SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 000-31989
CONVERA CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 54-1987541
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1921 Gallows Road, Suite 200, Vienna, Virginia 22182
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (703) 761 - 3700
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 the filing
requirements for the past 90 days.
Yes |X| No __
----
The numbers of shares outstanding of the registrant's Class A and Class B common
stocks, par value $0.01 per share, as of December 6, 2001 were 30,762,296 and
12,207,038, respectively.
CONVERA CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED OCTOBER 31, 2001
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements: Page
----
Consolidated Balance Sheets
October 31, 2001 (unaudited) and January 31, 2001...................................3
Consolidated Statements of Operations and Comprehensive Loss (unaudited)
Three and nine months ended October 31, 2001 and 2000...............................4
Consolidated Statements of Cash Flows (unaudited)
Nine months ended October 31, 2001 and 2000.........................................5
Notes to Consolidated Financial Statements..........................................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................................13
PART II. OTHER INFORMATION
Items 1. - 6. ...................................................................................23
Signatures ...................................................................................24
CONVERA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
October 31, 2001 January 31, 2001
(Unaudited)
-------------------- --------------------
ASSETS
Current Assets:
Cash and cash equivalents........................................ $ 20,940 $ 37,061
Short term investments........................................... 99,581 119,083
Accounts receivable, net of allowance for doubtful
accounts of $2,691 and $1,231, respectively................. 8,654 17,392
Prepaid expenses and other ...................................... 3,001 4,394
-------------------- --------------------
Total current assets....................................... 132,176 177,930
Equipment and leasehold improvements, net of accumulated
depreciation of $10,201 and $8,785, respectively................... 4,484 2,635
Other assets.......................................................... 3,700 436
Goodwill and other intangible assets.................................. 59 845,444
-------------------- --------------------
Total assets................................................. $ 140,419 $ 1,026,445
==================== ====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable................................................. $ 3,329 $ 3,480
Accrued expenses................................................. 7,550 2,543
Accrued bonuses.................................................. 2,707 714
Restructuring reserve............................................ 2,274 -
Deferred revenues................................................ 4,071 4,650
-------------------- --------------------
Total current liabilities.................................. 19,931 11,387
Restructuring reserve, net of current portion......................... 2,339 -
-------------------- --------------------
Total liabilities............................................ 22,270 11,387
-------------------- --------------------
Commitments and Contingencies
Shareholders' Equity:
Preferred stock,
$0.01 par value, 5,000,000 shares
authorized; 0 shares issued and outstanding.................. - -
Common stock Class A, $0.01 par value,
100,000,000 shares authorized; 35,414,824
and 35,327,589 shares issued and 355 353
outstanding, respectively....................................
Common stock Class B, $0.01 par value,
40,000,000 shares authorized; 12,207,038
shares issued and outstanding................................ 122 122
Additional paid-in capital....................................... 1,100,484 1,094,192
Accumulated deficit.............................................. (981,940) (78,920)
Accumulated other comprehensive loss............................. (872) (689)
-------------------- --------------------
Total shareholders' equity................................... 118,149 1,015,058
-------------------- --------------------
Total liabilities and shareholders' equity $ 140,419 $ 1,026,445
==================== ====================
See accompanying notes.
CONVERA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(unaudited)
(in thousands, except share and per share data)
Three Months Ended Nine Months Ended
October 31, October 31,
2001 2000 2001 2000
---------------- ----------------- ---------------- ----------------
Revenues:
Software.....................................$ 6,868 $ 10,601 $ 19,897 $ 28,106
Maintenance.................................. 1,512 1,703 4,771 4,956
---------------- ----------------- ---------------- ----------------
License-related................................ 8,380 12,304 24,668 33,062
Services....................................... 456 - 806 -
---------------- ----------------- ---------------- ----------------
8,836 12,304 25,474 33,062
---------------- ----------------- ---------------- ----------------
Cost of revenues:
Software.....................................$ 3,351 $ 2,375 $ 11,578 $ 5,150
Maintenance.................................. 539 345 1,459 1,079
---------------- ----------------- ---------------- ----------------
License-related................................ 3,890 2,720 13,037 6,229
Services....................................... 700 - 3,750 -
---------------- ----------------- ---------------- ----------------
4,590 2,720 16,787 6,229
---------------- ----------------- ---------------- ----------------
Gross margin 4,246 9,584 8,687 26,833
---------------- ----------------- ---------------- ----------------
Operating expenses:
Sales and marketing............................ 7,296 5,547 24,656 16,554
Research and product development............... 5,615 2,934 20,352 8,466
General and administrative..................... 2,157 1,558 7,367 4,105
Restructuring charges.......................... 5,195 - 8,128 -
Amortization of goodwill and other intangible
assets....................................... 25,082 29 98,275 88
Amortization of incentive bonus payments due
to employees................................. 96 - 6,660 -
Reduction in goodwill and other long-lived
assets....................................... 754,424 - 754,424 -
---------------- ----------------- ---------------- ----------------
799,865 10,068 919,862 29,213
---------------- ----------------- ---------------- ----------------
Operating loss..................................... (795,619) (484) (911,175) (2,380)
Other income, net.................................. 1,086 109 3,704 336
---------------- ----------------- ---------------- ----------------
Net loss before income taxes....................... (794,533) (375) (907,471) (2,044)
Income tax benefit................................. 1,233 - 4,452 -
---------------- ----------------- ---------------- ----------------
Net loss........................................... (793,300) (375) (903,019) (2,044)
Dividends on preferred stock....................... - 3 - 10
---------------- ----------------- ---------------- ----------------
Net loss applicable to common shareholders.........$ (793,300) $ (378) $ (903,019) $ (2,054)
================ ================= ================ ================
Basic and diluted net loss per common share........$ (16.64) $ (0.02) $ (18.96) $ (0.14)
================ ================= ================ ================
Weighted-average number of common shares
outstanding - basic and diluted.................... 47,681,862 15,143,826 47,624,434 14,925,674
================ ================= ================ ================
Comprehensive loss:
Net loss.......................................$ (793,300) $ (375) $ (903,019) $ (2,044)
Foreign currency translation adjustment....... (181) (29) (183) (84)
---------------- ----------------- ---------------- ----------------
Comprehensive loss.................................$ (793,486) $ (404) $ (903,207) $ (2,128)
================ ================= ================ ================
See accompanying notes.
CONVERA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
For the Nine Months Ended October 31,
2001 2000
-------------------- --------------------
Cash Flows from Operating Activities:
Net loss........................................................ $ (903,019) $ (2,044)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation.............................................. 1,694 978
Provision for doubtful accounts........................... 2,946 270
Amortization of goodwill and other intangibles............ 98,275 88
Amortization of incentive bonus payments due
to employees, net of cash paid......................... 1,237 -
Restructuring charges, net of cash paid................... 6,383 -
Write-off of investments.................................. 481 -
Deferred tax benefit...................................... (4,452) -
Reduction of goodwill & other long-lived assets........... 754,424 -
Changes in operating assets and liabilities:
Accounts receivable....................................... 5,716 (4,233)
Prepaid expenses and other assets......................... (894) (1,851)
Accounts payable and accrued expenses..................... 2,773 299
Deferred revenues......................................... (597) 1,322
-------------------- --------------------
Net cash used in operating activities........................... (35,033) (5,171)
-------------------- --------------------
Cash Flows from Investing Activities:
Proceeds from maturities of investments......................... 19,221 36
Purchases of equipment and leasehold improvements............... (5,086) (1,329)
Direct acquisition costs........................................ (1,416) -
-------------------- --------------------
Net cash provided by (used in) investing activities............. 12,719 (1,293)
-------------------- --------------------
Cash Flows from Financing Activities:
Proceeds from the issuance of common stock, net................. 871 258
Proceeds from the exercise of stock options..................... - 4,978
Capital contribution from Intel................................. 5,422 -
-------------------- --------------------
Net cash provided by financing activities....................... 6,293 5,236
-------------------- --------------------
Effect of Exchange Rate Changes on Cash.............................. (100) 473
-------------------- --------------------
Net Decrease in Cash and Cash Equivalents............................ (16,121) (755)
Cash and Cash Equivalents, beginning of period....................... 37,061 10,884
-------------------- --------------------
Cash and Cash Equivalents, end of period............................. $ 20,940 $ 10,129
==================== ====================
See accompanying notes.
