from 35% for the
third quarter of fiscal 2001, and increased to 49% for the first nine months of
fiscal 2002 from 40% for the first nine months of fiscal 2001. The improvement
in the percentage of license fee revenue from existing customers for the third
quarter and first nine months of fiscal 2002 from the same periods last year was
a result of our focus on increasing license fee revenue from our installed base
of customers during fiscal 2002. Average sales price for our installed base of
customers increased 98% to $192,000 for the third quarter of fiscal 2002 from
$98,000 for the same period last year and remained flat for the first nine
months of fiscal 2001 and 2002. The mix of revenue from new and existing
customers varies from quarter to quarter, and our future growth is dependent on
our ability to both retain our installed base of customers while adding new
customers, as well as our ability to offer competitive products. There can be no
assurance that our license fee revenue will not be adversely affected in future
periods as a result of continued downturns in global economic conditions, or
intensified competitive pressures.
Services. Services revenue consists of fees generated by our personnel
providing direct consulting, software maintenance services, education services
to customers, fees generated through subcontracted third-party arrangements, and
referral fees from service providers who contract directly with customers.
Services revenue for the third quarter of fiscal 2002 increased 9% to $174.0
million
17
from $159.4 million for the third quarter of fiscal 2001, and increased 10% to
$504.3 million for the first nine months of fiscal 2002 from $458.3 million for
the first nine months of fiscal 2001. These increases were primarily a result of
increased software maintenance revenue and consulting revenue, offset, in part,
by a decline in education services revenue. The increase in software maintenance
revenue was primarily a result of our installed base of customers continuing to
grow together with an increase in maintenance prices. We expect maintenance
revenue to continue to rise during fiscal 2002 over fiscal 2001 due to these
factors. There can be no assurance, however, that we will maintain consistent
maintenance renewals in the future or that we will achieve maintenance revenue
growth. The increase in consulting revenue for the third quarter and first nine
months of fiscal 2002 compared to the same periods last year was primarily due
an increase in direct service engagements as we continue our focus on gaining
more direct implementation work. Additionally, we have implemented an incentive
program for our account executives to sell direct service engagements resulting
in improved utilization of our consultants during the third quarter and first
nine months of fiscal 2002. We seek to provide our customers with high-quality
implementation services in the most efficient and effective manner. While our
goal is to increase the level of services sold directly to a customer, we intend
to continue business partner relationships under both subcontract and referral
arrangements.
The decline in education revenue for the third quarter and first nine months
of fiscal 2002 compared to the same periods last year was due to the
consolidation or elimination of education offerings due to weakening customer
demand for classroom training and less customer travel following terrorism
attacks on September 11, 2001 and the slowdown in global economic conditions. We
intend to offer more custom on-site customer training as well as on-line
offerings in the future. However, we expect total education revenue in fiscal
2002 to decrease compared to fiscal 2001 due to these factors.
During the second quarter of fiscal 2002, we adopted Financial Accounting
Standards Board (FASB) Emerging Issues Task Force (EITF) No. 01-14, "Income
Statement Characterization of Reimbursements Received for 'Out-of Pocket'
Expenses Incurred." EITF Issue No. 01-14 requires reimbursements received for
out-of-pocket expenses to be reported as revenue in the statement of operations.
Prior to adoption of EITF Issue No. 01-14, we recorded revenue and operating
expenses net of reimbursable expenses. Our financial results of operations for
prior periods have been reclassified to conform to the new presentation. In
accordance with EITF Issue No. 01-14, reimbursable expenses of $4.7 million and
$14.1 million for the third quarter and first nine months of fiscal 2002,
respectively, and $5.2 million and $14.8 million for the third quarter and first
nine months of fiscal 2001, respectively, are now reflected as revenue and cost
of revenue. This change had no effect on operating income or net income for any
period presented.
In any period, total services revenue is dependent on license transactions
closed during the current and preceding periods, the growth in our installed
base of customers, the amount and size of consulting engagements, and the level
of competition from alliance partners for consulting and implementation work. We
believe services revenue will continue to vary from quarter to quarter depending
on the mix between consulting, maintenance, and education revenue and the mix of
direct, subcontract, and referral arrangements from our business partners. There
can be no assurance that future fluctuations in our license fee revenue will not
have an adverse effect on future services revenue. Additionally, services
revenue is dependent on the availability of our consultants to staff
engagements, the number of customers who have contracted for support services,
billing rates for education services, and the number of customers purchasing
education services.
Total costs and expenses. Our total costs and expenses declined 15% to
$220.3 million for the third quarter of fiscal 2002 from $258.0 million for the
third quarter of fiscal 2001, and declined 10% to $650.1 million for the first
nine months of fiscal 2002 from $726.1 million for the first nine months of
fiscal 2001. As discussed above, costs and expenses for the third quarter and
first nine months of fiscal 2002 included a $2.3 million reduction related to
the reduction of the accrual for employee vacations. Costs and expenses for the
third quarter of fiscal 2001 and 2002 also included amortization of acquired
intangibles and acquisition related deferred compensation of $6.6 million and
$5.3 million, respectively. Additionally, total costs and expenses for the third
quarter of fiscal 2001 included restructuring and related charges of $21.7
million and a $12.8 million of write-offs in prepaid royalties associated with
the exit of certain third-party product arrangements. The first nine months of
fiscal 2001 and 2002 included amortization of acquired intangibles and
acquisition related deferred compensation of $19.0 million and $18.0 million and
restructuring and related charges of $24.2 million and $1.5 million,
respectively. Additionally, total costs and expenses for the first nine months
of fiscal 2001 included a $20.6 million write-off of prepaid royalties
associated with the exit of certain third-party product arrangements. The first
nine months of fiscal 2002 included a charge of $4.6 million for acquired IPR&D
resulting from our YOUcentric acquisition.
