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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 September 30, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-22993
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INDUS INTERNATIONAL, INC.
(Exact name of Registrant issuer as specified in its charter)
Delaware 94-3273443
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3301 Windy Ridge Parkway, Atlanta, Georgia 30339
(Address of principal executive offices) (Zip code)
(770) 952-8444
(Registrant's telephone number, including area code)
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of November 11, 2002, the Registrant had outstanding 35,175,023 shares of
Common Stock, $.001 par value.
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TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Operations - three and nine months ended
September 30, 2002 and 2001................................................................ 3
Condensed Consolidated Balance Sheets - September 30, 2002 and December 31, 2001............... 4
Condensed Consolidated Statements of Cash Flows - nine months ended
September 30, 2002 and 2001................................................................ 5
Notes to Condensed Consolidated Financial Statements........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risks.................................... 27
Item 4. Controls and Procedures........................................................................ 27
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 28
Item 2. Changes in Securities and Use of Proceeds...................................................... 28
Item 3. Defaults Upon Senior Securities................................................................ 28
Item 4. Submission of Matters to a Vote of Security Holders............................................ 28
Item 5. Other Information.............................................................................. 28
Item 6. Exhibits and Reports on Form 8-K............................................................... 28
Signature...................................................................................... 29
2
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INDUS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
REVENUES:
Software license fees ............. $ 3,057 $ 5,203 $ 11,596 $ 11,540
Services, maintenance and other ... 23,400 39,004 78,335 118,179
-------- ------- -------- ---------
Total revenues ................ 26,457 44,207 89,931 129,719
Cost of revenues ...................... 13,868 19,757 46,144 61,211
-------- ------- -------- ---------
Gross margin .......................... 12,589 24,450 43,787 68,508
-------- ------- -------- ---------
OPERATING EXPENSES:
Research and development ......... 10,607 12,825 35,588 36,629
Sales and marketing .............. 7,256 7,165 22,338 22,430
General and administrative ....... 2,768 4,246 11,752 13,929
Restructuring expenses ........... -- -- 7,425 10,169
-------- ------- -------- ---------
Total operating expenses ....... 20,631 24,236 77,103 83,157
-------- ------- -------- ---------
Income (loss) from operations ......... (8,042) 214 (33,316) (14,649)
Interest and other income, net ........ 31 453 1,029 1,830
-------- ------- -------- ---------
Income (loss) before income taxes ..... (8,011) 667 (32,287) (12,819)
Provision (benefit) for income taxes .. (4,728) 284 (4,426) (96)
-------- ------- -------- ---------
Net income (loss) ..................... $ (3,283) $ 383 $(27,861) $ (12,723)
======== ======= ======== =========
NET INCOME (LOSS) PER SHARE:
Basic ................................. $ (0.09) $ 0.01 $ (0.79) $ (0.37)
======== ======= ======== =========
Diluted ............................... $ (0.09) $ 0.01 $ (0.79) $ (0.37)
======== ======= ======== =========
Shares used in computing per share data
Basic ................................. 35,175 34,906 35,236 34,799
Diluted ............................... 35,175 37,338 35,236 34,799
See accompanying notes
3
INDUS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
ASSETS September 30, 2002 December 31, 2001
------------------ -----------------
Current assets:
Cash and cash equivalents .......................... $ 42,962 $ 59,901
Marketable securities .............................. 871 1,757
Restricted cash .................................... 5,015 --
Billed accounts receivable, net of allowance for
doubtful accounts of $2,224 at September 30, 2002
and $5,713 at December 31, 2001 ................. 15,429 31,337
Unbilled accounts receivable ....................... 3,517 14,666
Income tax receivable .............................. 5,596 1,430
Other current assets ............................... 6,010 5,445
--------- ---------
Total current assets ............................ 79,400 114,536
Property and equipment, net ............................. 18,469 21,877
Other assets ............................................ 1,702 2,754
--------- ---------
Total assets .................................... $ 99,571 $ 139,167
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................... $ 5,300 $ 6,190
Income tax liability ............................... 4,511 1,747
Other accrued liabilities .......................... 18,617 24,432
Current portion of obligations under capital leases 259 4
Deferred revenue ................................... 29,328 39,970
--------- ---------
Total current liabilities ....................... 58,015 72,343
Obligations under capital leases and other liabilities .. 8,216 5,878
Stockholders' equity:
Common stock ....................................... 35 35
Additional paid-in capital ......................... 125,280 123,671
Treasury stock ..................................... (4,680) (2,181)
Note receivable from stockholder ................... -- (55)
Deferred compensation .............................. (128) (157)
Accumulated deficit ................................ (86,148) (58,287)
Accumulated other comprehensive loss ............... (1,019) (2,080)
--------- ---------
Total stockholders' equity ...................... 33,340 60,946
--------- ---------
Total liabilities and stockholders' equity ...... $ 99,571 $ 139,167
========= =========
See accompanying notes.