CONVERA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY
The consolidated financial statements include the accounts of Convera
Corporation ("Convera") and its wholly owned subsidiaries. These entities are
collectively referred to hereinafter as the "Company." All significant
inter-company transactions and accounts have been eliminated.
Convera was established through the combination of the former Excalibur
Technologies Corporation ("Excalibur") and Intel Corporation's ("Intel")
Interactive Media Services ("IMS") division. On December 21, 2000, Excalibur and
Intel consummated a business combination transaction (the "Combination")
pursuant to an Agreement and Plan of Contribution and Merger, dated as of April
30, 2000, as amended, by and among Excalibur, Intel, the Company and Excalibur
Transitory, Inc., a wholly owned subsidiary of the Company. At the completion of
the Combination, Excalibur became a wholly owned subsidiary of the Company, each
outstanding share of Excalibur common stock was converted into one share of
Class A common stock of the Company, and Intel contributed to the Company its
IMS division, intellectual property assets and other assets used by that
division, as well as $150,000,000 in cash at closing, in exchange for 14,949,384
shares of Class A common stock of the Company and 12,207,038 shares of Class B
non-voting common stock of the Company.
The Combination was accounted for using the purchase method of accounting. All
references in this Form 10-Q to financial results of the Company for the
nine-month period ended October 31, 2000 reflect the historical financial
results of Excalibur and its subsidiaries.
The Company principally earns revenues from the licensing of its software
products and the provision of services in deployment of the Company's technology
to commercial businesses and government agencies throughout North America,
Europe and other parts of the world. The Company licenses its software to end
users directly and also distributes its software products through license
agreements with value-added resellers, system integrators, original equipment
manufacturers, application service providers and other strategic partners.
The Company's operations are subject to certain risks and uncertainties
including, but not limited to: the dependence upon the timing of the closing on
sales of large software licenses; actual and potential competition by entities
with greater financial resources, experience and market presence than the
Company; rapid technological changes; the success of the Company's product
marketing and product distribution strategies; the risks associated with
acquisitions and international expansion; the need to manage growth; the need to
retain key personnel and protect intellectual property; the effect of general
economic conditions on demand for the Company's products and services; possible
disruption in commercial activities caused by terrorist activity and armed
conflict, such as changes in logistics and security arrangements, and the
availability of additional capital financing on terms acceptable to the Company.
(2) SIGNIFICANT ACCOUNTING POLICIES
Financial Statement Presentation
These consolidated financial statements are unaudited and have been prepared by
the Company pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do not
include all of the information and footnotes required by accounting principles
generally accepted in the United States for complete financial statements. It is
suggested that these consolidated financial statements be read in conjunction
with the consolidated financial statements, and the notes thereto, included in
the Company's Annual Report on Form 10-K for the fiscal year ended January 31,
2001. In the opinion of management, the consolidated financial statements for
the fiscal periods presented herein include all adjustments that are normal and
recurring which are necessary for a fair presentation of the results for these
interim periods. The results of operations for the nine-month period ended
October 31, 2001 are not necessarily indicative of the results for the entire
fiscal year ending January 31, 2002.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition
The Company recognizes revenue in accordance with American Institute of
Certified Public Accountants' Statement of Position 97-2, Software Revenue
Recognition ("SOP 97-2"), as amended by Statement of Position 98-9, Software
Revenue Recognition, with respect to certain transactions.
Revenue from the sale of software licenses is recognized upon shipment of
product, provided that the fee is fixed and determinable, persuasive evidence of
an arrangement exists and collection of the resulting receivable is considered
probable. Software revenues include revenues from licenses, training and system
implementation services. Training and systems implementation services are sold
as part of a bundled software license agreement as well as separately to
customers who have previously purchased software licenses. When training or
systems implementation services that are not essential to the functionality of
the software are sold as part of a bundled license agreement, the fair value of
these services, based on the price charged for the services when sold
separately, is deferred and recognized when the services are performed.
Historically, the Company has not experienced significant returns or exchanges
of its products from direct sales to customers. Revenue related to customer
support agreements is deferred and recognized ratably over the term of
respective agreements. Customer support agreements generally include bug fixes,
telephone support and product upgrades on a when and if available basis. When
the Company provides a software license and the related customer support
arrangement for one bundled price, the fair value of the customer support, based
on the price charged for that element when sold separately, is deferred and
recognized ratably over the term of the respective agreement.
Significant customization work is sometimes required to ensure that the
Company's software functionality meets the requirements of its customers. Under
these circumstances, the Company's revenues are derived from fixed price
contracts and revenue is recognized using the percentage of completion method
based on the relationship of actual costs incurred to total costs estimated over
the duration of the contract. Estimated losses on such contracts would be
charged against earnings in the period such losses are identified. No such
losses have been incurred on such contracts to date.
The in-process customer contracts assigned to the Company by the IMS division
were accounted for using the completed contract method, and accordingly, revenue
was deferred until all remaining costs, obligations and potential risks were
insignificant and the contract deliverables were agreed to and accepted by the
customer. As Convera completed these contracts, revenue and the related costs,
including profit on work performed by Convera subsequent to the acquisition, was
recognized. All obligations under the contracts assigned by the IMS division
have been completed.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents. Cash equivalents
consist of funds deposited in money market accounts. Consequently, the carrying
amount of cash and cash equivalents approximates fair value. Substantially all
cash and cash equivalents are on deposit with two major financial institutions.
Short Term Investments
Highly liquid investments with maturities in excess of three months but not in
excess of one year are classified as short-term investments. Short-term
investments consist primarily of U.S. Government treasury bills and are carried
at amortized cost.
Income Taxes
Deferred taxes are provided for utilizing the liability method, whereby deferred
tax assets are recognized for deductible temporary differences and operating
loss and tax credit carryforwards and deferred tax liabilities are recognized
for taxable temporary differences. Temporary differences are the differences
between the reported amounts of assets and liabilities for financial reporting
purposes and the amounts for income tax purposes at the tax rates expected to be
in effect when the differences reverse. Deferred tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on the date of
enactment. Deferred tax assets are reduced by a valuation allowance when, in the
opinion of management, it is more likely than not that some portion or all of
the deferred tax assets will not be realized.
(3) REDUCTION IN GOODWILL AND OTHER LONG-LIVED ASSETS
On September 20, 2001, the Company announced that it had terminated its
agreement with the National Basketball Association ("NBA") to provide
interactive content services. The termination of this agreement led to the
Company's decision to exit the interactive media services market and focus on
its enterprise information infrastructure software products. In connection with
this shift in focus, on October 4, 2001, the Company closed facilities in
Hillsboro, Oregon and Lafayette, Colorado, and all positions supporting the
interactive media services offerings and the related content security technology
development were eliminated.