Other decreases in costs and expenses were primarily due to the
organizational changes effected as part of our fiscal 2001 restructuring plan
coupled with our recent cost control efforts. Total office expense declined
across our organization for the third quarter and first nine months of fiscal
2002 by $16.9 million, or 50%, and $25.2 million, or 32%, respectively, compared
to the same periods last year due to our cost controls associated with overhead
expenses and the general decline in overall interest rates, which significantly
reduced rent expense. Computer expense declined company-wide for the third
quarter and first nine months of fiscal 2002 by $5.1 million, or 30%, and by
$14.2 million, or 28%, respectively, compared to the same periods last year due
to our cost controls over computer and network spending. Additionally, travel
and entertainment expenses declined for the third quarter and first nine months
of fiscal 2002 by $2.6 million, or 22%, and $8.7 million, or 25%, respectively,
compared to the same periods last year, due to our focus on cost savings and
reducing discretionary travel. These decreases were offset, in part, by
increases in our company-wide
18
bonus expense for the third quarter and first nine months of fiscal 2002 of $4.7
million, or 323%, and $10.7 million, or 193%, respectively, compared to the same
periods last year. The fiscal 2002 year-to-date funding of our company-wide
bonus plan is based on our quarterly financial performance. We implemented a
profit sharing plan during the second quarter of fiscal 2001, whereby we
reversed an excess charge associated with a former employee plan, and we accrued
minimal expense during the third quarter of fiscal 2001. The fiscal 2002 bonus
plan is based on our quarterly financial performance, and the plan has been
funded each quarter. Benefits on compensation expense increased slightly in the
third quarter and first nine months of fiscal 2002 by $159,000, or 1%, and $1.6
million, or 3%, respectively, compared to the same periods last year. The slight
increase in compensation benefits for the periods presented was offset, in part,
by a $2.3 million reduction in our vacation accrual.
Cost of license fees. Cost of license fees includes business partner
commissions, royalties, amortization of internally developed capitalized
software (including contractual payments to third parties related to internal
projects and contractual payments to third parties for source code and license
fees that are used in development of products for external sale), documentation,
and software delivery expenses. Cost of license fees decreased by 57% to $9.3
million for the third quarter of fiscal 2002 from $21.5 million for the third
quarter of fiscal 2001, and decreased by 56% to $23.8 million for the first nine
months of fiscal 2002 from $54.3 million for the first nine months of fiscal
2001. The decreases are due primarily to our fiscal 2001 exit from certain
reseller arrangements for which prepaid royalty balances existed. In the third
quarter and first nine months of fiscal 2001, we wrote off $12.8 million and
$20.6 million, respectively, in prepaid royalties associated with these third
party product arrangements. These charges are included in cost of license fees
on the accompanying consolidated statement of operations.
We record amortization expense on our capitalized software, primarily major
enhancements of our OneWorld applications, excluding software acquired as part
of a business acquisition, on a straight-line basis (generally over three years)
to cost of license fees beginning once the product is generally available. We
recorded amortization expense of $4.1 million and $11.7 million for the third
quarter and first nine months of fiscal 2002, respectively, and $3.6 million and
$7.9 million for the third quarter and first nine months of fiscal 2001,
respectively.
Gross margin on license fee revenue varies from quarter to quarter depending
on the revenue volume in relation to certain fixed costs, such as the
amortization of capitalized software development costs and the portion of our
software products subject to royalty payments. The third quarter and first nine
months of fiscal 2002 gross margin on license fee revenue increased to 83.1% and
84.4%, respectively, from 57.0% and 72.2% for the same periods last year,
respectively. In the third quarter and first nine months of fiscal 2001, we
wrote off $12.8 million and $20.6 million, respectively, in prepaid royalties
associated with third party product arrangements compared to no such write-offs
during the third quarter and first nine months of fiscal 2002. These write-offs
resulted in lower fiscal 2001 gross margins. Excluding these write-offs, the
gross margin for the third quarter and first nine months of fiscal 2001 was
82.5% and 82.7%, respectively. The increase to 83.1% and 84.4% for the third
quarter and first nine months of fiscal 2002 from the adjusted 82.5% and 82.7%
for the third quarter and first nine months of fiscal 2001 was primarily a
result of the decrease in reseller royalties, offset, in part, by increased
amortization of capitalized software.
Cost of services. Cost of services includes the personnel and related
overhead costs for providing services to customers, including consulting,
implementation, support, and education, as well as fees paid to third parties
for subcontracted services. We seek to provide our customers with high-quality
implementation and education services in the most efficient and effective
manner. Cost of services for the third quarter of fiscal 2002 decreased 5% to
$80.0 million from $84.6 million for the third quarter of fiscal 2001 and
decreased 8% to $239.7 million for the first nine months of fiscal 2002 from
$261.0 million for the first nine months of fiscal 2001. The declines in the
third quarter and first nine months of fiscal 2002 were primarily due to a
continuing decline in education services costs attributable to the elimination
and consolidation of several training facilities as part of our fiscal 2001
restructuring and overall consolidation of classes offered. Additionally, our
cost savings efforts contributed to lower computer expense, travel and
entertainment expenses, and total office expense. The overall decline from the
third quarter and first nine months of fiscal 2001 was offset, in part, by
increased commission expense resulting from both a new commission plan for
selling services and increased professional services and maintenance revenue for
the same periods in fiscal 2002. Additionally, bonus expense increased in the
fiscal 2002 periods due to the year-to-date funding of our fiscal 2002
company-wide bonus plan which is based on our quarterly financial performance.