4
INDUS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
------------------------------
2002 2001
----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .............................................. $(27,861) $(12,723)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ................... 6,336 5,966
Loss on sale of fixed assets .................... 130 --
Changes in operating assets and liabilities:
Billed accounts receivable ................... 15,908 12,971
Unbilled accounts receivable ................. 11,149 (10,799)
Other current assets ......................... (565) 5,163
Other accrued liabilities .................... (5,072) 7,682
Deferred revenue ............................. (10,642) 2,746
Other operating assets and liabilities ....... (682) (1,577)
-------- --------
Net cash (used in) provided by operating activities .... (11,299) 9,429
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities ................. (35,854) (42,819)
Sales of marketable securities ..................... 37,799 57,819
Increase in restricted cash ........................ (5,015) --
Acquisitions of property and equipment, net ........ (2,619) (2,831)
-------- --------
Net cash (used in) provided by investing activities .... (5,689) 12,169
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of capital leases ........................ (108) (55)
Proceeds from issuance of common stock ............. 1,610 816
Purchase of treasury stock ......................... (2,500) --
-------- --------
Net cash (used in) provided by financing activities .... (998) 761
-------- --------
Effect of exchange rate differences on cash ............ 1,047 117
Net (decrease) increase in cash and cash equivalents ... (16,939) 22,476
Cash and cash equivalents at beginning of period ....... 59,901 37,535
-------- --------
Cash and cash equivalents at end of period ............. $ 42,962 $ 60,011
======== ========
See accompanying notes.
5
INDUS INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BUSINESS AND BASIS OF PRESENTATION
Indus International, Inc. (the "Company" or "Indus") develops, markets,
implements and supports integrated Enterprise Asset Management ("EAM") and
supply chain software and service products for capital-intensive industries
worldwide. The Company's three principal software products are PassPort, EMPAC
and Indus InSite(TM), which is offered as a hosted product. These products are
implemented by the Company's Professional Services organization and supported by
its Worldwide Customer Service organization. The Company derives its revenues
from software licensing fees, implementation and training services, maintenance
fees and hosting services. The Company was formed through the combination of The
Indus Group, Inc., a California corporation, and TSW International, Inc., a
Georgia corporation, in August 1997.
Indus' EAM products benefit customers by reducing maintenance and operating
costs, increasing production capacity and speeds, increasing return on assets,
and maintaining regulatory compliance. Proper maintenance of equipment and
facilities can prevent costly failures, limit disruptions, increase tenant
retention, and minimize downtime. More efficient use of personnel and better
control of spare parts can reduce costs. Properly maintained equipment can run
at higher production speeds and have a longer life cycle. Delaying new equipment
purchases lowers the capital expense budget. Proper regulatory compliance can
help companies avoid fines and forced shutdowns. Each of these benefits
represents proven strategies that enable customers to sustain long-term
competitive advantage.
The Company markets its principal EAM products, known as PassPort, EMPAC and
Indus InSite, internationally and to distinct industry segments. Overall Indus'
products and services consist of scalable, flexible business application
software; regional professional services centers positioned throughout the
Americas, Europe, the Middle East and Africa, and Asia Pacific; and service
packages, which support such functional areas as: asset and work management,
materials procurement and eProcurement, knowledge management, safety and
regulatory compliance, mobile computing, electronic document management, and
integration with financial and human resources products.
Historically, the Company has been focused on delivering PassPort and EMPAC
products to industries that have very complex assets, such as utilities, oil and
gas drilling and refining, defense, pulp and paper, metals and mining, and
process manufacturing. In March 2002, the Company launched Indus InSite, a
product designed for the collaborative asset management market that is
accessible through the Internet. Indus InSite was developed using a pure JAVA 2
EE design, thereby ensuring compliance with Internet standards, and is designed
to deliver collaborative asset management to the mid-tier market of industries
with less complex assets. Indus InSite brings Indus EAM expertise to the
mid-tier market of industries that need asset management functionality, but with
higher collaborative capabilities and much lower cost points.
In 2003, Indus will incorporate the broader functionality of the EMPAC product
into InSite and consolidate EMPAC and InSite onto a single development platform.
