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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
COMMISSION FILE NUMBER 0-14713
Interleaf
Interleaf, Inc.
(Exact Name of Registrant as Specified)
in Its Charter)
Massachusetts 04-2729042
(State or Other Jurisdiction (I.R.S. Employer Identification Number)
of Incorporation or Organization)
62 Fourth Avenue, Waltham, MA 02154
(Address of Principal Executive Offices) (Zip Code)
(781) 290-0710
(Registrant's Telephone Number,
Including Area Code)
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 last 90 days.
Yes X No
--- ----
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of the issuer's Common Stock, $.01 par value,
as of November 13, 1998 was 18,962,386.
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TABLE OF CONTENTS
PAGE
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated balance sheets at September 30, 1998 and March 31, 1998................................. 3
Consolidated statements of operations for the three and six months ended
September 30, 1998 and 1997 .......................................................................... 4
Consolidated statements of cash flows for the six months ended
September 30, 1998 and 1997 .......................................................................... 5
Notes to consolidated financial statements ........................................................... 6
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................................................. 9
PART II - OTHER INFORMATION
Item 4 - Submission of Matters to Vote of Security Holders ........................................... 15
Item 5 - Other Information ........................................................................... 16
Item 6 - Exhibits and Reports on Form 8-K ............................................................ 16
SIGNATURES ........................................................................................... 17
2
PART I - FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
INTERLEAF, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30,1998 March 31, 1998
----------------- ---------------
In thousands, except for share and per share amounts (unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 16,787 $ 21,112
Accounts receivable, net of reserve for doubtful accounts of $1,119 9,979 12,706
at September 30, 1998 and $1,364 at March 31, 1998
Prepaid expenses and other current assets 2,315 838
----------- -----------
Total Current Assets 29,081 34,656
Property and equipment, net 2,446 3,321
Intangible assets, net 2,017 583
Other assets 398 828
----------- -----------
Total Assets $ 33,942 $ 39,388
----------- -----------
----------- -----------
LIABILITIES and SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 2,334 $ 2,079
Accrued expenses 13,403 11,657
Unearned revenue 8,527 12,136
Accrued restructuring 1,202 2,143
----------- -----------
Total Current Liabilities 25,466 28,015
Long-term restructuring 1,440 2,063
----------- -----------
Total Liabilities 26,906 30,078
----------- -----------
Shareholders' Equity
Preferred stock, par value $.10 per share, authorized 5,000,000
shares:
Series A Junior Participating, none issued and outstanding
Senior Series B Convertible, shares issued and outstanding, 86 86
861,911 at September 30, 1998 and March 31, 1998
Series C Convertible, shares issued and outstanding, 1,010,348 at 101 101
September 30, 1998 and March 31, 1998
Series D 6% Convertible, shares issued and outstanding, 6,987 at 1 1
September 30, 1998 and 7,625 at March 31, 1998
Common stock, par value $.01 per share, authorized 50,000,000 188 182
shares, issued and outstanding, 18,834,924 at September 30, 1998
and 18,155,309 at March 31, 1998
Additional paid-in capital 93,187 93,369
Retained earnings (accumulated deficit) (86,389) (84,072)
Cumulative translation adjustment (138) (357)
----------- -----------
Total Shareholders' Equity 7,036 9,310
----------- -----------
Total Liabilities and Shareholders' Equity $ 33,942 $ 39,388
----------- -----------
----------- -----------
See notes to consolidated financial statements
3
INTERLEAF, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended September 30 Six months ended September 30
------------------------------- -----------------------------
1998 1997 1998 1997
---- ---- ---- ----
(unaudited) (unaudited)
In thousands, except for per share amounts
Revenues:
Products $ 1,658 $ 3,158 $ 3,885 $ 5,900
Maintenance 5,168 6,695 11,016 13,344
Services 3,184 3,265 6,117 6,700
-------- -------- -------- --------
Total revenues 10,010 13,118 21,018 25,944
-------- -------- -------- --------
Costs of Revenues:
Products 636 952 1,272 1,682
Maintenance 752 1,012 1,576 1,958
Services 2,969 2,877 5,667 5,716
-------- -------- -------- --------
Total costs of revenues 4,357 4,841 8,515 9,356
-------- -------- -------- --------
Gross margin 5,653 8,277 12,503 16,588
-------- -------- -------- --------
Operating Expenses:
Selling, general and administrative 5,393 5,475 10,363 11,032
Research and development 2,059 2,316 3,832 4,767
Purchased in process research & development 990 -- 990 --
-------- -------- -------- --------
Total operating expenses 8,442 7,791 15,185 15,799
-------- -------- -------- --------
Income (loss) from operations (2,789) 486 (2,682) 789
Other income expenses 244 (37) 391 46