The gross margin on services revenue for the third quarter and first nine
months of fiscal 2002 improved to 54.0% and 52.5%, respectively, compared to
46.9% and 43.1% for the third quarter and first nine months of fiscal 2001,
respectively. The improvement was due to higher maintenance revenue and improved
utilization and realization of internal consultants resulting from increased
direct service engagements. Generally, maintenance revenue produces a higher
margin than professional services and education revenue. Gross margins on
services revenue for the remainder of fiscal 2002 will depend on the mix of
total services revenue, the extent to which we are successful in increasing the
utilization and realization from our revenue-generating consulting employees and
the number of direct service engagements, as well as the extent to which we
utilize our service partner relationships under either subcontract or referral
arrangements. Gross margins on services revenue are expected to decline slightly
in the fourth quarter of fiscal 2002 due to decreased utilization of our
internal consultants as they use their remaining vacation time.
19
Gross margins on services revenue were minimally impacted by the adoption of
EITF Issue No. 01-14. As described above, EITF Issue No. 01-14 requires
reimbursements received for out-of-pocket expenses to be reported as revenue in
the statement of operations. Comparative financial statements for prior periods
reflect the reclassification of the reimbursements to conform to the current
year presentation.
Sales and marketing. Sales and marketing expense consists of personnel,
commissions, and related overhead costs for the sales and marketing activities,
together with advertising and promotion costs. Sales and marketing expense for
the third quarter of fiscal 2002 decreased 7% to $73.3 million from $78.4
million for the third quarter of fiscal 2001 and decreased 8% to $205.9 million
for the first nine months of fiscal 2002 from $224.7 million for the same period
last year. The decrease was primarily due to our cost savings efforts and
reduction in headcount from our fiscal 2001 restructuring that resulted in
decreased advertising and promotion, travel and entertainment, computer,
contract professional services, and total office expenses. Additionally,
commission expense was lower for the first nine months of fiscal 2002 compared
to the same period last year due to lower license fee revenue, as discussed
previously. The overall decrease in sales and marketing expense was offset, in
part, by an increase in bonus expense due to our year-to-date funding of our
fiscal 2002 company-wide bonus plan that is based on our quarterly financial
performance.
General and administrative. General and administrative expense includes
personnel and related overhead costs for support and administrative functions.
General and administrative expense for the third quarter of fiscal 2002
increased 3% to $21.8 million from $21.2 million for the third quarter of fiscal
2001 and decreased 3% to $66.6 million for the first nine months of fiscal 2002
from $68.7 million for the first nine months of fiscal 2001. The increase in
general and administrative expense for the third quarter of fiscal 2002 compared
to the third quarter of fiscal 2001 was primarily due to the increase in bonus
expense related to the funding of our company-wide bonus plan. The decrease in
general and administrative expense for the first nine months of fiscal 2002
compared to the first nine months of fiscal 2001 was primarily due to our cost
savings efforts and reduction in headcount from our fiscal 2001 restructuring
which reduced outside contract professional services, travel and entertainment
expenses, and office occupancy costs, offset, in part by the increase in bonus
expense related to our company-wide bonus plan.
Research and development. Research and development (R&D) expense includes
personnel and related overhead costs for product development, minor
enhancements, upgrades, testing, quality assurance, and documentation, net of
any capitalized internal development costs. R&D expense for the third quarter of
fiscal 2002 increased 28% to $30.6 million compared to $23.9 million for the
third quarter of fiscal 2001, representing 13% of total revenue. For the first
nine months of fiscal 2002 R&D expense increased 21% to $90.2 million from $74.2
million for the first nine months of fiscal 2001, representing 14% of total
revenue. Salary expense increased resulting from the addition of approximately
60 employees with the YOUcentric acquisition in the first quarter of fiscal 2002
as well as other additional hiring of development personnel during the year.
Bonus expense increased for the third quarter and first nine months of fiscal
2002 compared to the same periods last year due to the funding of our
company-wide bonus plan. Additionally, the capitalization of internally
developed software decreased in the third quarter of fiscal 2002 compared to the
third quarter of fiscal 2001 as certain development projects have reached
general availability and related costs are no longer being capitalized and we
are capitalizing fewer current projects. We continue to devote development
resources to major enhancements and new products associated with our J.D.
Edwards 5 product offerings. These overall increases were offset, in part, by
our cost savings efforts that resulted in decreased travel related expenses,
computer expenses, and total office expenses. Including capitalized internal
development cost, R&D expenditures were $35.6 million and $105.8 million,
representing 16% of total revenue, for both the third quarter and first nine
months of fiscal 2002, respectively. Including capitalized internal development
cost, R&D expenditures were $31.3 million and $96.7 million, representing 15% of
total revenue for both the third quarter and first nine months of fiscal 2001,
respectively.
In addition to our internal R&D activities, we are outsourcing the
development of software for some specialized industries, and we recently
acquired source code rights for certain applications and other embedded
technology. We capitalize internally developed software costs and software
purchased from third parties in accordance with Statement of Financial
Accounting Standards (SFAS) No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed." During the third quarter of
fiscal 2002, we capitalized $5.0 million of internal development costs and
$672,000 of third-party product rights and outsourced development, and for the
first nine months of fiscal 2002, we capitalized $15.6 million associated with
internal development costs and $3.1 million of third party product rights and
outsourced development costs. Comparatively, during the third quarter of fiscal
2001, we capitalized $7.4 million of internal development costs and $2.3 million
of third-party product rights and outsourced development costs, and for the
first nine months of fiscal 2001, we capitalized $22.5 million of internal
development costs and $6.5 million of third-party product rights and outsourced
development costs.