The Company believes that this consolidated platform will lower its costs and
enhance its ability to deliver competitive software products at economical
prices. The expanded InSite platform will also be functionally richer than
EMPAC, making it an attractive option for existing EMPAC customers, with whom
Indus will work to develop migration plans.
The accompanying unaudited condensed consolidated financial information has been
prepared by management in accordance with accounting principles generally
accepted in the United States for interim financial information and pursuant to
the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted pursuant to the Securities and
Exchange Commission's ("SEC") rules and regulations. In the opinion of
management, all adjustments (which include only normal recurring adjustments)
necessary to present fairly the Company's financial position at September 30,
2002 and results of operations and cash flows for all periods presented have
been made. The condensed, consolidated balance sheet at December 31, 2001 has
been derived from the audited consolidated financial statements at that date.
Certain prior period amounts have been reclassified to conform to current period
classifications.
These condensed, consolidated financial statements should be read in conjunction
with the Company's audited consolidated financial statements for the year ended
December 31, 2001 that are included in the Company's 2001 Annual Report on Form
10-K as filed with the Securities and Exchange Commission. The consolidated
results of operations for the three and nine
-6-
months ended September 30, 2002 are not necessarily indicative of the results to
be expected for any subsequent quarter or period, or for the entire year ending
December 31, 2002.
2. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss), which includes net income (loss), plus foreign
currency translation effects and unrealized gain (loss) on securities
investments, amounted to ($3.0) million and $1.9 million, for the three months
ended September 30, 2002 and 2001, respectively, and ($26.8) million and ($12.6)
million for the nine months ended September 30, 2002 and 2001, respectively.
3. SIGNIFICANT CUSTOMERS
In the first quarter of 2001, the Company announced that the United Kingdom's
Ministry of Defense ("MoD") had selected the Company as the application provider
for the MoD's Defense Stores Management Solution ("DSMS") for logistics and
asset management. The DSMS project represented 29.0% and 24.0% of the Company's
revenues for the three and nine months ended September 30, 2001, respectively.
On January 2, 2002, the Company announced that the MoD had reduced the scope of
its DSMS project due to budget constraints in its current fiscal year, which
ended March 31, 2002. On January 24, 2002, the Company announced that it
received notification that the MoD has suspended all current contractual work on
this project, as it reviews its priorities against long-term resource
availability. The MoD has not advised the Company when this review will be
completed. The DSMS contract represented 6.0% and 2.1% of the Company's revenues
for the three and nine months ended September 30, 2002, respectively.
In the third quarter of 2001, the Company announced that Magnox Electric Plc
("Magnox") had selected the Company to provide work management and compliance
system software for eight nuclear stations. The Company is providing a total
business solution, including the PassPort product suite, implementation
services, and five years of application hosting via Indus' web hosting services.
Magnox is a wholly-owned subsidiary of British Nuclear Fuels Ltd ("BNFL"),
operating BNFL's nuclear power stations. The project is scheduled to include
eight site implementations into 2003. The Magnox contract represented 9.2% and
4.5% of the Company's revenues for the three months ended September 30, 2002 and
2001, respectively, and 12.2% and 2.3% of the Company's revenues for the nine
months ended September 30, 2002 and 2001, respectively.
4. RESTRUCTURING EXPENSES
The Company recorded restructuring costs of $2.1 million and $10.2 million in
2000 and 2001, respectively, in connection with the ongoing relocation of the
Company's headquarters and certain administrative functions to Atlanta, Georgia,
severance payments related to the elimination of 56 global positions, and
charges representing lease termination costs for redundant San Francisco office
space. This relocation was approved by the Board of Directors in July 2000 and
the restructuring charges include costs of approximately $2.8 million for
severance pay for employees affected, and approximately $9.5 million for lease
termination costs associated with reducing leased space in San Francisco. The
San Francisco office leases expire May 31, 2008.
The Company recorded restructuring costs of approximately $3.4 million in the
first quarter of 2002, in connection with the suspension of the MoD's DSMS
project and subsequent demobilization and reduction in workforce. A formal
restructuring plan was approved by the Board of Directors in March 2002 and
includes costs of approximately $947,000 for computer lease termination costs
due to the suspension of the DSMS project, approximately $728,000 of severance
payments related to the elimination of 81 global positions, and approximately
$1.7 million for lease termination costs associated with closing the Company's
Dallas office and reducing leased space in the Company's Pittsburgh office. The
Dallas lease expires December 31, 2005 and the Pittsburgh lease expires
September 30, 2005.