Following the termination of the NBA contract and the Company's change in focus,
the Company evaluated the recoverability of the intangible and other long-lived
assets including goodwill associated with the Combination and associated with
the NBA agreement. The intangible assets acquired in the Combination, including
developed technology, customer contracts and assembled workforce, were primarily
related to the interactive media services offerings. The assessment of
recoverability was performed pursuant to Statement Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-lived Assets and for
Long-Lived Assets to be Disposed Of (SFAS 121). Additional guidance related to
goodwill impairment was provided by APB 17, "Intangible Assets."
Prior to the impairment charge, the unamortized balance of intangible assets
associated with the NBA agreement was approximately $67,318,000. Having no
future economic benefit to the Company, this unamortized balance was written
down to zero. As a result of the Company's shift in focus, there were no future
cash flows expected to be generated from the intangible assets acquired in the
Combination; thus, the unamortized balance of approximately $9,764,000 related
to these intangible assets was also written down to zero. Since the assets
acquired from Intel were never integrated into the Company's overall operations,
the goodwill associated with the Combination was evaluated for impairment along
with the other intangible assets acquired from Intel. As a result, the
unamortized goodwill balance of $675,896,000 was written down to zero. In
addition, there was an additional impairment charge of approximately $1.4
million to reflect the fair value of certain computer equipment and furniture to
be disposed of in connection with the closing of the various facilities
described above. The total of these charges is $754,424,000 and is presented in
the Company's Consolidated Statement of Operations under the caption "Reduction
in goodwill and other long-lived assets."
(4) RESTRUCTURINGS
During the second quarter of the current fiscal year, the Company adopted a
restructuring plan in response to the downturn in the economy and in conjunction
with the integration of the IMS division's operations following the Combination
with Intel. This restructuring resulted in a reduction of Convera's total
workforce by 22 employees, including 17 individuals from the Company's
engineering group and five individuals from the business development group. As
part of this restructuring, the Company also reduced the number of independent
contractors that were working on behalf of the Company by approximately 40
contractors and reduced the amount of space to be used in certain of the
Company's leased facilities.
On October 3, 2001, the Company announced an additional restructuring plan to
consolidate all operations around the development, marketing, sales and support
of its enterprise class information infrastructure software products, Convera
RetrievalWare(R) and Convera Screening Room(R). The Company also announced that
it was eliminating operations supporting the digital content security and
interactive services business units and closing offices in Hillsboro, Oregon and
Lafayette, Colorado. As a result of the restructuring in the third quarter of
the current year, Convera's total workforce was reduced by an additional 66
employees, including 44 employees from the engineering group, 13 from the
professional services and training groups, seven from the G&A group and two from
the marketing group.
As a result of the restructuring plans, the Company recorded restructuring
charges in the second and third fiscal quarters of the current fiscal year of
$2,933,000 and $5,195,000, respectively, for a total of $8,128,000 in
restructuring charges for the nine months ended October 31, 2001. The
restructuring charges include approximately $1,338,000 in costs incurred under
contractual obligations with no future economic benefit to the Company, accruals
of approximately $1,590,000 for employee termination costs and approximately
$5,200,000 related to future facility losses for the offices closed in
Hillsboro, Oregon and Lafayette, Colorado.
The following table sets forth a summary of the restructuring charges, the
payments made against those charges and the remaining restructuring liability as
of October 31, 2001 (in thousands):
Accrued
Second Third restructuring
quarter quarter costs at
restructuring restructuring Non-cash October 31,
charge charge Total charges Payments 2001
Employee severance and other
termination benefits....... $ 409 $ 1,181 $ 1,590 $ - $ (716) $ 874
Costs of facilities closing.... 2,066 3,134 5,200 (1,769) (141) 3,290
Contractual obligations........ 458 880 1,338 - (888) 450
-------- ------------ ----------- ----------- ------------ -------------
Total $ 2,933 $ 5,195 $ 8,128 $ (1,769) $ (1,745) $ 4,614
============ ============ =========== ============ ============ ===========
The Company paid a total of $1,745,000 through October 31, 2001 against the
restructuring accruals recorded in the current fiscal year. Non-cash charges
represent the write-down of facility improvements included in the costs of
facilities closings. As of October 31, 2001, unpaid amounts of $2,274,000 and
$2,339,000 have been classified as current and long-term accrued restructuring
costs, respectively, in the accompanying consolidated balance sheet. Remaining
cash expenditures relating to employee severance costs will be substantially
paid during the fourth quarter. Amounts related to contractual obligations will
be paid within one year. The Company expects to settle amounts related to
facility closings over the remaining term of the related facility leases, which
is through February 2006.
(5) SEGMENT REPORTING
The Company has one reportable segment.
Major Customers
In the current quarter, revenues derived from sales to agencies of the U.S.
Government were approximately $1.1 million, or 13% of total revenues. Revenues
derived from one individual customer accounted for 21% of the Company's total
revenues for the quarter ended October 31, 2001. During the quarter ended
October 31, 2000, one customer accounted for 20% of the Company's revenues.
(6) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that all business combinations initiated after
June 30, 2001 be accounted for under the purchase method and addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. SFAS No. 142 addresses the initial
recognition and measurement of intangible assets acquired outside of a business
combination and the accounting for goodwill and other intangible assets
subsequent to their acquisition. SFAS No. 142 provides that intangible assets
with finite useful lives will continue to be amortized and that goodwill and
intangible assets with indefinite lives will not be amortized, but will rather
be tested at least annually for impairment. In-process research and development
will continue to be written off immediately. Under the provisions of SFAS No.
142, any impairment loss identified upon adoption of this standard is recognized
as a cumulative effect of a change in accounting principle. Any impairment loss
incurred subsequent to initial adoption of SFAS No. 142 is recorded as a charge
to current period earnings. In the event the Company reports goodwill from
acquisitions subsequent to June 30, 2001, the goodwill will not be amortized.
The Company will adopt SFAS No. 142 in the first quarter of fiscal 2003 and at
that time will stop amortizing goodwill resulting from business combinations
completed prior to the adoption of SFAS No. 141.
(7) INCOME TAXES
In connection with the Combination and as a result of the NBA agreement,
deferred tax liabilities of approximately $37,303,000 were established relating
to the differences between the book treatment and the tax treatment of the
identified intangible assets, excluding goodwill. Prior to the consummation of
these transactions, the Company had recorded a full valuation allowance against
its net deferred tax asset, which was related primarily to net operating loss
carryforwards (NOLs) generated by the Company. With the establishment of these
deferred tax liabilities, which more than offset the existing deferred tax
assets, the Company determined that the valuation allowance that had been
previously recorded was no longer necessary.
The Company's interim effective income tax rate is based on management's best
current estimate of the expected annual effective income tax rate. Based on
current projections of taxable income for the year ending January 31, 2002, the
Company expects that it will generate additional NOLs for the remainder of the
year. As of October 31, 2001, the Company's deferred tax assets again exceed its
deferred tax liabilities. Given the Company's inability to predict sufficient
taxable income to realize the benefits of those net deferred tax assets, the
Company has provided a full valuation allowance against such deferred tax assets
as of October 31, 2001.
(8) AMORTIZATION OF INCENTIVE BONUS PAYMENTS
Specified former Intel employees who became Convera employees and remain
employees through September 30, 2002 will receive a payment for the excess, if
any, of the calculated aggregate gain they would have realized on forfeited
Intel stock options, based on the fair value of Intel shares at a fixed date
prior to the closing of the merger, that would have vested between 2002 and 2005
over the calculated aggregate gain on Convera stock options as of September 30,
2002. The maximum aggregate amount that Convera could be required to pay,
assuming no aggregate gain on the Convera stock options at September 30, 2002,
is approximately $1,587,000. The Company is amortizing this amount over the
period leading up to September 30, 2002, and, as such, has recorded additional
bonus expense of approximately $96,000 and $1,237,000 for the three- and
nine-month periods ended October 31, 2001.