-------- -------- -------- --------
Income (loss) before income taxes (2,545) 449 (2,291) 835
Provision for income taxes 25 -- 25 --
-------- -------- -------- --------
Net Income (loss) $ (2,570) $ 449 $ (2,316) $ 835
Dividends on Preferred Stock (518) -- (1,092) --
-------- -------- -------- --------
Net income (loss) applicable to common
shareholders $ (3,088) $ 449 $ (3,408) $ 835
-------- -------- -------- --------
-------- -------- -------- --------
INCOME PER SHARE:
Basic $ (0.16) $ 0.03 $ (0.18) $ 0.05
-------- -------- -------- --------
-------- -------- -------- --------
Diluted $ (0.16) $ 0.02 $ (0.18) $ 0.03
-------- -------- -------- --------
-------- -------- -------- --------
Shares used in computing income per share
Basic 18,721 17,757 18,550 17,691
-------- -------- -------- --------
-------- -------- -------- --------
Diluted 18,721 24,820 18,550 23,900
-------- -------- -------- --------
-------- -------- -------- --------
4
INTERLEAF, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
Six months ended September 30
-----------------------------
Unaudited
---------
1998 1997
-------- --------
In thousands
Cash Flows from Operating Activities:
Net income $ (2,316) $ 835
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization expense 1,377 2,030
Purchased in-process research & development 990 --
Changes in assets and liabilities, net of amounts acquired:
Decreases in accounts receivable, net 3,926 1,888
Decreases in other assets (24) (619)
Decreases in accounts payable and accrued expenses (378) (2,310)
Decreases in unearned revenue (3,793) (3,769)
Decreases in other liabilities (1,298) (1,692)
Other, net (84) 278
-------- --------
Net cash used in operating activities (1,600) (3,359)
-------- --------
Cash Flows from Investing Activities:
Capital expenditures, net (414) (655)
Acquisitions, net of cash acquired (2,731) --
-------- --------
Net cash used in investing activities (3,145) (655)
-------- --------
Cash Flows from Financing Activities:
Net proceeds from issuance of common stock -- 597
Repayment of long-term debt & capital leases -- (20)
Dividends Paid (251) --
-------- --------
Net cash (used in) provided by financing activities (251) 577
-------- --------
Effect of exchange-rate changes on cash 671 (534)
-------- --------
Net increase (decrease) in cash and cash equivalents (4,325) (3,971)
Cash and cash equivalents at beginning of period 21,112 17,349
-------- --------
Cash and cash equivalents at end of period $ 16,787 $ 13,378
-------- --------
-------- --------
See notes to consolidated financial statements
5
INTERLEAF, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The consolidated financial statements include the accounts of Interleaf, Inc.
and its subsidiaries. All significant intercompany balances and transactions
have been eliminated in consolidation. Interleaf, Inc. and its subsidiaries are
collectively referred to as the "Company."
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all financial information and
disclosures required by generally accepted accounting principles for complete
financial statements. In the opinion of management, these financial statements
include all adjustments (consisting only of normal recurring accruals) necessary
for a fair presentation of the results of operations for the interim periods
reported and of the financial condition of the Company as of the date of the
interim balance sheet. The results of operations for interim periods are not
necessarily indicative of the results to be expected for the full year.
These financial statements should be read in conjunction with the Company's
audited consolidated financial statements and related notes included in the
Company's Annual Report on Form 10-K for the year ended March 31, 1998.
2. Recently Issued Accounting Standards
Effective April 1, 1998, the Company adopted Statement of Position ("SOP") 97-2,
"Software Revenue Recognition" which provides guidance for applying generally
accepted accounting principles on software transactions and supersedes SOP 91-1,
"Software Revenue Recognition." The adoption of SOP 97-2 did not have a material
impact on the Company's revenue recognition for the quarter or six month period
ended September 30, 1998.
Effective April 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." This statement established
standards for reporting comprehensive income and its components. Comprehensive
income for the period is equal to net income plus "other comprehensive income,"
which, for the Company, consists of the change in cumulative translation
adjustments during the period. Total comprehensive income for the quarter ended
September 30, 1998 was a loss of $2.4 million. For the six months ended
September 30,1998, total comprehensive income was a loss of $2.1 million. For
the quarter and six months ended September 30, 1997, total comprehensive income
was $.3 million and $.7 million respectively.
On June 15, 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (FAS 133). FAS 133 is effective for all
fiscal quarters of all fiscal years beginning after June 15, 1999 (April 1, 2000
for the Company). FAS 133 requires that all derivative instruments be recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and, if it is,
the type of hedge transaction. The Company is currently evaluating the effect of
implementing this standard.