In the second quarter of 2002, the Company incurred restructuring expenses of
$4.0 million. These expenses related to a change in the Company's estimates of
excess lease costs associated with subleasing redundant office space in San
Francisco, Dallas and Pittsburgh. Due to the excess capacity of available lease
space in these markets, lease rates have significantly declined. In San
Francisco, rates have declined from approximately $60 per square foot at the
beginning of 2001 to the $18-$20 per square foot range, which is below the
Company's actual lease cost of $45 per square foot. In Dallas and Pittsburgh,
current lease rates for both markets are in the $10-$14 range, which is below
the Company's actual lease costs of $25-$26 per square foot.
In the third quarter of 2002, the Company announced that it was developing plans
for a reduction in workforce and other cost reductions, and that due to
unfavorable financial performance since the fourth quarter of 2001 and recently
completed reviews of worldwide operations, it would reconfigure its business
model to more effectively develop and support new product offerings and broader
distribution alternatives across the Company's product platforms. The Company
advised that these changes are
-7-
designed to minimize the Company's reliance on large-scale projects and broaden
the Company's focus on expanded market segments in order to create revenue
growth. The first of these actions was taken in July 2002, with the reduction of
31 positions in professional services and administrative functions in the United
States, Canada and Australia. In addition, in August 2002 the Company announced
that due to current customer and development commitments, the initiatives
announced in July 2002 are anticipated to be completed by the end of the second
quarter of 2003. Costs incurred to date in connection with these actions have
not been separately identified as restructuring charges in the accompanying
Condensed Consolidated Financial Statements.
The following is a summary of activity in the restructuring accrual for the nine
months ended September 30, 2002:
(In thousands) Severance and
Related Costs Equipment Facilities Total
------------- --------- ----------- --------
Balance at 12/31/01 ............ $ 174 $ -- $ 7,332 $ 7,506
----- ----- -------- --------
Payments in Q1 2002 .......... -- (6) (527) (533)
Accruals in Q1 2002 .......... 649 953 1,721 3,323
----- ----- -------- --------
Balance at 3/31/02 ............. $ 823 $ 947 $ 8,526 $ 10,296
----- ----- -------- --------
Payments in Q2 2002 .......... (754) (947) (754) (2,455)
Accruals in Q2 2002 .......... (44) -- 3,967 3,923
----- ----- -------- --------
Balance at 6/30/02 ............. $ 25 $ -- $ 11,739 $ 11,764
----- ----- -------- --------
Payments in Q3 2002 .......... (8) -- (1,049) (1,057)
----- ----- -------- --------
Balance at 9/30/02 ............. $ 17 $ -- $ 10,690 $ 10,707
----- ----- -------- --------
The Company does not anticipate taking any significant further restructuring
charges relating to the suspension of the MoD DSMS project. The Company could
incur future restructuring charges or credits, in the event that the underlying
assumptions used to develop the Company's estimates of excess lease costs, such
as the timing and the amount of any sublease income, change.
5. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed using net income and the weighted
average number of common shares outstanding during each period. Diluted earnings
(loss) per share is computed using net income and the weighted average number of
outstanding common shares and dilutive common stock equivalents during each
period, reflecting the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock.
For the three month period ending September 30, 2002 and nine month periods
ending September 30, 2002 and 2001, the Company has not included shares of
common stock issuable upon exercise of options and warrants in the calculation
of EPS as such inclusion would have an anti-dilutive effect. Approximately 10.2
million and 9.0 million common stock options and warrants were outstanding at
September 30, 2002 and 2001, respectively.
-8-
The calculation of the weighted average number of shares outstanding for the
three and nine month periods ended September 30, 2002 and 2001 are as follows
(in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ --------------------------
2002 2001 2002 2001
--------- ---------- --------- ---------
Weighted average shares outstanding
- used for basic ........................... 35,175 34,906 35,236 34,799
Options using the treasury stock method ...... -- 2,246 -- --
Dilutive effect of warrants .................. -- 186 -- --
------ ------ ------ ------
Weighted average shares outstanding and
dilutive equivalents - used for diluted .... 35,175 37,338 35,236 34,799
====== ====== ====== ======
6. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. Under SFAS No. 142, goodwill is no longer subject to amortization;
instead it will be subject to new impairment testing criteria. Other intangible
assets will continue to be amortized over their estimated useful lives, although
those with indefinite lives are not to be amortized but will be tested at least
annually for impairment, using a lower of cost or fair value approach. The
Company adopted SFAS No. 142 in the first quarter of 2002, with no significant
impact on its financial statements.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of, and the accounting and reporting provisions
of Accounting Principles Board Opinion No. 30, Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business. The
Company adopted SFAS No. 144 in the first quarter of 2002, with no significant
impact on its financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment
of Debt, and an amendment of that statement, SFAS No. 64, Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements. In addition, SFAS No. 145
rescinds SFAS No. 44, Accounting for Intangible Assets of Motor Carriers. SFAS
No. 145 amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects similar to
sale-leaseback transactions. SFAS No. 145 also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. SFAS No. 145
is effective for financial statements issued on or after May 15, 2002. The
Company adopted SFAS No. 145 effective May 15, 2002, with no significant impact
on its financial statements.