Additionally, on May 16, 2001, the Company paid approximately $5,423,000 in
bonuses to specified former employees of Intel that remained employed by Convera
as of April 30, 2001. These bonus payments were funded through an additional
capital contribution from Intel. Since the bonus amounts were contingent upon
the former Intel employees' continued employment at Convera, the Company
recorded this bonus in operations for the three month period ended April 30,
2001.
(9) NET LOSS PER COMMON SHARE
The Company follows Financial Accounting Standards Board Statement No. 128,
"Earnings Per Share," ("SFAS 128") for computing and presenting net loss per
share information. Basic loss per common share is computed by dividing net loss
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted loss per common share excludes common
equivalent shares, including convertible preferred stock and unexercised stock
options, as their inclusion in the computation would be anti-dilutive.
The following table sets forth the computation of basic and diluted net loss per
common share (in thousands, except share and per share data):
Three Months Ended October 31, Nine Months Ended October 31,
2001 2000 2001 2000
---------------- --------------- ---------------- ---------------
Numerator:
Net loss........................................ $ (793,300) $ (375) $ (903,019) $ (2,044)
Less: Dividends on preferred stock.............. - 3 - 10
---------------- --------------- ---------------- ---------------
Net loss applicable to common shareholders... $ (793,300) $ (378) $ (903,019) $ (2,054)
================ =============== ================ ===============
Denominator:
Weighted average number of common shares
outstanding - basic and diluted.............. 47,681,862 15,143,826 47,624,434 14,925,674
Basic and diluted net loss per common share......... $ (16.64) $ (0.02) $ (18.96) $ (0.14)
The following equity instruments were not included in the computation of diluted
net loss per common share because their effect would be antidilutive:
Three Months Ended October 31, Nine Months Ended October 31,
2001 2000 2001 2000
---------------- --------------- ---------------- ---------------
Convertible preferred stock........................ - 271,800 - 271,800
Stock options...................................... 1,830 1,900,466 297,291 1,696,108
---------------- --------------- ---------------- ---------------
Dilutive potential common stock................ 1,830 2,172,266 297,291 1,967,908
================ =============== ================ ===============
(10) STOCK OPTION EXCHANGE PROGRAM
On June 11, 2001, the Company announced a voluntary stock option exchange
program (the Offer) for its employees. Under this program, existing option
holders had the opportunity to cancel outstanding stock options previously
granted to them in exchange for an equal number of replacement options to be
granted at a future date. The Offer was open until 12:00 AM Eastern Time on July
9, 2001 (the Expiration Date). The Company will grant the replacement options on
January 14, 2002 (the Replacement Grant Date). The exercise price of the
replacement options will be equal to the closing sale price of our common stock
on the NASDAQ National Market on the business day preceding the Replacement
Grant Date. Any option holder electing to participate in the exchange program
was also required to exchange any options granted to him or her during the six
months preceding the Expiration Date, and to not receive any additional option
grants until the Replacement Grant Date. The exchange program was designed to
comply with FASB Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation" and is not expected to result in any additional
compensation charges or variable plan accounting. A total of 9,251,963 options
were surrendered for exchange under this program.
(11) STOCK REPURCHASE PROGRAM
On October 4, 2001, the Company announced a stock repurchase program whereby the
Company may repurchase up to $10 million of the Company's common stock in the
open market, through block trades or in privately negotiated transactions. The
timing and amount of any shares repurchased will be determined by the Company's
management based on its evaluation of market conditions and other factors. The
repurchase program may be suspended or discontinued at any time without prior
notice. As of October 31, 2001, no shares have been repurchased.
(12) SUBSEQUENT EVENTS
Stock Repurchase
On November 30, 2001, the Company reached an agreement to repurchase from NBA
Media Ventures, LLC 4,746,221 shares, representing the entirety of its holdings,
for $11 million. This repurchase was independent of the Company's $10 million
repurchase program referred to above.
Contingencies
On November 1, 2001, DSMC, Incorporated ("DSMCI") filed a complaint against the
Company in the U.S. District Court for the District of Columbia in which it
alleged that the Company misappropriated DSMCI's trade secrets, engaged in civil
conspiracy with the NGT Library, Inc., a subsidiary of the National Geographic
Society ("NGTL"), to obtain access to DSMCI's trade secrets, and was unjustly
enriched by the Company's alleged access to and use of such trade secrets. In
its complaint, DSMCI seeks five million dollars in actual damages and ten
million dollars in punitive damages from the Company. The Company is in the
process of investigating the allegations and at this time believes that they are
without merit. Accordingly, the Company believes that this matter will not have
a material adverse effect on its financial position, operations or cash flows.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The statements contained in this report that are not purely historical are
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including
without limitation statements about the Company's expectations, beliefs,
intentions or strategies regarding the future. All forward-looking statements
included in this report are based on information available to the Company on the
date hereof, and the Company assumes no obligation to update any such
forward-looking statements. The forward-looking statements contained herein
involve risks and uncertainties including, but not limited to: the dependence
upon the timing of the closing on sales of large software licenses; actual and
potential competition by entities with greater financial resources, experience
and market presence than the Company; rapid technological changes; the success
of the Company's product marketing and product distribution strategies; the
risks associated with acquisitions and international expansion; the need to
manage growth; the need to retain key personnel and protect intellectual
property; the effect of general economic conditions on demand for the Company's
products and services; possible disruption in commercial activities caused by
terrorist activity and armed conflict, such as changes in logistics and security
arrangements, and the availability of additional capital financing on terms
acceptable to the Company. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth in this report.
The Company principally earns revenues from the licensing of its software
products and the provision of services in deployment of the Company's technology
to commercial businesses and government agencies throughout North America,
Europe and other parts of the world. The Company licenses its software to end
users directly and also distributes its software products through license
agreements with value-added resellers, system integrators, original equipment
manufacturers, application service providers and other strategic partners.
Revenues are generated from software licenses with customers and from the
related sale of product maintenance, training and implementation support
services. Additions to the number of authorized users, licenses issued for
additional products and the renewal of product maintenance arrangements by
customers pursuant to existing licenses also provide revenues to the Company.
Under software maintenance contracts, customers are typically entitled to
receive telephone support, software bug fixes and upgrades or enhancements of
particular software products when and if they are released.
Results of Operations
Total revenues decreased 28% to $8.8 million in the third quarter of the current
fiscal year from $12.3 million in the third quarter last year. The net loss for
the quarter ended October 31, 2001 was $793.3 million, or $16.64 per common
share, compared to a net loss of $0.4 million, or $0.02 per share in the same
period last year. For the nine months ended October 31, 2001, total revenues
were $25.5 million, a decrease of 23% over total revenues of $33.1 million
reported for the corresponding period last year. The net loss for the nine
months ended October 31, 2001 was $903.0 million, or $18.96 per common share,
compared to a net loss of $2.1 million, or $0.14 per common share in the same
period last fiscal year.
The Company uses EBITDA (earnings before interest, taxes depreciation and
amortization) as an additional measure of performance. EBITDA is not a
measurement of financial performance under accounting principles generally
accepted in the United States and should not be considered as an alternative to
net loss or as an indicator of Convera's operating performance. The Company
believes that EBITDA is widely used by analysts, investors and other interested
parties as a financial measure. EBITDA is not necessarily comparable with
similarly titled measures for other companies.