We anticipate that the R&D costs for major enhancements and new products
will continue to be capitalized in the future. In addition, we expect total R&D
expense to increase in subsequent periods due to the addition of key development
personnel. We are continuing our internal product enhancements in e-business and
other areas of new technology, as well as further integration of modules such as
advanced planning and scheduling, and e-procurement.
Amortization of acquired software and other acquired intangibles and
acquisition related deferred compensation. Total amortization for the third
quarter of fiscal 2002 related to the software, in-place workforce, customer
base, and goodwill resulting
20
from our business acquisitions was $2.0 million, $427,000, $1.4 million, and
$1.1 million, respectively, and for the first nine months of fiscal 2002 was
$8.4 million, $1.2 million, $4.1 million, and $3.3 million, respectively.
Additionally, amortization of deferred stock compensation related to our
YOUcentric acquisition totaled $335,000 and $948,000 for the third quarter and
first nine months of fiscal 2002, respectively. Total amortization for the third
quarter of fiscal 2001 related to the software, in-place workforce, customer
base, and goodwill resulting from our business acquisitions was $3.3 million,
$828,000, $1.4 million, and $1.1 million, respectively, and for the first nine
months of fiscal 2001 was $9.0 million, $2.5 million, $4.2 million, and $3.3
million, respectively.
Acquired IPR&D. The estimated value of $4.6 million assigned to acquired
IPR&D from YOUcentric was determined by identifying research projects in areas
for which technological feasibility has not been established and there is no
alternative future use. The fair value of acquired IPR&D includes revisions to
the YOUrelate Platform V4.X, High Tech Application V4.5, High Tech Application
V5.0, and FinServ Application V4.5. The value was determined by a hypothetical
royalty receipts method, a variation of the discounted cash flow method. Using
this method, a hypothetical royalty rate was applied to the after-tax cash flows
of the IPR&D application projects that leverage Platform V4.X. A royalty rate
ranging from 5% to 20% was used to discount the cash flows varying in relation
to the increased reliance on Platform V4.X and decreased reliance on the core
technology. The estimated net cash flows generated by the products over a 3-year
period were discounted at rates ranging from 35% to 60% in relation to the stage
of completion and the risks associated with achieving technological feasibility.
The net cash flows for such projects were based on our estimates of revenue,
expenses, asset requirements, and the core technology royalty rate.
Fiscal 2001 restructuring and related charges and exit from certain
third-party product arrangements. We completed all actions related to Phase I of
the fiscal 2001 restructuring by the fourth quarter of fiscal 2001 and Phase II
actions completed by April 30, 2002. At July 31, 2002, the outstanding accrual
was $7.7 million and consisted of remaining lease obligations for office and
training facilities closed or consolidated which will be paid over the remaining
lease terms through 2007 and unsettled employee termination costs.
We reviewed our business alliances during fiscal 2001. As a result of this
review, we exited certain reseller arrangements for which prepaid royalty
balances existed. In the second and third quarter of fiscal 2001, we wrote off
$7.8 million and $12.8 million, respectively, in prepaid royalties associated
with these third party product arrangements. These charges are included in cost
of license fees on the accompanying consolidated statement of operations.
The fiscal 2001 restructuring accrual will continue to be reduced until all
remaining obligations have been settled by 2007. We recorded adjustments to
increase the restructuring accrual from the original estimate by approximately
$1.5 million during the first nine months of fiscal 2002. The adjustments
primarily represent an increase in the employee termination and severance
accrual due to unsettled employee termination costs, an increase in the office
closure costs, which are expected to be higher than originally estimated due to
higher vacancy rates and lower sublease rates, which serve to decrease the
period of time over which we will receive sublease income, and a decrease in the
final amount of operating lease buyouts. Any cost true-ups subsequent to April
30, 2002 related to the fiscal 2001 restructuring were recorded through
operating expense with no impact to the restructuring charge. For a detailed
reconciliation refer to Note 8 in the Notes to the Consolidated Financial
Statements in Item 1 of this Quarterly Report on Form 10-Q.
Fiscal 2000 restructuring and related charges. We completed all actions
related to the fiscal 2000 restructuring as of April 30, 2001. The outstanding
accrual of $1.9 million remaining at July 31, 2002, consists mainly of lease
obligations for office and training facilities closed or consolidated and will
be paid over the remaining lease terms. The accrual will continue to be reduced
until all remaining obligations have been settled in 2007. We recorded
adjustments to decrease the restructuring accrual by $627,000 during fiscal
2001. The adjustments are primarily a result of operating lease buyouts being
reduced from the original estimate and successful elimination of rental
obligations on office closures earlier in the fiscal year. Additionally, the
charge was reduced as a result of favorable negotiations and reduced obligations
surrounding employee termination costs. Any cost true-ups subsequent to April
30, 2001, related to the fiscal 2000 restructuring were charged to operating
expense with no impact to the restructuring charge. For further details on the
fiscal 2000 restructuring see "Item 7: Management's Discussion and Analysis of
Financial Condition and Results of Operations" under the heading "Fiscal Years
Ended October 31, 1999 and 2000," in our Annual Report on Form 10-K for October
31, 2001.