In July 2002, the FASB issued Statement No. 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS No. 146"). SFAS No. 146 addresses the
financial accounting and reporting for costs associated with exit or disposal
activities, including a definition of Restructuring, and nullifies EITF 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity. SFAS No. 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. The effective date of
SFAS No. 146 is January 1, 2003, with early application encouraged. The Company
will adopt SFAS No. 146 on January 1, 2003. Management is presently assessing
the potential impact of SFAS No. 146.
7. INCOME TAXES
In March 2002, United States federal income tax laws were changed to allow for
the carryback of net operating losses to the previous five years, whereas
previously the maximum period of carryback was two years. Based on this new law
and losses incurred in 2001 and to date in 2002, the Company recorded the
benefit of the new carryback provisions for losses incurred in
-9-
these periods. In July 2002 the Company received a refund of $2.5 million from
carryback of the 2001 loss, and anticipates receiving an additional $0.5 million
for that year before the end of 2002. Application for the carryback of 2002
losses will be made in 2003, concurrent with the filing of the Company's 2002
federal income tax return.
At September 30, 2002, the Company has a net operating loss of approximately
$36.0 million, inclusive of losses through the first nine months of 2002, to
carry forward which, subject to certain limitations, may be used to offset
future income through 2022.
8. STOCK REPURCHASE
In July 1999, the Company's Board of Directors approved a stock repurchase
program for up to 2.0 million shares of the Company's outstanding common stock.
The Company is authorized to use available cash to buy back its shares in open
market transactions from time to time, subject to price and market conditions.
As of September 30, 2002, the Company held as treasury stock 435,500 shares that
had been repurchased under the program.
In April 2002, the Company entered into an agreement with Robert W. Felton, a
founder of the Company and former Chief Executive Officer and Chairman of the
Board of Directors. Under this agreement, the Company repurchased 500,000 shares
of the Company's common stock from Mr. Felton at a price of $5.00 per share,
which approximated market value at the time of the purchase, for an aggregate
purchase price of $2.5 million. As part of this agreement, Mr. Felton agreed not
to transfer or enter into any agreement to transfer the remainder of his shares
of the Company's common stock for a period of one year. These repurchased shares
are also held as treasury stock.
9. RESTRICTED CASH
Certain certificates of deposit, performance bonds, compensating balances and
other accounts are considered restricted cash. The Company had restricted cash
of approximately $5.3 million on September 30, 2002 and $0.3 million on December
31, 2001.
During the first quarter of 2002, the Company generated a net loss of $9.5
million. This loss, as well as the Company's second and third quarter 2002
losses of $15.1 million and $3.3 million, respectively, triggered a default of
the profitability and minimum tangible net worth covenants within the Company's
revolving bank line of credit. This default requires the Company to establish
and maintain a restricted compensating balance with the lender, California Bank
& Trust, equal to all outstanding credit line and letter of credit usage. On
April 1, 2002, the Company established a restricted, interest bearing,
compensating balance account for $2.3 million, to support a standby letter of
credit for the same amount, held by the Company's San Francisco office landlord.
No other usage of the line of credit is anticipated and the Company intends to
maintain the restricted compensating balance for as long as it is required.
At September 30, 2002, the Company had additional, current restricted cash of
approximately $2.7 million, related to a 1.8 million Pound Sterling performance
bond maturing in July 2003, that was established in April 2002 for the Magnox
project. The recoverability of these restricted investments is generally tied to
satisfactory fulfillment of the San Francisco lease obligation and to specific
performance criteria in license and/or professional services contracts.
10. LITIGATION
In June 2000, the Company was served with a demand for arbitration by William
Grabske, the Company's former Chief Executive Officer. Mr. Grabske seeks
enforcement of a purported Settlement Agreement and Mutual Release. The demand
seeks severance pay and reimbursement of expenses of approximately $1.0 million
plus interest, options to purchase approximately 200,000 shares of stock in the
Company, and fees and costs. The Company intends to vigorously contest Mr.