For the quarter ended October 31, 2001, on an EBITDA basis and excluding the
restructuring charge of approximately $5.2 million and the reduction in goodwill
and other long-lived assets of approximately $754.4 million, the loss was $9.3
million, or $0.19 per common share compared to positive EBITDA of $0.4 million,
or $0.02 per common share on a diluted basis in the third quarter last year. On
an EBITDA basis for the nine months ended October 31, 2001 and excluding
restructuring charges of approximately $8.1 million and the reduction in
goodwill and other long-lived assets of approximately $754.4 million, the loss
was $38.2 million, or $0.80 per common share compared to positive EBITDA of $21
thousand, which is break even on a per share basis, for the comparable period
last year.
The following charts summarize the components of revenues and the categories of
expenses, including the amounts expressed as a percentage of total revenues, and
EBITDA for the three and nine months ended October 31, 2001 and 2000,
respectively. (dollars in thousands).
Components of Revenues and Expenses
Three Months Ended October 31, Increase
2001 2000 (Decrease)
$ % $ % %
-------------- --------- --------------- --------- -----------
Revenues:
Software $6,868 78% $10,601 86% (35)%
Maintenance 1,512 17% 1,703 14% (11)%
-------------- --------- --------------- --------- -----------
License-related 8,380 95% 12,304 100% (32)%
Services 456 5% - - 100%
-------------- --------- --------------- --------- -----------
Total revenues $8,836 100% $12,304 100% (28)%
-------------- --------- --------------- --------- -----------
Expenses:
Cost of license-related
revenues $3,890 44% $2,720 22% 43%
Cost of services revenues 700 8% - - 100%
Sales and marketing 7,296 83% 5,547 45% 32%
Research and product
development 5,615 64% 2,934 24% 91%
General and administrative 2,157 24% 1,558 13% 38%
Restructuring charge 5,195 59% - - 100%
Amortization of goodwill
and other intangible
assets 25,082 284% 29 - 86390%
Amortization of incentive
bonus payments due
to employees 96 1% - - 100%
Reduction in goodwill and
other long-lived assets 754,424 8538% - - 100%
-------------- --------- --------------- --------- -----------
Total expenses $804,455 9104% $12,788 104% 6191%
-------------- --------- --------------- --------- -----------
Operating loss $(795,619) $(484)
Other income, net 1,086 109
-------------- ---------------
Net loss before income taxes $(794,533) $(375)
Income tax benefit 1,233 --
-------------- ---------------
Net loss $(793,300) $(375)
============== ===============
Three Months Ended October 31,
2001 2000
-------------- ---------------
EBITDA:
Net loss $(793,300) $(375)
Income tax benefit (1,233) --
Other income, net (1,086) (109)
Restructuring charge 5,195 --
Depreciation 661 338
Amortization of goodwill and
acquisition related intangible
assets 25,082 29
Amortization of other intangible
assets 907 536
Amortization of incentive bonus
payments due to employees 96 --
Reduction in goodwill and other
long-lived intangible assets 754,424 --
-------------- ---------------
EBITDA (loss) $(9,254) $419
============== ===============
EBITDA (loss) per common share -
basic $(0.19) $0.03
============== ===============
EBITDA (loss) per common share -
diluted $(0.19) $0.02
============== ===============
Components of Revenues and Expenses
Nine Months Ended October 31, Increase
2001 2000 (Decrease)
$ % $ % %
-------------- --------- --------------- --------- -----------
Revenues:
Software $19,897 78% $28,106 85% (29)%
Maintenance 4,771 19% 4,956 15% (4)%
-------------- --------- --------------- --------- -----------
License-related 24,668 97% 33,062 100% (25)%
Services 806 3% - - 100%
-------------- --------- --------------- --------- -----------
Total revenues $25,474 100% $33,062 100% (23)%
-------------- --------- --------------- --------- -----------
Expenses:
Cost of license-related
revenues $13,037 51% $6,229 19% 109%
Cost of services revenues 3,750 15% - - 100%
Sales and marketing 24,656 97% 16,554 50% 49%
Research and product
development 20,352 80% 8,466 26% 140%
General and administrative 7,367 29% 4,105 12% 79%
Restructuring charge 8,128 32% - - 100%
Amortization of goodwill
and other intangible
assets 98,275 386% 88 - 111576%
Amortization of incentive
bonus payments due
to employees 6,660 26% - - 100%
Reduction in goodwill and
other long-lived assets 754,424 2962% - - 100%
-------------- --------- --------------- --------- -----------
Total expenses $936,649 3677% $35,442 107% 2543%
-------------- --------- --------------- --------- -----------
Operating loss $(911,175) $(2,380)
Other income, net 3,704 336
-------------- ---------------
Net loss before income taxes $(907,471) $(2,044)
Income tax benefit 4,452 --
-------------- ---------------
Net loss $(903,019) $(2,044)
============== ===============
Nine Months Ended October 31,
2001 2000
-------------- ---------------
EBITDA:
Net loss $(903,019) $(2,044)
Income tax benefit (4,452) --
Other income, net (3,704) (336)
Restructuring charge 8,128 --
Depreciation 1,694 979
Amortization of goodwill and
acquisition related intangible
assets 98,275 88
Amortization of other intangible
assets 3,778 1,334
Amortization of incentive bonus
payments due to employees 6,660 --
Reduction in goodwill and other
long-lived intangible assets 754,424 --
-------------- ---------------
EBITDA (loss) $(38,216) $21
============== ===============
EBITDA (loss) per common share -
basic & diluted $(0.80) $0.00
============== ===============
Revenues
Software revenues, which include amounts generated through software licensing
and implementation services, decreased 35% to $6.9 million for the three months
ended October 31, 2001 from $10.6 million for the three months ended October 31,
2000. Total software revenues for the nine months ended October 31, 2001 were
$19.9 million, a decrease of 29% over total software revenues of $28.1 million
reported for the corresponding period last year. The decrease in software
revenues for both the quarter and the nine months of the current fiscal year
continues to be primarily attributable to the general downturn in the economy
which has caused certain of our prospects to re-evaluate and defer their
spending on enterprise information infrastructure initiatives.
Revenues derived from contracts and orders issued by agencies of the U.S.
Government were approximately 13% and 15% of total revenues for the three months
ended October 31, 2001 and 2000, respectively. Revenues derived from one
individual customer accounted for 21% of the Company's total revenues for the
quarter ended October 31, 2001. During the quarter ended October 31, 2000, one
customer accounted for 20% of the Company's revenues.
Software maintenance and customer support revenues decreased 11% in the third
quarter of the current year to $1.5 million from $1.7 million in the third
quarter last year, representing 17% and 14% of total revenues, respectively. For
the nine months ended October 31, 2001, software maintenance and customer
support revenues were $4.8 million compared to $5.0 million in the same period
last year, representing 19% and 15% of total revenues respectively. The decrease
in maintenance revenues is attributable to the decline in license revenues this
fiscal year as well as the conclusion of a specific long term maintenance
agreement that had yielded approximately $100,000 in quarterly maintenance
revenues. The increase in the maintenance revenues as a percentage of total
revenues reflects the Company's continued pursuit of maintenance renewals for
existing customers.
Revenues from international operations are derived primarily by software
licenses with various European commercial and government customers and a
well-established European reseller network. The Company's international sales
operation, Convera Technologies International, Ltd. ("CTIL"), is headquartered
in the United Kingdom, with offices in Germany and France. International
revenues from CTIL decreased 71% for the three months ended October 31, 2001 to
$1.2 million from $4.1 million in the same quarter last year. For the nine
months ended October 31, 2001, international revenues from CTIL decreased 70% to
$3.0 million from $9.9 million in the comparable period last year. This decrease
can also be attributed to the overall weak market conditions, which have led to
reduced spending by many of our prospective and existing customers.
Revenues from the Company's interactive services offerings were $0.5 million and
$0.8 million for the three and nine months ended October 31, 2001, respectively.