Other income (expense). Other income and expense includes interest and
dividend income, losses on equity investments and the sale of a product line,
interest expense, foreign currency gains and losses, and other non-operating
income and expenses. Interest and dividend income decreased $1.2 million, or
39%, and $6.4 million, or 57%, during the third quarter and first nine months of
fiscal 2002 compared to the third quarter and first nine months of fiscal 2001,
respectively, due primarily to lower interest rates and lower investments in
marketable securities balances. During the third quarter and first nine months
of fiscal 2001 and the third quarter and first nine months of fiscal 2002, we
recorded losses of $4.1 million and $4.7 million, respectively, and losses of
$459,000 and $1.0 million, respectively, for other than temporary declines in
the fair value of certain equity investments.
During fiscal 2001, our $5.9 million secured promissory note obligation from
a privately held company related to the sale of a product line was not collected
when due; therefore, during fiscal 2001 we recorded a reserve against the note
receivable of $4.6 million
21
in order to reduce the note to its net realizable value, based on the fair value
of the software code collateral. At July 31, 2002, the remaining fair value of
the collateral was included in capitalized software costs, in the accompanying
consolidated balance sheets, and is being amortized over a three-year period.
Also, included in other income and expense were net foreign exchange losses
of $429,000 for the third quarter of fiscal 2001 and $780,000 for the first nine
months of fiscal 2001, and gains of $654,000 for the third quarter of fiscal
2002 and losses of $522,000 for the first nine months of fiscal 2002. The losses
in the third quarter and first nine months of fiscal 2001 related primarily to
the overall strengthening of the U.S. dollar against European currencies. The
gains in the third quarter of fiscal 2002 were due primarily to the recent
appreciation in foreign currency during the quarter, particularly the Euro and
the British Pound. The losses for the first nine months of fiscal 2002 were due
to the strengthening U.S. dollar against European currencies during the first
half of fiscal 2002.
Provision for income taxes. Our effective income tax rate was 14% for the
first nine months of fiscal 2002, which represented the local taxes paid for our
international subsidiaries, together with state and local taxes paid, and a
negative 183% for the first nine months of fiscal 2001. This difference was
primarily due to a non-cash valuation allowance provided during the third
quarter of fiscal 2001 to fully offset the net deferred tax asset at July 31,
2001. We considered a number of factors, including our cumulative operating
losses in fiscal 1999, 2000, and the first three quarters of fiscal 2001. Based
upon the weight of positive and negative evidence regarding the recoverability
of the net deferred tax asset, we concluded that a valuation allowance was
required to fully offset the net deferred tax asset, as it is more likely than
not that the net deferred tax asset will not be realized. As a result of this
valuation allowance, the income tax provision reflected in the financial
statements since July 31, 2001 represents taxes paid.
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 2002, our principal sources of liquidity consisted of $304.6
million of unrestricted cash, cash equivalents, and short- and long-term
marketable securities and other investments, $35.6 million of restricted cash,
cash equivalents, and investments, and a $50.0 million secured, revolving line
of credit that can be utilized for working capital requirements and other
general corporate purposes. In June 2002, we elected to permanently reduce the
commitment under our bank line of credit to $50 million from $100 million as a
result of our improved financial position, results of operations, and cash
flows. As of July 31, 2002, no amounts were outstanding under our bank line of
credit.
As of July 31, 2002, we had working capital of $142.9 million, including
$194.6 million of short-term deferred revenue and customer deposits. The
short-term deferred revenue and customer deposits primarily represent annual
maintenance billings to customers that are recognized as revenue ratably over
the support service period. Excluding the short-term deferred revenue and
customer deposits, working capital would have been $337.5 million.
Comparatively, as of October 31, 2001, we had working capital of $125.2 million,
and no amounts were outstanding under our bank line of credit. Excluding the
short-term deferred revenue and customer deposits totaling $167.5 million,
working capital was $292.7 million at October 31, 2001. The fiscal 2002
improvement in liquidity was primarily due to improved cash collections and
financial results.
We calculate accounts receivable DSO on a "gross" basis by dividing the
accounts receivable balance at the end of the quarter by revenue recognized for
the quarter multiplied by 90 days. Accordingly, the accounts receivable balances
related to the deferred revenue are generally included in the computation prior
to the recognition of the related revenue. Calculated as such, DSO decreased to
71 days as of July 31, 2002 compared to 80 days as of October 31, 2001, and 99
days at July 31, 2001. The decrease was primarily due to strong collection
efforts during the first nine months of fiscal 2002, offset, in part, by lower
revenue volume compared to the fourth quarter of fiscal 2001. Our DSO can
fluctuate depending on a number of factors, including the volume of revenue that
is recognized toward the end of each period, the timing of annual maintenance
billings during the first quarter of any fiscal year, customer payment terms,
and the variability of quarterly revenue. Additionally, during the first nine
months of fiscal 2002, we released $5.0 million of the allowance for doubtful
accounts receivable no longer required given our successful collection
activities.
Net intangibles and other assets increased to $77.3 million at July 31, 2002
compared to $22.2 million at October 31, 2001 resulting from the first quarter
of fiscal 2002 acquisition of YOUcentric. The $27.1 million increase in unearned
revenue and customer deposits from October 31, 2001, was primarily due to annual
maintenance contract and renewal billings offset, in part, by the proportion of
the billings that were recognized as revenue during the first nine months of
fiscal 2002. Accrued liabilities of $140.0 million at July 31, 2002 decreased
slightly from $144.2 million at October 31, 2001. The small decrease from
October 31, 2001 was the result of the payment of accrued commissions and
related benefits, restructuring accruals, payables for purchased software, and a
decline in vacation benefit accruals, offset, in part, by acquired YOUcentric
accruals.