Grabske's demand and has asserted various counterclaims.
The Company does not believe that, individually or in aggregate, the legal
matters to which it is currently a party are likely to have a material adverse
effect on its results of operations or financial condition.
From time to time, the Company is involved in other legal proceedings incidental
to the conduct of its business. The outcome of these claims cannot be predicted
with certainty. The Company intends to defend itself vigorously in these
actions. However, any settlement or judgment may have a material adverse effect
on the Company's results of operations in the period in which such settlement or
judgment is paid or payment becomes probable.
-10-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In addition to historical information, this "Management's Discussion and
Analysis of Financial Condition and Results of Operations" may contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended. These forward-looking statements are not based on historical
facts, but rather reflect management's current expectations concerning future
results and events. These forward-looking statements generally can be
identified by the use of phrases and expressions such as "believe," "expect,"
"anticipate," "intend," "plan," "foresee," "likely," "will" or other similar
words or phrases. Forward-looking statements include, without limitation,
statements related to: the Company's plans, objectives, expectations and
intentions; the timing, availability and functionality of products under
development or recently introduced; and market and general economic conditions.
These forward-looking statements are subject to known and unknown risks and
uncertainties that could cause actual results, performance or achievements to
be different from any future results, performance and achievements expressed or
implied by these statements. Important factors that might cause actual results
to differ materially from those suggested by the forward-looking statements
include, but are not limited to, those discussed in the section of this report
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors Affecting Future Performance" beginning on page
18. Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's opinions only as of the date hereof. The
Company undertakes no obligation to revise or publicly release the results of
any revision to these forward-looking statements. Readers should carefully
review the risk factors described in other documents the Company files from
time to time with the Securities and Exchange Commission ("SEC"), including the
Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and the
quarterly reports on Form 10-Q filed by the Company in fiscal 2002.
On January 22, 2002, the SEC issued Financial Reporting Release No. 61, Release
No. 33-8056, Commission Statement about Management's Discussion and Analysis of
Financial Condition and Results of Operations. The SEC's statement contains
suggested enhanced MD&A disclosures covering liquidity, special purpose
entities and other off-balance sheet arrangements, contractual obligations and
commercial commitments, energy and other commodity contracts, and related party
and other transactions conducted at arm's-length. The Company adopted these
suggested disclosures for reporting within this report and related financial
statements, footnotes, and MD&A. Exclusive of operating leases of the Company's
office facilities and computers and equipment necessary in the ordinary course
of the Company's business, the Company has no special purpose entities or other
off-balance sheet arrangements. The adoption of these disclosure requirements
did not have a significant impact on the Company's financial statements.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosures
of contingent assets and liabilities. On an on-going basis, the Company
evaluates its estimates, including those related to revenue recognition,
accounts receivable and allowance for doubtful accounts, and restructuring. The
Company bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
We have identified the policies below as critical to the Company's business
operations and the understanding of the Company's results of operations. For a
detailed discussion on the application of these and other accounting policies,
see the Notes to Consolidated Financial Statements contained within the
Company's 2001 Annual Report on Form 10-K, as filed with the SEC.
Revenue Recognition:
Revenues from the Company's professional services, which include consulting,
implementation and training services, are generally time and material based and
are recognized as the work is performed. Delays in project implementation will
result in delays in revenue recognition. Some professional services involve
fixed-price and/or fixed-time arrangements and are recognized using contract
accounting, which requires the accurate estimation of the cost, scope and
duration of each engagement. Revenue and the related costs for these projects
are recognized on the percentage-of-completion method, with
progress-to-completion measured by using labor cost inputs and with revisions
to estimates reflected in the period in which
-11-
changes become known. Project losses are provided for in their entirety in the
period they become known. If the Company does not accurately estimate the
resources required or the scope of work to be performed, or does not manage its
projects properly within the planned periods of time or satisfy its obligations
under the contracts, then future consulting margins on these projects may be
negatively affected or losses on existing contracts may need to be recognized.