6
3. Earnings Per Share
The following table sets forth the computation of basic and diluted (loss)
earnings per share:
Three Months Six Months
ended September 30, ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
In thousands, except for per share amounts
Numerator:
Net Income $ (2,570) $ 449 $ (2,316) $ 835
-------- -------- -------- --------
Preferred Stock Dividends:
Series C Convertible (126) -- (252) --
Series D Convertible (56) -- (168) --
Preferred Stock Deemed Dividend:
Series D Convertible (336) -- (672) --
-------- -------- -------- --------
(518) -- (1,092) --
-------- -------- -------- --------
Numerator for basic (loss) income per share:
Net (loss) income available to common stockholders $ (3,088) $ 449 $ (3,408) $ 835
-------- -------- -------- --------
-------- -------- -------- --------
Denominator:
Denominator for basic earnings per share:
Weighted average shares 18,721 17,757 18,550 17,691
-------- -------- -------- --------
Effect of dilutive securities:
Senior Series B Convertible Preferred Stock -- 1,158 -- 1,158
Series C Convertible Preferred Stock -- 4,025 -- 4,025
Stock options -- 1,818 -- 983
Stock purchase plan rights -- 62 -- 31
Warrants -- -- -- 13
-------- -------- -------- --------
Dilutive potential common shares -- 7,063 -- 6,209
Denominator for diluted earnings per share
adjusted weighted average share and assumed conversion 18,721 24,820 18,550 23,900
-------- -------- -------- --------
-------- -------- -------- --------
Basic (loss) earnings per share $ (0.16) $ 0.03 $ (0.18) $ 0.05
-------- -------- -------- --------
-------- -------- -------- --------
Diluted (loss) earnings per share $ (0.16) $ 0.02 $ (0.18) $ 0.03
-------- -------- -------- --------
-------- -------- -------- --------
For the three and six months ended September 30, 1998, potential common shares
of 10,464 and 10,222, respectively were excluded from the computation of diluted
earnings per share because the Company had a net loss applicable to common
shareholders, and the effect would have been antidilutive.
7
4. Acquisitions
Effective August 31, 1998, the Company purchased 100% of the outstanding
common shares of PDR Automated Systems and Publications, Inc. ("PDR").
PDR provides outsourcing services for the development, management and
distribution of information, and has developed certain technology
surrounding image processing. The acquisition will be accounted for as a
purchase business combination and, therefore, the operating results of
PDR have been included in the Consolidated Statement of Operations since
the date of acquisition. The Company paid cash of $2.9 million and,
depending upon certain financial contingencies, may pay an additional
$3.0 million or more, payable in stock, except that the Company may pay
in cash under certain circumstances. A minimum contingent payment of $.7
million is included in accrued expenses in the accompanying balance
sheet as part of the initial purchase price. The Company recorded costs
associated with the acquisition of $.1 million related to valuation
services, legal and audit fees.
In connection with this acquisition, the acquired net tangible assets of
PDR were recorded at $1.3 million, which approximates fair value. The
Company has also recorded $1.6 million of goodwill and other intangibles,
and $.8 million of purchased in-process research and development. It has
been determined that technological feasibility of the in-process technology
purchased has not been established and the technology has no alternative
future use. Therefore, in accordance with generally accepted accounting
principles, the Company has expensed the amount of the purchase price
allocated to purchased research and development of approximately $.8
million. The goodwill and other intangibles will be amortized on a straight
line basis over estimated useful lives ranging up to ten years.
The following pro-forma results of operations combine the operations of
the Company and PDR as if the combination had occurred at the beginning
of each period. The results for the three and six months ended September
30, 1997 exclude the impact of $.8 million of purchased in-process
research and development cost. Inclusion of this amount would have
resulted in a decrease of $.05 and $.04 for basic and diluted earnings
per share, respectively, for the three months ended September 30, 1997,
and a decrease of $.05 and $.03 for basic and diluted earnings per
share, respectively, for the six months ended September 30, 1997.
Three months ended Six months ended
9/30/98 9/30/97 9/30/98 9/30/97
Amounts in thousands, except per share ------- ------- ------- -------
Revenue $10,862 $14,673 $23,500 $28,864
------- ------- ------- -------
------- ------- ------- -------
Net income (loss) applicable to common
stockholders $(3,111) $553 $(3,269) $1,008
------- ------- ------- -------
------- ------- ------- -------
Earning per share:
Basic $(.17) $.03 $(.18) $.06
------- ------- ------- -------
------- ------- ------- -------
Diluted $(.17) $.02 $(.18) $.04
------- ------- ------- -------
------- ------- ------- -------
Effective September 11, 1998, the Company acquired the Panorama and CD
Web Publishing product lines from Softquad Inc. for $.4 million. The
acquisition provides the Company with products which are complementary to
its existing complex publishing product line and in-process technologies
which are expected to contribute to the development of the Company's new
content management products. The total fair value of the assets acquired
was approximately $.1 million.
In connection with this acquisition, it has been determined that
technological feasibility of the in-process technology purchased has not
been established and the technology has no alternative future use.
Therefore, in accordance with generally accepted accounting principles,
the Company has expensed the amount of the purchase price allocated to
purchased research and development of approximately $.2 million. The
excess of purchase price over the fair value of the assets acquired ($.1
million) has been recorded as goodwill, and will be amortized on a
straight line basis over five years. This acquisition is not considered
material to the Company's financial position or results of
8
operation.
5. Credit Agreement
At September 30, 1998 and March 31, 1998, the Company had an equipment
letter of credit for $0.5 and $0.6 million, respectively, which was secured
by the equivalent amount of cash. This letter of credit expires on July 31,
1999.