We generated $112.4 million in cash from operating activities during the
first nine months of fiscal 2002 compared to $6.5 million in the first nine
months of fiscal 2001. The increase in cash generated in fiscal 2002 from
operations was primarily due to income from operations and increased collections
of accounts receivable. Cash from operating activities for the first nine months
of fiscal 2001 was negatively affected by operating losses and the 2001
restructuring activities, together with higher payments for reseller
arrangements.
22
We used $46.7 million in cash from non-operating activities during the first
nine months of fiscal 2002 compared to using $29.7 million in cash in the first
nine months of fiscal 2001. The increase in cash usage in the first nine months
of fiscal 2002 from the same period last year was primarily due to reduced
proceeds from the sales or maturities of investments in marketable securities
due to lower investment balances during the current period and reduced cash
proceeds from the issuance of common stock. Additionally, an increase in
restricted cash, cash equivalents, and investments resulted from designating a
portion of our lease collateral associated with our corporate headquarters as
restricted. These increases in cash usage were offset, in part, by a decrease in
the purchase of marketable securities and other investments resulting in
carrying lower investment balances during the current period.
Our corporate headquarters were constructed on land owned by us and are
leased under operating leases. The lessor (a wholly owned subsidiary of a bank)
and a syndication of banks financed $121.2 million in purchase and construction
costs through a combination of debt and equity. We guarantee the residual value
of each building up to approximately 85% of its original cost. We do not believe
that the residual guarantee will be exercised to satisfy any of our financial
obligations under the lease. Our lease obligations are based on a return on the
lessor's costs. We can elect to reduce the interest rate used to calculate lease
expense by collateralizing the financing arrangements with investments
consistent with our investment policy. At July 31, 2001, investments totaling
$67.2 million were designated as collateral for these leases. During the third
quarter of fiscal 2002, we elected to increase the total amount of investments
designated as financing collateral to $117.6 million in order to reduce our
interest rate used to calculate our lease expense. The majority of investments
designated as collateral are included in cash and cash equivalents on the
accompanying consolidated balance sheets. As a result of this collateral and
reduced interest rates, we expect to pay approximately $700,000 in rent expense
for our headquarters during the fourth quarter of fiscal 2002 based on current
and expected interest rates compared to $1.3 million in rent expense during the
fourth quarter of fiscal 2001.
During the fourth quarter of fiscal 2001, we obtained a covenant compliance
waiver related to the profitability covenant from one of the syndicate banks. In
connection with the waiver, we designated $16.0 million of existing collateral
as restricted cash and cash equivalents. During the first quarter of fiscal
2002, we executed amendments to the security agreements on the remaining leased
buildings and designated an additional $19.4 million of the collateral as
restricted cash and cash equivalents. The lease collateral represents
substantially all of the $36.0 million restricted cash, cash equivalents, and
investments on the accompanying consolidated balance sheets. We may withdraw the
funds used as collateral, excluding the restricted amounts at our sole
discretion provided that we are not in default under the lease agreements. At
July 31, 2002, we were in compliance with the covenants, representations, and
warranties required under the lease agreements.
We believe that our cash and cash equivalents balance, our short- and
long-term investments, our $50 million bank line of credit, and our funds
generated from operations will be sufficient to meet cash needs for the short-
and long-term. We may use a portion of those investments to make strategic
investments in other companies or acquire businesses, products, or technologies
that are complementary to our business. We also may invest more of our cash
balances in additional short- and long-term investments. During the third
quarter and first nine months of fiscal 2001 and 2002, a significant portion of
our cash inflows were generated by our operations. However, the continued
slowdown in global economic conditions, strong competitive forces, the maturity
of the traditional enterprise resource planning market, challenges of entering
new markets, and effects from organizational and management changes may
negatively impact our ability to generate positive cash flow from operations.
There can be no assurance that we will not require additional funds to support
working capital requirements or for other purposes, in which case we may seek to
raise such additional funds through public or private equity financing or from
other sources. There can be no assurance that such additional financing will be
available or that, if available, such financing will be obtained on terms
favorable to us and would not result in additional dilution to our stockholders.
CRITICAL ACCOUNTING POLICIES
Management's Discussion and Analysis of our financial condition and
financial results of operations are based on our consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. We review the accounting
policies we use in reporting our financial results on a regular basis. The
preparation of our consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an ongoing basis, we evaluate our estimates, including those
related to revenue recognition, accounts receivable, capitalized software costs,
intangible assets, and income taxes. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates. These estimates and judgments are reviewed by senior management on an
ongoing basis, and by the Audit Committee at the end of each quarter prior to
the public release of our financial results. We have identified the policies
below as critical to our business operations and the understanding of our
financial results of operations. For a detailed discussion on the application of
these and other accounting policies, see Note 1 in the Notes to the Consolidated
Financial Statements in Item 14 of our Annual Report on Form 10-K for October
31, 2001, beginning on page F-6.
23
o Revenue recognition. Our revenue recognition policy is significant
because our revenue is a key component of our results of operations and
determines the timing of certain expenses, such as commissions and
royalties. We follow very specific and detailed guidelines in measuring and
recognizing revenue; however, certain judgments affect the application of
our revenue policy, such as our allowances for doubtful accounts
receivable. We maintain allowances for doubtful accounts receivable for
estimated losses resulting from the inability of our customers to make
required payments and decrease our revenue for the related amount. If the
financial condition of our customers or business partners were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Additionally, revenue results are
difficult to predict, and any shortfall in revenue or delay in recognizing
revenue could cause our operating results to vary significantly from
quarter to quarter and could result in future operating losses.
o Capitalized software research and development costs. Our policy on
capitalized software costs determines the timing of our recognition of
certain development costs. This policy determines whether the cost is
classified as development expense or cost of license fees. In addition,
management is required to use professional judgment in determining whether
development costs meet the criteria for immediate expense or
capitalization.