There were no revenues recorded from interactive services offerings in the
corresponding periods last year.
Cost of Revenues
Cost of license-related revenues, which includes cost of software revenues and
cost of maintenance revenues, increased 43% to $3.9 million in the third quarter
of the current year from $2.7 million in the third quarter last year. Cost of
license-related revenues as a percentage of total revenues was 44% in the
current quarter compared to 22% in the third quarter last year. For the nine
months ended October 31, 2001, costs of license-related revenues increased 109%
to $13.0 million from $6.2 million in the nine months ended October 31, 2000,
representing 51% and 19% of total revenues, respectively. Cost of software
revenues increased 41% to $3.4 million in the third quarter of the current year
from $2.4 million in the third quarter last year. For the nine months ended
October 31, 2001, cost of software revenues increased 125% to $11.6 million from
$5.2 million in the first nine months of last year. The increase in cost of
software revenues is primarily attributable to an increase in the amortization
of prepaid third-party licensing costs, which have been incurred to add new
features and functionality to the Company's products, as well as an increase in
the cost of professional services resulting in part from the increase in the
number of employees in the Company's professional services group. Cost of
maintenance increased 56% to $0.5 million for the three months ended October 31,
2001 from $0.3 million for the three months ended October 31, 2000. For the nine
months of the current fiscal year, cost of maintenance increased 35% to $1.5
million from $1.1 million in the same period last year. The increase in cost of
maintenance is attributable to an increase in personnel and related expenses in
the customer support organization.
Cost of services represents the personnel and other direct costs incurred in
connection with performing on the Company's service related contracts. For the
quarter ended October 31, 2001, cost of services was $0.7 million. For the nine
months ended October 31, 2001, cost of services was $3.8 million. There were no
associated costs recorded for the three and nine-month periods ended October 31,
2000.
Operating Expenses
Sales and marketing expenses increased 32% in the quarter ended October 31, 2001
to $7.3 million from $5.5 million in the third quarter last year, representing
83% and 45% of total revenues, respectively. For the nine months ended October
31, 2001, sales and marketing expenses increased 49% to $24.7 million from $16.6
million for the corresponding period last year, representing 97% and 50% of
total revenues, respectively. The increase in sales and marketing expenses for
the quarter was due to overall growth in sales and marketing personnel and
increased spending on marketing programs. The growth in sales and marketing
expenses for the nine months of the current fiscal year compared to the
corresponding period last year was due to an increase in the provision for
doubtful accounts as well as overall growth in sales and marketing personnel and
increased spending on marketing programs.
Total research and product development costs increased 91% to $5.6 million in
the current quarter compared to $2.9 million in the same quarter last year.
Research and product development costs as a percentage of total revenues were
64% in the current quarter compared to 24% in the third quarter last year. For
the nine months ended October 31, 2001, research and development expenses
increased 140% to $20.4 million from $8.5 million for the corresponding period
last year, representing 80% and 26% of total revenues, respectively. The
increase is largely due to the addition of a significant number of engineering
personnel in connection with the business combination with the IMS division of
Intel as well as the Company's continued investment to enhance the RetrievalWare
and Screening Room products. During the current fiscal year, the Company has
released Convera RetrievalWare 6.8, RetrievalWare 6.9 and RetrievalWare
WebExpress 2.1. RetrievalWare 6.8 and RetrievalWare WebExpress 2.1 provide
enhanced support for Java developers, a new search interface for intranet users,
added capabilities for indexing secure content and expanded language plug-ins.
Updated dictionaries in RetrievalWare 6.8 enhance search results by
accommodating language changes such as new words and idioms and updated
spellings. RetrievalWare 6.8 also offers a new user interface for intranet
search users called SmartSearch, a new HTML-based search client that is designed
to increase user productivity and reduce the time that knowledge workers spend
looking for information. RetrievalWare 6.9 provides user-level and
document-level security simultaneously across enterprise groupware and document
management systems. Other significant enhancements to RetrievalWare 6.9 include
enhanced Microsoft Exchange security, general availability of specialized
medical and pharmaceutical search aids and updated platform and third party
support.
General and administrative expenses increased 38% for the quarter ended October
31, 2001 to $2.2 million from $1.6 million in the third quarter of last year.
For the nine months ended October 31, 2001, general and administrative expenses
increased 79% to $7.4 million from $4.1 million for the corresponding period
last year. The growth in general and administrative expenses was due to
increased corporate expenses such as legal, insurance and accounting expenses.
There were also additional general and administrative personnel required to
support the Company's expanding operations.
During the second quarter of the current fiscal year, the Company implemented a
restructuring plan in response to the downturn in the economy and in conjunction
with the integration of the IMS division's operations following the Combination
with Intel. This restructuring resulted in a reduction of Convera's total
workforce by 22 employees, including 17 individuals from the Company's
engineering group and five individuals from the business development group. As
part of this restructuring, the Company also reduced the number of independent
contractors that were working on behalf of the Company by approximately 40
contractors and reduced the amount of space to be used in certain of the
Company's leased facilities.
On October 3, 2001, the Company announced an additional restructuring plan to
consolidate all operations around the development, marketing, sales and support
of its enterprise class information infrastructure software products, Convera
RetrievalWare(R) and Convera Screening Room(R). The Company also announced that
it was eliminating operations supporting the development of the Company's
digital content security technology and interactive services offerings and
closing offices in Hillsboro, Oregon and Lafayette, Colorado. As a result of
this restructuring in the third quarter, Convera's total workforce was reduced
by an additional 66 employees, including 44 employees of the engineering group,
13 from the professional services and training groups, seven from the G&A group
and two from the marketing group.
As a result of the restructuring plans, the Company recorded restructuring
charges in the second and third fiscal quarters of the current fiscal year of
$2.9 million and $5.2 million, respectively, for a total of $8.1 million in
restructuring charges for the nine months ended October 31, 2001. The
restructuring charges include approximately $1.3 million in costs incurred under
contractual obligations with no future economic benefit to the Company, accruals
of approximately $1.6 million for employee termination costs and approximately
$5.2 million related to future facility losses for the offices closed in
Hillsboro, Oregon and Lafayette, Colorado.
The Company paid a total of $1.7 million through October 31, 2001 against the
restructuring accruals recorded in the current fiscal year. As of October 31,
2001 unpaid amounts of $2.3 million and $2.3 million have been classified as
current and long-term accrued restructuring costs, respectively, in the
accompanying consolidated balance sheet. Remaining cash expenditures relating to
employee severance costs will be substantially paid during the fourth quarter.
Amounts related to contractual obligations will be paid within one year. The
Company expects to settle amounts related to facility closings over the
remaining term of the related facility leases, which is through February 2006.
Amortization of goodwill and other intangible assets was approximately $25.1
million for the current quarter and $98.3 million for the nine months ended
October 31, 2001. The majority of these amounts relate to amortization of
goodwill and intangible assets related to the Company's business combination
with Intel's IMS division, which was accounted for using the purchase method.
These amounts also include amortization of the intangible assets acquired from
the NBA pursuant to the contribution agreement. Amortization of goodwill and
other intangible assets was stopped effective October 3, 2001, when the Company
determined that such assets were impaired and wrote down the remaining
unamortized balance to zero (see below). Amortization of goodwill and other
intangible assets was approximately $29 thousand for the same quarter last year
and $88 thousand for the nine months ended October 31, 2000. These prior year
amounts related to an acquisition made by the Company in May 1997 also accounted
for using the purchase method.