6. Subsequent Events
Subsequent to the end of the second quarter, the Company redeemed 100%
of its Series C Convertible Preferred Stock ("Series C Stock") for $1.6
million. Additionally, dividends accrued at September 30, 1998 totaling
$.3 million will not be paid. For purposes of the 1998 third quarter
basic earnings per share calculation, this redemption will result in
$8.7 million being added to net income to arrive at net income available
to common shareholders. The $8.7 million represents the excess of the
carrying amount of the Series C Stock over the fair value of the
consideration paid by the Company.
On November 4, 1998, the Company reached agreement with the holders of 79%
of the 6% Convertible Preferred Stock ("Series D Stock") outstanding, under
which all of the Series D Stock held by such persons will be converted into
cash and Common Stock of the Company. There are currently 6,987 shares of
Series D Stock outstanding, and the Company has reached agreement with the
holders of 5,487 of such shares. Under this agreement, all 5,487 shares of
the Series D Stock held by them will be converted into a total of
approximately $2.2 million in cash and approximately 3.5 million shares
of Common Stock. The shares of Common Stock issued upon conversion shall
be held by the Series D stockholders subject to the restrictions on
re-sale, prohibitions against short-selling and the other terms and
conditions of the Preferred Stock Investment Agreement under which the
Series D Stock was originally issued.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
Overview
The Company reported a net loss of $2.6 million on revenues of $10.0 million for
its second quarter and a net loss of $2.3 million on revenues of $21.0 million
for the six months ended September 30, 1998. The Company has recorded preferred
stock dividends of $.5 million and $1.1 million for the second quarter and six
months ended September 30, 1998, respectively. Therefore, after dividends on
preferred stock, the Company's net loss applicable to common shareholders was
$3.1 million and $3.4 million for the second quarter and six months ended
September 30, 1998, respectively. This compares with net income of $.4 million
on revenues of $13.1 million and $.8 million on revenues of $25.9 million for
the same periods during the prior year. The Company did not record dividends in
the second quarter or the six months ended September 30, 1997. Therefore, net
income applicable to common shareholders was $.4 million and $.8 million,
respectively, for those periods.
Much of the decline in revenue is due to a decrease in product revenue and the
related decline in maintenance and service revenue caused by the continuing
maturation and saturation of the market for complex authoring products and the
increasing popularity of low-end versions of Windows-based authoring software.
The Company has continued its efforts to focus on developing a new content
9
management product family, targeted to its customers' extended enterprises.
Effective August 31, 1998, the Company purchased 100% of the outstanding
common shares of PDR Automated Systems and Publications, Inc. ("PDR"). PDR
provides outsourcing services for the development, management and
distribution of information, and has developed certain technologies
surrounding image processing. The acquisition will be accounted for as a
purchase business combination and, therefore, the operating results of PDR
have been included in the Consolidated Statement of Operations since the date
of acquisition. The Company paid cash of $2.9 million and, depending upon
certain financial contingencies, may pay an additional $3.0 million or more,
payable in stock, except that the Company may pay in cash under certain
circumstances. A minimum contingent payment of $.7 million is included in
accrued expenses in the accompanying balance sheet as part of the initial
purchase price. The Company recorded costs associated with the acquisition of
$.1 million related to valuation services, legal and audit fees.
In connection with this acquisition, the acquired net tangible assets of PDR
were recorded at $1.3 million, which approximates fair value. The Company has
also recorded $1.6 million of goodwill and other intangibles and $.8 million
of purchased in-process research and development. It has been determined that
technological feasibility of the in-process technology purchased has not been
established and the technology has no alternative future use. Therefore, in
accordance with generally accepted accounting principles, the Company has
expensed the amount of the purchase price allocated to purchased research and
development of approximately $.8 million. The goodwill and other intangibles
will be amortized on a straight line basis over estimated useful lives
ranging up to ten years.
Effective September 11, 1998, the Company acquired the Panorama and CD Web
Publishing product lines from SoftQuad Inc. for $.4 million. The acquisition
provides the Company with products which are complementary to its existing
complex publishing product line and in-process technologies which are
expected to contribute to the development of the Company's new content
management products. The total fair value of the assets acquired approximated
$.1 million.
In connection with this acquisition, it has been determined that
technological feasibility of the in-process technology purchased has not been
established and the technology has no alternative future use. Therefore, in
accordance with generally accepted accounting principles, the Company has
expensed the amount of the purchase price allocated to purchased research and
development of approximately $.2 million. The excess of purchase price over
the fair value of the assets acquired ($.1 million) has been recorded as
goodwill, and will be amortized on a straight line basis over five years.
This acquisition is not considered material to the Company's financial
position or results of operation.