Accounts Receivable and Allowance for Doubtful Accounts:
Billed and unbilled accounts receivable comprise trade receivables that are
credit based and do not require collateral. The Company maintains an allowance
for doubtful accounts for estimated losses resulting from the inability or
failure of its customers to make required payments. The Company fully reserves
for all billed accounts receivable over 120 days, plus 1.5% of the remaining
billed accounts receivable, plus any other amounts where the Company deems
there is collectibility risk. If the methodology the Company uses to calculate
these estimates does not properly reflect future collections, revenue could be
overstated or understated. On an ongoing basis, the Company evaluates the
collectibility of accounts receivable based upon historical collections and an
assessment of the collectibility of specific accounts. The Company evaluates
the collectibility of specific accounts using a combination of factors,
including the age of the outstanding balance(s), evaluation of the account's
financial condition and credit scores, recent payment history, and discussions
with the Company's account executive for the specific customer and with the
customer directly. Based upon this evaluation of the collectibility of accounts
receivable, any increase or decrease required in the allowance for doubtful
accounts is reflected in the period in which the evaluation indicates that a
change is necessary. If the financial condition of the Company's customers were
to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. The allowance amounted to $2.2 million
as of September 30, 2002 and $5.7 million as of December 31, 2001. The
reduction in the allowance from December 31, 2001 to September 30, 2002 is due
to lower revenues during the first nine months of 2002, translating to a lower
billed accounts receivable balance and correspondingly lower necessary
reserves. Additionally, during the first nine months of 2002 significant
collection activity has resulted in the Company reducing the reserve balance.
The Company generates a significant portion of revenues and corresponding
accounts receivable from sales to the utility industry. As of September 30,
2002, approximately $12.5 million of the Company's gross billed accounts
receivable were attributable to software license fees and support and services
sales to utility customers. In determining the Company's allowance for doubtful
accounts, the Company has considered the utility industry's financial
condition, as well as the financial condition of individual utility customers.
The Company does not foresee collectibility issues related to the utility
industry in general, except for specific customers for which the Company has
specifically reserved for potential uncollectibility.
The Company generated 9.2% of its revenues during the quarter ended September
30, 2002 from a single customer, Magnox, in the United Kingdom. As of September
30, 2002, approximately $1.1 million of the Company's accounts receivable were
attributable to this customer. The Company does not anticipate accounts
receivable collectibility issues related to this customer.
The Company generates a significant portion of its revenues and corresponding
accounts receivable through sales denominated in currencies other than the U.S.
Dollar. As of September 30, 2002, approximately $4.5 million of the Company's
gross billed accounts receivable were denominated in foreign currencies, of
which approximately $2.3 million were denominated in Pound Sterling.
Historically, the foreign currency gains and losses on these receivables have
not been significant, and the Company has determined that foreign currency
derivative products are not required to hedge the Company's exposure. If there
were a significant decline in the Pound Sterling exchange rate, the U.S. Dollar
equivalents received from the Company's customers could be significantly less
than the reported amount. A decline in the exchange rate of the Pound Sterling
to the U.S. Dollar of 10% from the rate as of September 30, 2002 would result
in an exchange loss of approximately $0.2 million.
Restructuring:
At September 30, 2002, the Company had a balance in accrued liabilities of
approximately $10.7 million related to restructuring charges. This
restructuring liability represents lease costs for redundant San Francisco
office space, due to the relocation of the Company's headquarters and certain
administrative functions to Atlanta, Georgia, in 2000 and 2001, as well as
lease costs associated with closing the Company's Dallas office and reducing
leased space in the Company's Pittsburgh office, due to the suspension of the
MoD's DSMS project and subsequent demobilization and reduction in workforce.
The Company could incur future charges or credits in the event that the
underlying assumptions used to develop the Company's estimates of excess lease
costs, such as the timing and the amount of any sublease income, change.
Currently, the Company has sublease arrangements for four of the five redundant
San Francisco office floors. The Company estimates that the remaining floor
will come under sublease arrangement in 2003. The four floors currently under
subleases are projected to generate approximately $5.3 million in sublease
income from October 2002 through May 2008, the date of the
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expiration of these leases. The Company estimates that sublease arrangements
for all five floors could generate approximately $6.2 million of sublease
income from October 2002 through May 2008. If the Company is unable to sublease
the remaining floor, the shortfall of $1.0 million of estimated sublease income
will generate charges against the Company's income from 2003 through 2008, with
the 2003 charge being approximately $77,000. Conversely, the Company could
generate higher than estimated sublease income from 2002 through 2008, if the
remaining floor is sublet faster and/or at higher than estimated sublease
rental rates. Any required increase or decrease in the restructuring accrual
would be reflected in the period in which the evaluation indicates that a
change is necessary.