Amortization of incentive bonus payments due to employees was approximately $96
thousand for the current quarter and $6.7 million for the nine months ended
October 31, 2001. Specified former Intel employees who became Convera employees
and remain employed through September 30, 2002 will receive a payment for the
excess, if any, of the calculated aggregate gain they would have realized on
forfeited Intel stock options, based on the fair value of Intel shares at a
fixed date prior to the closing of the merger, that would have vested between
2002 and 2005 over the calculated aggregate gain on Convera stock options as of
September 30, 2002. The maximum aggregate amount that Convera could be required
to pay, assuming no aggregate gain on the Convera stock options at September 30,
2002, is approximately $1.6 million. The Company is amortizing this amount over
the period leading up to September 30, 2002, and, as such, has recorded
additional bonus expense of approximately $96,000 and $1,237,000 for the three-
and nine-month periods ended October 31, 2001. Additionally, in May 2001, the
Company paid approximately $5.4 million in bonuses to specified former employees
of Intel that remained employed by Convera as of April 30, 2001. These bonus
payments were funded through an additional capital contribution from Intel. The
bonus amounts were contingent upon the former Intel employees' continued
employment at Convera, and the Company recorded this bonus in operations.
The Company recorded a charge of $754.4 million in the current fiscal quarter
for reduction of goodwill and other long-lived assets. On September 20, 2001,
the Company announced that it had terminated its agreement with the National
Basketball Association ("NBA") to provide interactive content services.
Following the termination of the NBA contract and the Company's change in focus,
the Company evaluated the recoverability of the intangible and other long-lived
assets including goodwill associated with the Combination and associated with
the NBA agreement. The intangible assets acquired in the Combination, including
developed technology, customer contracts and assembled workforce, were primarily
related to the interactive media services offerings. The assessment of
recoverability was performed pursuant to Statement Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-lived Assets and for
Long-Lived Assets to be Disposed Of (SFAS 121). Additional guidance related to
goodwill impairment was provided by APB 17, "Intangible Assets."
Prior to the impairment charge, the unamortized balance of intangible assets
associated with the NBA agreement was approximately $67.3 million. Having no
future economic benefit to the Company, this unamortized balance was written
down to zero. As a result of the Company's shift in focus, there were no future
cash flows expected to be generated from the intangible assets acquired in the
Combination; thus, the unamortized balance of approximately $9.8 million related
to these intangible assets was also written down to zero. Since the assets
acquired from Intel were never integrated into the Company's overall operations,
the goodwill associated with the Combination was evaluated for impairment along
with the other intangible assets acquired from Intel. As a result, the
unamortized goodwill balance of $675.9 million was written down to zero. In
addition, there was an additional impairment charge of approximately $1.4
million to reflect the fair value of certain computer equipment and furniture to
be disposed of in connection with the closing of the various facilities
described above.
Other Income, net
Other income increased to $1.1 million for the third quarter of the current
fiscal year, compared to $0.1 million in the third quarter of last year. For the
nine months ended October 31, 2001, other income increased to $3.7 million from
$0.3 million in the same period last year. For the third quarter, other income
represents interest income on the Company's invested funds. For the first nine
months of this fiscal year, other income includes interest income which
increased to $4.2 million from $0.3 million in the same period last year, offset
by a write-off of approximately $0.5 million for equity securities whose decline
in value was deemed to be other-than temporary and for which the net realizable
value was believed to be zero. The increase in interest income was due to a
higher level of invested funds.
The income tax benefit of $1.2 million for the three months ended October 31,
2001 and $4.5 million for the nine months ended October 31, 2001 represents the
reversal of the remaining net deferred tax liability established primarily as a
result of the Intel IMS division merger and the NBA contract. The Company's
interim effective income tax rate is based on its current best estimate of its
expected annual effective income tax rate. Based on current projections of
taxable income for the year ending January 31, 2002, the Company expects that it
will generate additional NOLs for the remainder of the year. As of October 31,
2001, the Company's deferred tax assets again exceed its deferred tax
liabilities. Given the Company's inability to predict sufficient taxable income
to realize the benefits of those net deferred tax assets, the Company provided a
full valuation allowance against such deferred tax assets as of October 31,
2001.
Liquidity and Capital Resources
The Company's combined balance of cash, cash equivalents and short-term
investments at October 31, 2001 as compared to January 31, 2001 is summarized
below (in thousands).
October 31, January 31, Change
2001 2001
-------------- --------------- -----------------
Cash and cash
equivalents $ 20,940 $ 37,061 $ (16,121)
Investments 99,581 119,083 (19,502)
-------------- --------------- -----------------
Total $ 120,521 $ 156,144 $ (35,623)
============== =============== =================
During the nine months ended October 31, 2001, $35.0 million was used to fund
operating activities, compared to $5.2 million used in the same period last
year. The net loss of $903.0 million was offset by non-cash charges totaling
$861.0 million, consisting primarily of $754.4 million from the reduction of
goodwill and other long-lived assets. Non-cash charges also included
depreciation of $1.7 million, amortization of $98.3 million, bad debt expense of
$2.9 million and restructuring charges, net of cash paid of $6.4 million. Cash
was also provided by a reduction in accounts receivable of $5.7 million, and an
increase to accounts payable and accrued expenses of $2.8 million. A decrease in
deferred revenues and an increase in prepaid expenses and other assets combined
used cash of $1.5 million. During the nine months ended October 31, 2000, the
Company used cash of $5.2 million to fund operating activities. The net loss of
$2.0 million was offset by non-cash charges of $1.3 million including
depreciation and amortization of $1.0 million. However, increases in accounts
receivable, prepaid expenses and other assets used cash of $6.1 million while
increases to accounts payable and accrued expenses and deferred revenues
provided cash of $1.6 million.
Cash flows from investing activities provided the Company $12.7 million during
the first nine months of the current fiscal year. Net cash provided from the
maturity of U.S. Treasury Bills provided cash of $19.2 million while purchases
of equipment and leasehold improvements used cash of $5.1 million. The Company
also used cash of $1.4 million related to direct acquisition costs in connection
with the business combination with Intel's IMS division. For the nine months
ended October 31, 2000, the Company used cash of $1.3 million from investing
activities related to the purchase of equipment and leasehold improvements.
Financing activities provided cash of $6.3 million and $5.2 million for the nine
months ended October 31, 2001 and 2000, respectively. During the nine months
ended October 31, 2001, Intel contributed additional capital in the amount of
approximately $5.4 million to fund bonus payments to specified former Intel
employees that remained employed by Convera as of April 30, 2001. Proceeds from
the issuance of stock under the employee stock purchase plan provided cash of
$0.9 million and $0.3 million for the nine months ended October 31, 2001 and
2000, respectively. During the nine months ended October 31, 2000, cash of
approximately $5.0 million was provided from the exercise of employee stock
options.
At October 31, 2001, the Company's balance of cash, cash equivalents and
short-term investments was $120.5 million. The Company believes that its current
balance of cash, cash equivalents and short-term investments and its funds
generated from operations, if any, will be sufficient to fund the Company's
current projected cash needs for the foreseeable future. Prior to fiscal year
2001, the Company had primarily used cash provided from sales of its common
stock to finance its operations. If the actions taken by management are not
effective in achieving profitable operating results, the Company may be required
to pursue additional external sources of financing to support its operations and
capital requirements. There can be no assurance that external sources of
financing will be available to fund the Company's ongoing operations or other
capital requirements on terms acceptable to the Company.
The number of days sales outstanding ("DSO") decreased to 88 days at October 31,
2001 from 130 days at October 31, 2000. Management believes that that the
allowance for doubtful accounts of $2.7 million at October 31, 2001 is adequate.