Revenues
Product: The product revenue decreased by $1.5 million (47%) and $2.0 million
(34%) for the second quarter and six months ended September 30, 1998,
respectively, compared with the same periods in fiscal 1998. The continuing
trend of reduction in product revenue is due to two factors. The first factor is
the saturation of UNIX-based high-end authoring software in the
aerospace/defense industry, where the Company had historically derived most of
its authoring product license revenue. The second factor is the decline in
licensing of the Company's UNIX-based high-end authoring products which is
primarily attributable to the increasing popularity of Windows-based publishing
software.
The Company is refocusing its business strategy on providing a new family of
content management products targeted toward specific vertical markets. While the
Company has built well-accepted integrated document publishing based solutions
for individual customers, it has not yet demonstrated the ability to develop,
market and sell content management products. There is no assurance that the
Company will be successful in implementing its strategy and, therefore, the
Company is unable to predict if or when
10
product revenues will stabilize or grow. Additionally, since the Company's
services and maintenance revenue are largely dependent on new product licenses,
these revenue components have also experienced downward pressure. This trend
will continue unless product revenue stabilizes.
Maintenance: Maintenance revenue decreased by $1.5 million (23%) and $2.3
million (17%) for the second quarter and six months ended September 30, 1998,
respectively, compared with the same periods in fiscal 1998. Future maintenance
revenue is dependent on the Company's ability to maintain its existing customer
base and to increase maintenance contract volume related to the new content
management products. This will be necessary to offset the general downward
pricing pressure on maintenance in the software industry and a reduction in
customers' perceived value of maintenance services.
Services: Service revenue, consisting of consulting and training revenue,
decreased by $.1 million (2%) and $.6 million (9%) for the second quarter and
six months ended September 30, 1998, respectively, compared with the same
periods in fiscal 1998. Future services revenue is dependent on the Company's
ability to maintain its existing customer base and to increase consulting and
training contracts based on the introduction and success of new products.
Fiscal 1999: During the balance of fiscal 1999, the Company plans to develop
and release several upgrades to its traditional products. The Company also
plans to develop product offerings which address at least two vertical
segments of the content management market. Growth in revenues during fiscal
1999 and fiscal 2000 will be largely dependent on the introduction and
customer acceptance of the new and enhanced software products planned to be
released in fiscal 1999 and the following year, and the Company's success in
leveraging software products with services to provide content management
solutions to its customers, improving sales force productivity and the
effectiveness of the Company's investment in marketing and lead generation
programs. If the Company is unable to grow or stabilize its revenues in
fiscal 1999, further expense reductions will be necessary in order to sustain
profitable operations. As part of its strategy to increase revenues, the
Company acquired PDR and acquired the Panorama and CD Web Publishing product
lines of SoftQuad Inc. The acquisition of PDR also provides the Company with
in-process development of certain technology surrounding image processing
that is expected to result in a completed product in fiscal 2000 and may be
incorporated into a content management software product currently under
development. The acquisition of the Panorama and CD Web Publishing product
line complements the Company's existing complex publishing products, and
provides technologies and resources to be used in the development of content
management products. The technologies acquired from this acquisition are
expected to shorten the development cycle of the Company's new content
management products.
Costs of Revenues
Cost of product revenue includes amortization of capitalized software
development costs, product media, documentation materials, packaging and
shipping costs, and royalties paid for licensed technology. Cost of product
revenues decreased by $.3 million (33%) and $.4 million (24%) for the second
quarter and six months ending September 30, 1998 compared to the same periods
in fiscal 1998. Cost of product revenues as a percentage of product revenues
were (38%) and (33%) for the second quarter and the six months ended
September 30, 1998, respectively, compared with (30%) and (29%) for the same
periods in fiscal 1998. The increase in cost of product revenue as a
percentage of product revenue was mainly attributable to one-time start up
cost associated with a change in the Company's product manufacturing vendor.
The cost of maintenance revenue declined by $.3 million (26%) and $.4 million
(20%) for the second quarter and the six months ended September 30, 1998,
compared with the same periods in fiscal 1998. The cost of services revenue
increased by $.1 million in the second quarter of fiscal 1999 compared with
the second quarter of fiscal 1998 and was comparable for the six months ended
September 30, 1998 compared with the same period in fiscal 1998. Cost of
service revenue as a percentage of service revenue was 93% for the second
quarter and six months ended September 30, 1998, respectively, compared with
11
88% and 85% for the same periods in fiscal 1998. The increase in cost of
services as a percentage of revenues reflects the pricing pressure in the
Company's consulting service business coupled with increasing salary and related
costs of consultants.
Operating Expenses
Selling, general and administrative ("SG&A") expenses decreased by $.1 million
(2%) and $.7 million (6%) for the second quarter and six months ended September
30, 1998, respectively, compared with the same periods in fiscal 1998. The
declines were primarily due to a continued focus on stringent cost controls by
management.
Research and development ("R&D") expenses consist primarily of personnel and
related overhead expenses to support product development. R&D expenses
decreased by $.3 million (11%) and $.9 million (20%) for the second quarter
and the six months ended September 30, 1998, respectively, compared to the
same periods in fiscal 1998. The decline can be attributed to the Company's
focus on cost controls resulting in lower overhead expenses, mainly for
reduced facility costs of the Company's engineering group and dedication of
the Company's engineering resources to fewer development projects.