o Intangible assets. Our business acquisitions typically result in
goodwill and other intangible assets, which affect the amount of future
period amortization expense and possible impairment expense that we will
incur. When we adopt SFAS 142, no later than November 1, 2002, we will
cease to amortize goodwill. In lieu of amortization we will be required to
perform an initial impairment review of our goodwill beginning in fiscal
2003 and an annual impairment review thereafter. We expect to complete our
initial review during the first quarter of fiscal 2003. We cannot determine
the future extent of impairment, if any, until such impairment review is
completed and there can be no assurance that at the time the review is
completed a material impairment charge will not be recorded. In addition to
the annual impairment reviews, we will continue to assess the impairment of
goodwill and other identifiable intangibles, whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Some
factors we consider important which could trigger an impairment review
outside of the annual impairment reviews include the following:
o Significant underperformance relative to historical or expected future
operating results;
o Significant decline in our stock price for a sustained period;
o Significant changes in the manner of our use of the acquired assets
or the strategy for our overall business; and,
o Significant negative industry or economic trends.
When we determine that an impairment review is necessary based upon the
existence of one or more of the above indicators of impairment, we evaluate
whether or not impairment has occurred based on future undiscounted cash
flows. If that analysis indicates that impairment has occurred, we measure
it based on a comparison of discounted cash flows or fair values, whichever
is more readily determinable, to the carrying value of the related asset.
o Income taxes. Our income tax policy records the estimated future tax
effects of temporary differences between the tax bases of assets and
liabilities and amounts reported in the accompanying consolidated balance
sheets, as well as operating loss and tax credit carryforwards. We follow
very specific and detailed guidelines regarding the recoverability of any
tax assets recorded on the balance sheet and provide any necessary
allowances as required.
RECENT ACCOUNTING PRONOUNCEMENTS
The FASB has recently issued certain accounting pronouncements that may
impact our business. For a complete discussion on these accounting
pronouncements, see Note 14 of Notes to Consolidated Financial Statements in
Item 1 of this Quarterly Report on Form 10-Q.
RISK FACTORS
IN ADDITION TO OTHER INFORMATION CONTAINED IN THIS QUARTERLY REPORT ON FORM
10-Q, THERE ARE NUMEROUS FACTORS THAT SHOULD BE CAREFULLY CONSIDERED IN
EVALUATING THE COMPANY AND ITS BUSINESS BECAUSE SUCH FACTORS CURRENTLY HAVE A
SIGNIFICANT IMPACT OR MAY HAVE A SIGNIFICANT IMPACT IN THE FUTURE ON THE
COMPANY'S BUSINESS, OPERATING RESULTS, OR FINANCIAL CONDITIONS.
We operate in a rapidly changing industry that involves numerous risks, some
of which are beyond our control. Additional risks and uncertainties that we do
not presently know or that we currently deem immaterial may also impair our
business. You should carefully consider the risk factors listed below before
making an investment decision. For a more complete discussion of risk factors
that affect our business, see "Risk Factors" in our Annual Report on Form 10-K
for the fiscal year ended October 31, 2001. These risk factors include the
following:
o Downturns in general economic and market conditions could materially affect
our business;
24
o Reduced investor confidence in equity markets, due in part to recent
corporate collapses, which could adversely affect the price of our stock;
o Our quarterly financial results are subject to significant fluctuations,
and a failure to meet expectations could adversely affect the price of our
stock;
o Our sales cycle is often lengthy and unpredictable, which could affect our
sales;
o The enterprise software industry is highly competitive, and we may be
unable to successfully compete;
o The markets in which we compete experience rapid technological change, and
we face risks associated with new versions and products and defects that
could materially affect our business and revenue;
o We may not successfully integrate or realize the intended benefits of our
acquisitions;
o Our recent expansion into new business areas and partnerships is uncertain
and may not be successful;
o Our continued growth depends on our ability to develop and maintain our
third-party relationships;
o We depend on third-party technology that could result in increased costs or
delays in the production and improvement of our software offerings;
o We depend to a significant extent on certain key personnel and our
continued ability to hire qualified personnel;
o If use of the Internet for commerce and communication does not increase as
we anticipate, our business will suffer;
o Our continued success depends on our ability to achieve growth;
o We continue to depend on revenue from customers who use the IBM iSeries
platform for a large portion of our total revenue;
o Our implementation process may be lengthy, which could result in customer
dissatisfaction or damage to our reputation;
o We depend to a significant extent on our services revenue, which could
be adversely effected in the future by fluctuations in our license fee
revenue;
o Recent terrorist activities and resulting military and other actions could
adversely affect our business;
o Our international operations and sales subject us to various risks
associated with growth outside the U.S;
o We may be unable to compete effectively if we are forced to offer a
significant number of fixed-price service contracts;
o We have limited protection of our proprietary technology and intellectual
property and face potential infringement claims;
o We face risks associated with the security of our products;
o Our stock price is volatile, and there is a risk of litigation;
o Control by existing shareholders could significantly influence matters
requiring stockholder approval;
o Future regulation of the Internet may slow its growth, resulting in
decreased demand for our products and services and increased cost of doing
business, and
o Our stockholder rights plan, anti-takeover provisions, and Delaware law
could materially affect our stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
In the ordinary course of our operations, we are exposed to certain market
risks, primarily changes in foreign currency exchange rates and interest rates.
Uncertainties that are either nonfinancial or nonquantifiable, such as
political, economic, tax, other regulatory, or credit risks, are not included in
the following assessment of our market risks.