Factors That May Affect Future Results - Forward Looking Information
The Company's business environment is characterized by intense competition,
rapid technological changes, changes in customer requirements and emerging new
market segments. Consequently, to compete effectively, the Company must make
frequent new product introductions and enhancements while protecting its
intellectual property, retain its key personnel and deploy sales and marketing
resources to take advantage of new business opportunities. Future operating
results will be affected by the ability of the Company to maintain and grow
demand for the Company's products and services under uncertain domestic and
international economic conditions, expand its product distribution channels and
to manage the expected growth of the Company. Future results may also be
impacted by the effectiveness of the Company in executing future acquisitions
and integrating the operations of acquired companies with those of the Company.
Failure to meet any of these challenges could adversely affect future operating
results.
The Company's quarterly operating results have varied substantially in the past
and are likely to vary substantially from quarter to quarter in the future due
to a variety of factors. In particular, the Company's period-to-period operating
results are significantly dependent upon the timing of the closing of large
license agreements. In this regard, the purchase of the Company's products can
require a significant investment from a potential customer which the customer
generally views as a discretionary cost that can be deferred or canceled due to
budgetary or other business reasons and can involve long sales cycles of six
months or more. Estimating future revenues is also difficult because the Company
ships its products soon after an order is received and, as such does not have a
significant backlog. Thus, quarterly license fee revenues are heavily dependent
upon a limited number of orders for large licenses received and shipped within
the same quarter. Moreover, the Company has generally recorded a significant
portion of its total quarterly license fee revenues in the third month of a
quarter, with a concentration of these revenues occurring in the last half of
that third month. This concentration of revenues is influenced by customer
tendencies to make significant capital expenditures at the end of a fiscal
quarter. The Company expects these revenue patterns to continue for the
foreseeable future. Despite the uncertainties in its revenue patterns, the
Company's operating expenses are based upon anticipated revenue levels and such
expenses are incurred on an approximately ratable basis throughout a quarter. As
a result, if expected revenues are deferred or otherwise not realized in a
quarter for any reason, the Company's business, operating results and financial
condition would be materially adversely affected.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The Company believes that inflation has not had a material effect on the results
of its operations to date.
Other Factors
EURO Conversion
On January 1, 1999, the exchange rates of eleven countries (Germany, France, the
Netherlands, Austria, Italy, Spain, Finland, Ireland, Belgium, Portugal and
Luxembourg) were fixed amongst one another and became the currencies of the
EURO. The currencies of the eleven countries will remain in circulation until
mid-2002. The EURO currency will be introduced on January 1, 2002. The Company
does not expect future balance sheets and statements of earnings and cash flows
to be materially impacted by the EURO Conversion.
New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that all business combinations initiated after
June 30, 2001 be accounted for under the purchase method and addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. SFAS No. 142 addresses the initial
recognition and measurement of intangible assets acquired outside of a business
combination and the accounting for goodwill and other intangible assets
subsequent to their acquisition. SFAS No. 142 provides that intangible assets
with finite useful lives will continue to be amortized and that goodwill and
intangible assets with indefinite lives will not be amortized, but will rather
be tested at least annually for impairment. In-process research and development
will continue to be written off immediately. Under the provisions of SFAS No.
142, any impairment loss identified upon adoption of this standard is recognized
as a cumulative effect of a change in accounting principle. Any impairment loss
incurred subsequent to initial adoption of SFAS No. 142 is recorded as a charge
to current period earnings. In the event the Company reports goodwill from
acquisitions subsequent to June 30, 2001, the goodwill will not be amortized.
The Company will adopt SFAS No. 142 in the first quarter of fiscal 2003 and at
that time will stop amortizing goodwill resulting from business combinations
completed prior to the adoption of SFAS No. 141. After the $676 million
reduction of goodwill taken in the current fiscal quarter related to goodwill
generated in the combination with Intel's Interactive Media Services Division in
December 2000, the remaining goodwill balance and associated amortization is
immaterial.
Market Risk
The Company's market risk is principally confined to changes in foreign currency
exchange rates and potentially adverse effects of differing tax structures.
International revenues from CTIL, the Company's foreign sales subsidiary located
in the United Kingdom, along with entities established in Paris, France and
Munich, Germany, were approximately 14% of total revenues in the third quarter
of the current fiscal year. International sales are made mostly from the
Company's foreign subsidiary and are typically denominated in British pounds,
French Francs or German Deutsche Marks. As of October 31, 2001, approximately
43%, 2% and 3% of total consolidated accounts receivable were denominated in
British pounds, French Francs and German Deutsche Marks, respectively.
Additionally, the Company's exposure to foreign exchange rate fluctuations
arises in part from intercompany accounts in which royalties on CTIL sales are
charged to CTIL and recorded as intercompany receivables on the books of the
U.S. parent company. The Company is also exposed to foreign exchange rate
fluctuations as the financial results of CTIL are translated into U.S. dollars
in consolidation. As exchange rates vary, those results when translated may vary
from expectations and adversely impact overall expected profitability.
As of October 31, 2001, 13% of the Company's cash and cash equivalents balance
was included in the Company's foreign subsidiaries. Cash equivalents consist of
funds deposited in money market accounts with original maturities of three
months or less. The Company's short-term investments consist primarily of U.S.
Government treasury bills, with maturity dates ranging from 3 months to 6
months. Given the relatively short maturity periods of cash equivalents and
short-term investments, the Company's exposure to fluctuations in interest rates
is limited.
PART II-- OTHER INFORMATION
Item 1. Legal Proceedings
On November 1, 2001, DSMC, Incorporated ("DSMCI") filed a complaint against the
Company in the U.S. District Court for the District of Columbia in which it
alleged that the Company misappropriated DSMCI's trade secrets, engaged in civil
conspiracy with the NGT Library, Inc., a subsidiary of the National Geographic
Society ("NGTL"), to obtain access to DSMCI's trade secrets, and was unjustly
enriched by the Company's alleged access to and use of such trade secrets. In
its complaint, DSMCI seeks five million dollars in actual damages and ten
million dollars in punitive damages from the Company. The Company is in the
process of investigating the allegations and at this time believes that they are
without merit. Accordingly, the Company believes that this matter will not have
a material adverse effect on the Company's financial position, operations or
cashflows.
Item 2. Changes in Securities None.
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Item 3. Defaults upon Senior Securities None.
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Item 4. Submission of Matters to Vote of Security Holders
The 2001 Annual Meeting of Shareholders was held October 12,
2001. The following individuals were elected to serve as the
Board of Directors for terms expiring at the 2002 Annual
Meeting:
Number of Shares Voted
For Withheld
--------------------------
Ronald J. Whittier 33,162,460 78,744
Patrick C. Condo 33,162,460 78,744
Herbert A. Allen 33,162,460 78,744
Andy D. Bryant 33,162,460 78,744
Robert A. Burgelman 33,162,460 78,744
Stephen D. Greenberg 33,162,460 78,744
Gerald H. Parker 33,162,460 78,744
Item 5. Other Information None.
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Item 6. Exhibits and Reports on Form 8-K
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On September 21, 2001, the Company filed a Form 8-K for Item 5, announcing that
the interactive services agreement the Company entered into with the National
Basketball Association in September 2000 was terminated.
On August 8, 2001, the Company filed a Form 8-K for Item 5, announcing that the
Company had rescheduled its 2001 Annual Meeting of Stockholders to Friday,
October 12, 2001. The Form 8-K also reported that the Company expected to mail
its proxy materials for the Annual Meeting on or about September 17, 2001.
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.
CONVERA CORPORATION
December 14, 2001 By: /s/ Patrick C. Condo
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Patrick C. Condo
President and Chief Executive Officer
(Principal Executive Officer)
December 14, 2001 By: /s/ Christopher M. Mann
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Christopher M. Mann
Chief Financial Officer
(Principal Financial and Accounting Officer)