In connection with the acquisition of PDR and the Panorama and CD Web
Publishing product line from SoftQuad, Inc., the Company recorded charges of
$.8 million and $.2 million, respectively, of purchased in-process research
and development.
Liquidity and Capital Resources
The Company had approximately $16.8 million of cash and cash equivalents at
September 30, 1998, a decrease of $4.3 million from March 31, 1998. The decrease
in cash is mainly attributed to the amounts paid for the acquisition of PDR
($2.4 million net of cash acquired) and the Panorama and CD Web Publishing
product line from SoftQuad, Inc. ($.3 million) coupled with the decreases in
cash due to operating activities, $1.6 million, capital expenditures, $.4
million and dividend payments, $.3 million. These decreases were partially
offset by the increase in cash due to the effect of exchange rate changes on
cash, mainly cash held by the Company's German subsidiary of $.7 million.
Subsequent to the end of the second quarter, the Company redeemed 100% of its
Series C Convertible Preferred Stock for $1.6 million. Additionally,
dividends accrued at September 30, 1998 totaling $.3 million will not be
paid. For purposes of the 1998 third quarter basic earnings per share
calculation, this redemption will result in $8.7 million being added to net
income to arrive at net income available to common shareholders. The $8.7
million represents the excess of the carrying amount of the Series C
preferred stock over the fair value of the consideration paid by the Company.
On November 4, 1998, the Company reached agreement with the holders of 79% of
the 6% Convertible Preferred Stock ("Series D Stock") outstanding, under
which all of the Series D Stock held by such persons will be converted into
cash and Common Stock of the Company. There are currently 6,987 shares of
Series D Stock outstanding, and the Company has reached agreement with the
holders of 5,487 of such shares. Under this agreement, all 5,487 shares of
the Series D Stock held by them will be converted into a total of
approximately $2.2 million in cash and approximately 3.5 million shares of
Common Stock. The shares of Common Stock issued upon conversion shall be held
by the Series D Stockholders subject to the restrictions on re-sale,
prohibitions against short-selling and the other terms and conditions of the
Preferred Stock Investment Agreement under which the Series D Stock was
originally issued.
At September 30, 1998 and March 31, 1998, the Company had approximately $1.0
million of cash restricted for potential payment of a withholding tax assessment
on its German subsidiary related to
12
payments remitted to the United States from Germany in 1990. The Company is
appealing this assessment. While the Company believes its current cash
balances and cash generated from operations, offset by restructuring
payments, will be sufficient to meet the Company's liquidity needs for fiscal
1999, the Company has reached agreement in principle with potential investors
regarding a private placement of common stock, subject to negotiation of
definitive agreements.
Year 2000
Background
Some computers, software, and other equipment include programming code in which
calendar year data is abbreviated to only two digits. As a result of this design
decision, some of the systems do not properly recognize a year that begins with
"20" instead of "19". These problems are widely expected to increase in
frequency and severity as the year 2000 approaches, and are commonly referred to
as the "Millenium Bug" or "Year 2000 problem".
Interleaf Approach
Interleaf established a Year 2000 project team to address all aspects of the
Year 2000 problem in each area of its business. The project team has four areas
of focus, each with its own project manager. These four areas are: (1) the
software that is created by Interleaf and sold to customers; (2) internal
business systems; (3) the hardware and operating system software used by
employees; and (4) facilities and critical vendors other than computer
suppliers.
Interleaf Created Products
Assessment:
In 1997 Interleaf began to focus on the Year 2000 problem regarding its software
products created for sale to customers. Products that generate the most revenue
or create the highest risk were prioritized for testing and repair. The
assessment of these products was completed in early 1998 and the repair process
begun. The Company made the decision to discontinue sales and support for
certain low volume products and computer platforms.
Customer Communications:
The Company sent a description of its Year 2000 product strategy to all of its
maintenance customers. It created and is maintaining a Year 2000 product status
page as part of its web site. Interleaf will distribute another mailing to the
entire maintenance base with the status of the year 2000 releases and a list of
retired products and platforms in the fourth calendar quarter of 1998.
Status:
Most major products have been tested and modified, and updates which correct
any known Year 2000 problems with those products are available at no extra
charge to the customers with current maintenance contracts for most of the
computer platforms that will be supported beyond the year 2000. Year 2000
updates will be completed for supported products by the end of the first
calendar quarter of 1999. The extent of the changes required ranges from
simple recompilation with Year 2000 compliant operating systems to extensive
modifications. Testing and repair of layered applications has begun and will
be completed by the end of the second calendar quarter of 1999. The Company
expects that the layered applications will not require significant
modifications, since initial analysis has indicated that there is no date
handling performed by these products. Moreover, in many instances the Company
created layered applications under contracts with specific customers, and not
for general re-sale, and the Company believes that it has no obligation to
modify those applications to address the Year 2000 problem. All products
under development are being developed to be Year 2000 compliant.