Foreign Currency Exchange Rates. Operations outside the U.S. expose us to
foreign currency exchange rate changes and could affect translations of foreign
denominated assets and liabilities into U.S. dollars and future earnings and
cash flows from transactions denominated in different currencies. The exposure
to currency exchange rate changes is diversified due to the number of different
countries in which we conduct business. We operate outside the U.S. primarily
through wholly owned subsidiaries in Europe, Africa, Asia-Pacific, Canada, and
Latin America. These foreign subsidiaries use either the local currency or the
euro as their functional currency because revenue is generated and expenses are
incurred in such currencies.
A substantial portion of our total revenue is derived from international
sales and is therefore subject to the related risks, including general economic
conditions in each country, overlap of different tax structures, difficulty of
managing an organization spread over various countries, changes in regulatory
requirements, compliance with a variety of foreign laws and regulations, longer
payment cycles, and volatilities of exchange rates in certain countries. A
significant portion of our business is conducted in currencies other than the
U.S. dollar. During the third quarter and first nine months of fiscal 2002, 39%
of our total revenue was generated from international operations, and the net
liabilities of our foreign operations at July 31, 2002 represented a negligible
percentage of consolidated net assets. Foreign exchange rates could adversely
affect our total revenue and results of operations throughout fiscal 2002 if the
U.S. dollar strengthens relative to certain foreign currencies.
In addition to the above, we have balance sheet exposure related to foreign
net asset and forward foreign exchange contracts. We enter into forward foreign
exchange contracts to mitigate the exposure effects of exchange rate changes on
cash from receivables and payables denominated in certain foreign currencies.
Such forward foreign exchange contracts cannot completely protect us from the
risk of foreign currency losses due to the number of currencies in which we
conduct business, the volatility of currency rates, and the constantly changing
currency exposures. Foreign currency gains and losses will continue to result
from fluctuations in the value of the currencies in which we conduct operations
as compared to the U.S. dollar, and future operating results will continue to be
affected by gains and losses from foreign currency exposure.
25
We prepared sensitivity analyses of our exposures from foreign net asset and
forward foreign exchange contracts as of July 31, 2002, and our exposure from
anticipated foreign revenue during the remainder of fiscal 2002 to assess the
impact of hypothetical changes in foreign currency rates. Our analysis assumed a
10% adverse change in foreign currency rates in relation to the U.S. dollar. At
July 31, 2002, there was not a material change in the sources or the estimated
effects of foreign currency rate exposures from our quantitative and qualitative
disclosures presented in Form 10-K for the year ended October 31, 2001. However,
there can be no assurance that a 10% adverse change in foreign exchange rates
from the July 31, 2002 rates would not result in a material impact to our
forecasted results of operations, cash flows, or financial condition for a
future quarter and the fiscal year ending October 31, 2002.
Interest Rates. Our portfolio of investments is subject to interest rate
fluctuations. Investments, including cash equivalents, consist of U.S.
government, state, municipal, and corporate debt securities with maturities of
up to 30 months, as well as money market mutual funds and corporate equity
securities. We classify all investments in marketable securities as available
for sale and these investments were carried at fair value as determined by their
quoted market prices. Unrealized gains or losses were included, net of tax
(prior to our valuation allowance), as a component of accumulated other
comprehensive income or loss. Additionally, we have lease obligations calculated
as a return on the lessor's costs of funding based on the London Interbank
Offered Rate, or LIBOR, and adjusted from time to time to reflect any changes in
our leverage ratio. Changes in interest rates could impact our anticipated
interest income and lease obligations or could impact the fair market value of
our investments.
We prepared sensitivity analyses of our interest rate exposures and our
exposure from anticipated levels of investments and financing for fiscal 2002 to
assess the impact of hypothetical changes in interest rates. At July 31, 2002,
there was not a material change in the sources or the estimated effects of
interest rate exposures from our quantitative and qualitative disclosures
presented in our Annual Report on Form 10-K for the year ended October 31, 2001.
Additionally, based upon the results of these analyses, a 10% adverse change in
interest rates from the July 31, 2002 rates would not have a material adverse
effect on the fair value of investments or financings and would not materially
impact our forecasted results of operations, cash flows, or financial condition
for the fiscal year ending October 31, 2002.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Litigation. We are involved in certain disputes and legal actions arising in
the ordinary course of our business. In our opinion, none of such disputes and
legal actions is expected to have a material impact on our consolidated
financial position, results of operations, or cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
26
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
J.D. EDWARDS & COMPANY
By: /s/ RICHARD E. ALLEN
------------------------------------------
Name: Richard E. Allen
Title: Chief Financial Officer, Executive Vice
President, Finance and Administration and
Director (principal financial officer)
Dated: September 12, 2002
By: /s/ PAMELA L. SAXTON
------------------------------------------
Name: Pamela L. Saxton
Title: Vice President of Finance, Controller
and Chief Accounting Officer
(principal accounting officer)
Dated: September 12, 2002
28
CERTIFICATIONS
I, Robert M. Dutkowsky, certify that:
1. I have reviewed this quarterly report on Form 10-Q of J.D. Edwards &
Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 12, 2002
/s/ ROBERT M. DUTKOWSKY
----------------------------------------
Chairman, President, and Chief Executive
Officer (principal executive officer)
I, Richard E. Allen, certify that:
1. I have reviewed this quarterly report on Form 10-Q of J.D. Edwards &
Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 12, 2002
/s/ RICHARD E. ALLEN
-----------------------------------------
Chief Financial Officer, Executive Vice
President, Finance and Administration and
Director (principal financial officer)
29
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.