13
Internal Business Systems
Interleaf contracted an independent third party to perform Year 2000 compliance
testing on its critical internal business systems. Some problems were identified
and appropriate modifications were made. The systems were then re-tested and
performed successfully. The software vital to corporate operations has been
proven by the independent third party to function without problems related to
the millenium change. The assessment phase is now underway for business software
used in Europe, Japan, and Australia. The Company's intent is to insure that all
critical internal business software is Year 2000 compliant by the end of the
first calendar quarter of 1999.
Hardware and Operating Systems Software
Assessment of the systems used by employees began in early 1997 and has been
completed. The Company has developed a plan to upgrade or replace all critical
systems used by employees, including all hardware in the enterprise from servers
to laptops. The upgrade/replacement process began in early 1998 and is
approximately 40% complete. The entire process is anticipated to be complete by
the end of the third calendar quarter of 1999.
Facilities and Critical Vendors
In the fourth calendar quarter of 1998 Interleaf will begin discussions with
facility management of its leased office spaces to ensure that the proper
actions are taken to avoid disruption of productivity in all Interleaf
facilities. Two major elements of Interleaf's business, payroll and
manufacturing, are outsourced. Interleaf is currently working with those service
providers to insure that operations of these critical business areas will not be
affected by the Millenium change.
Cost
The costs of the Interleaf Year 2000 efforts are being funded out of cash flow
from operations. The total cost associated with the required modifications and
upgrades associated with the Year 2000 projects is not expected to be material
to the Company's financial position. The process of repairing and testing the
software that Interleaf creates for sale has been done with existing personnel.
The Year 2000 testing equipment and lab environment have been created using
existing equipment and space. The capital costs associated with the upgrade and
replacement of corporate and field office computing environments is budgeted to
be approximately $250,000. These expenditures began in late 1997 and will
continue through the third calendar quarter of 1999. Software maintenance costs
attributable to the Year 2000 process will be approximately $50,000. Labor
associated with this process of implementing the internally used systems comes
from the existing budgeted personnel.
Risk
Interleaf has made a significant effort to address its Year 2000 issues. At
this time, there are no identifiable significant risks associated with its
Year 2000 readiness, although there is a risk that unanticipated problems may
arise. The Company intends to begin preparing a contingency plan to address
reasonably likely worst case scenarios in the second calendar quarter of 1999.
Euro Conversion.
On January 1, 1999, 11 of the 15 member countries of the European Union are
scheduled to establish fixed conversion rates between their existing
sovereign currencies and the Euro. The transition to the Euro will be
complete as of January 1, 2002. The Company has significant operations within
the European Union and is currently preparing for the Euro conversion. The
issues that the Company is addressing include preparing its information
systems for the Euro, analyzing the benefit of decreased exchange rate risk
in cross border transactions involving participating countries and assessing
the potential impact of increased price transparency. In addition, the Euro
is expected to affect general economic conditions within the participating
countries. For example, this has already caused a convergence of interest
rates among the Euro block countries. The Company is analyzing the impact of
the Euro
14
with a view to minimizing the impact of the Company's operations. The Company
does not expect the costs of upgrading its systems for the Euro to be material.
Forward-Looking Statements
This Report contains forward-looking statements concerning the Company's
performance and business operations. The Company cautions readers that actual
future results may differ materially from the projections or suggestions made in
such forward-looking statements.
Factors which might cause actual future results to differ materially from those
projected in the forward-looking statements contained herein include the
following: The Company's ability to develop and market new and enhanced
products, particularly the Company's content management products and services;
reliance by the Company on third party development partners who are engaged in
developing a portion of the Company's content management products and the
Company's dependence on the quality and timeliness of performance of those
vendors for on-time and high quality delivery of the Company's content
management products; delays in the development and introduction of such new and
enhanced products and services; failure to achieve customer and market
acceptance of the Company's new and enhanced products and services; delays in
the growth and development of market demand for content management software
products; inability to increase maintenance contract revenue related to content
management products; inability to increase revenue from consulting and training
contracts with respect to the introduction of new products; inability to improve
sales force productivity; the Company's ability to keep pace with the rapid
technological change in its industry and compete with companies which have
greater market penetration, and greater financial, technical and marketing
resources; failure to adequately protect the Company's intellectual property;
inability to successfully leverage the Company's software products with services
to provide content management solutions to its customers; inability to establish
or maintain strategic relationships with companies with outsourcing or service
bureau businesses and with companies that have presence and publishing expertise
in the financial services market; the inability of the Company to make
acquisitions of, or significant investments in, businesses that offer
complementary products and technologies; and failure to integrate the
operations, information systems and personnel of any acquired businesses.
Certain of these and other factors which might cause actual results to differ
materially from those projected are more fully set forth under the caption "Risk
Factors" on pages 13-15 of the Company's Annual Report on Form 10-K for the
fiscal year ended March 31, 1998.
PART II - OTHER INFORMATION
Item 4. Submission of Matters to Vote of Security Holders
At the Annual Meeting of Shareholders held on August 24, 1998 ("Annual
Meeting"), the shareholders of the Company elected Mr. Jaime W. Ellertson as a
Class II director of the Company whose term shall expire at the Company's year
2001 shareholder meeting, by a vote of 18,896,700 in favor with 206,928 votes
being withheld. The Company also has three Class I directors: Marcia J. Hooper,
Rory J. Cowan and John A. Lopiano, whose terms are set to expire at the annual
shareholders' meeting in the year 2000, and two Class III Directors, Frederick
B. Bamber and David A. Boucher, whose terms expire at the annual shareholders
meeting in 1999. At the Annual Meeting, the shareholders approved amendments to
the Company's 1993 Director Stock Option Plan to increase the number of shares
of the Company's Common Stock available for issuance under the Plan from 150,000
to 325,000, and to amend such plan in certain other respects, by a vote of
8,877,576 in favor, 800,493 against and with 92,776 abstentions. The
shareholders also approved the adoption of the Company's 1998 Employee Stock
Purchase Plan, under which employees of the Company are eligible to purchase
during the ten year term of this plan an aggregate of 2,500,000 shares of Common
Stock at a 15% discount, by a vote of 8,273,390 in favor, 1,317,305 against and
with 73,960 abstentions. The shareholders also ratified and approved the
selection
15
of PricewaterhouseCoopers LLP as the Company's independent auditors for fiscal
1999, by a vote of 18,998,804 in favor, 58,425 against and with 46,399
abstentions. A more complete description of these matters appears in the
Company's 1998 Proxy Statement, dated July 28, 1997.
Item 5. Other Information
Subsequent to the end of the second quarter, the Company redeemed 100% of its
Series C Convertible Preferred Stock for $1.6 million. Additionally,
dividends accrued at September 30, 1998 totaling $.3 million will not be
paid. For purposes of the 1998 third quarter basic earnings per share
calculation, this redemption will result in $8.7 million being added to net
income to arrive at net income available to common shareholders. The $8.7
million represents the excess of the carrying amount of the Series C
preferred stock over the fair value of the consideration paid by the Company.
On November 4, 1998, the Company reached agreement with the holders of 79% of
the 6% Convertible Preferred Stock ("Series D Stock") outstanding, under
which all of the Series D Stock held by such persons will be converted into
cash and Common Stock of the Company. There are currently 6,987 shares of
Series D Stock outstanding, and the Company has reached agreement with the
holders of 5,487 of such shares. Under this agreement, all 5,487 shares of
the Series D Stock held by them will be converted into a total of
approximately $2.2 million in cash and approximately 3.5 million shares of
Common Stock. The shares of Common Stock issued upon conversion shall be held
by the Series D stockholders subject to the restrictions on re-sale,
prohibitions against short-selling and the other terms and conditions of the
Preferred Stock Investment Agreement under which the Series D Stock was
originally issued.
The Company is financing the redemption of the Series C Shares and the cash
portion of the conversion of the Series D Shares out of its existing working
capital and the proposed sale of Common Stock to investors in a private
placement. The holders of the Series D Stock who have converted their Series
D Stock into cash and Common Stock have the right to participate in such a
sale.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number Description
-------------- ------------
3(a) Restated Articles of Organization of the
Company, as amended (incorporated herein
by reference to the applicable Exhibit in
the Company's Quarterly Report on Form
10-Q for the quarter ended September 30,
1997)
16
3(b) By-Laws of the Company, as amended
(incorporated herein by reference to the
applicable Exhibit to the Company's
Annual Report on From 10-K for the year
ended March 31, 1994)
4(a) Specimen Certificate for Shares of the
Company's Common Stock (incorporated
herein by reference to the applicable
Exhibit to the Company's Registration
Statement on Form S-1, File No. 33-5743)
10(a) Letter Agreement among Interleaf,
Inc., the Lindner Growth Fund and the
Lindner Dividend Fund dated as of August 19, 1998
10(b) Letter Agreement dated October 26, 1998,
amending the August 19, 1998 Letter Agreement
10(c) Form of Letter Agreements among Interleaf, Inc.,
and certain holders of the 6% Convertible Preferred
Stock, dated as of October 27, 1998
10(d) Form of Closing Letter dated November 4, 1998
with respect to the conversion of 6% Convertible
Preferred Stock
10(e) Letter Agreement between the Company and
Amanda Radice dated November 2, 1998,
regarding the employment of Ms. Radice by
the Company
11 Computation of Earnings Per Share (included as Note
3 to Financial Statements)
27 Financial Data Schedule
(b) A Current Report on Form 8-K was filed by the Company on September 24,
1998, as amended pursuant to Form 8-K/A filed on November 12, 1998,
reporting under Item 5 the acquisition by the Company of all of the
outstanding capital stock of PDR Automated Systems and Publications,
Inc.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
November 16, 1998
/s/ Peter J. Rice
-----------------
Peter J. Rice,
Vice President of Finance and Administration
and Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
17