The Company has no sublease arrangements for the redundant Dallas and
Pittsburgh office space. The Company estimates that this office space will come
under sublease arrangements in 2003. The Company estimates that sublease
arrangements for all of the Dallas and Pittsburgh office space could generate
approximately $0.9 million of sublease income from 2003 through 2005. If the
Company is unable to sublease the office space, the shortfall of $0.9 million
of estimated sublease income will generate charges against the Company's income
from 2003 through 2005. Conversely, the Company could generate higher than
estimated sublease income from 2003 through 2005 from faster signing of
subleases and/or from higher than estimated sublease rental rates. Any required
increase or decrease in the restructuring accrual will be reflected in the
period in which the evaluation indicates that a change is necessary.
As noted above under Note 6 to the Condensed Consolidated Financial Statements
entitled "Recent Accounting Pronouncements," Statement of Financial Accounting
Standards No. 146 establishes a definition of restructuring that is more
restrictive than that used previously. The Company may incur future charges
that previously have been recorded as restructuring charges but under the new
definition may not be separately identified.
-13-
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
total revenues represented by certain line items in the Company's consolidated
statements of operations:
PERCENTAGE OF TOTAL REVENUES
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----- ----- ----- -----
Revenues:
Software license fees .............. 11.6% 11.8% 12.9% 8.9%
Services, maintenance and other .... 88.4% 88.2% 87.1% 91.1%
----- ----- ----- -----
Total Revenues ................. 100.0% 100.0% 100.0% 100.0%
Cost of revenues ....................... 52.4% 44.7% 51.3% 47.2%
----- ----- ----- -----
Gross margin ........................... 47.6% 55.3% 48.7% 52.8%
----- ----- ----- -----
OPERATING EXPENSES:
Research and development .......... 40.1% 29.0% 39.6% 28.2%
Sales and marketing ............... 27.4% 16.2% 24.8% 17.3%
General and administrative ........ 10.5% 9.6% 13.1% 10.7%
Restructuring expenses ............ 0.0% 0.0% 8.2% 7.8%
----- ----- ----- -----
Total operating expenses ........ 78.0% 54.8% 85.7% 64.0%
----- ----- ----- -----
Income (loss) from operations .......... (30.4%) 0.5% (37.0%) (11.2%)
Interest and other income .............. 0.1% 1.0% 1.1% 1.4%
----- ----- ----- -----
Income (loss) before income taxes ...... (30.3%) 1.5% (35.9%) (9.8%)
Provision (benefit) for income taxes ... (17.9%) 0.6% (4.9%) 0.0%
----- ----- ----- -----
Net (income) loss ...................... (12.4%) 0.9% (31.0%) (9.8%)
===== ===== ===== =====
Revenues. The Company's revenues are derived from software licensing fees and
from professional services, which include implementation, consulting and
training services, customer funded development, support fees and hosting fees.
During the three months ended September 30, 2002, total revenues decreased 40%
to $26.5 million, as compared to $44.2 million in the same period of 2001. In
the first nine months of 2002, total revenues decreased 31% to $89.9 million,
as compared to $129.7 million in the same period of 2001.
Revenues from software licensing fees were 12% of total revenues for the three
months ended September 30, 2002 and 2001, and were 13% and 9% of total revenues
for the nine months ended September 30, 2002 and 2001, respectively. Revenues
from software licensing fees decreased 41% to $3.1 million in the quarter ended
September 30, 2002 from $5.2 million for the same period of 2001, and remained
constant at $12 million for the nine months ended September 30, 2002 and 2001.
The decrease in revenues from software license fees is a result of a lower level
of new license revenue bookings during 2002, offset in part by implementation
and delivery from the deferred revenue backlog the Company had when entering
2002. The year-to-date new license revenue bookings for the Company were $3.8
million through September 30, 2002, which was significantly below the $20.3
million booked for the same period of 2001. The lower new license revenue
bookings during 2002 are due to the weakness in capital spending in the primary
vertical markets served by the Company, which include utilities, defense, pulp
and paper, mining and metals, and oil and gas. The year-to-date license bookings
for 2002 of $3.8 million exclude the imputed license value of $2.0 million from
a web hosting sale. The $2.0 million imputed value for this contract represents
the license revenue that would have been booked had this been a traditional
license. Revenue from this web hosting contract, when and if recognized, will be
recognized as service revenue.
Revenues from support and services were 88% of total revenues for the three
months ended September 30, 2002 and 2001, and were 87% and 91% of total
revenues for the nine months ended September 30, 2002 and 2001, respectively.
Revenues from support and services decreased by 40% to $23.4 million for the
three months ended September 30, 2002 from $39.0 million in the same period of
2001, and decreased by 34% to $78.3 million for the nine months ended September
30, 2002 from $118.2 million in the same period of 2001. This decrease is
attributable to the suspension of the MoD's DSMS project, which was previously
announced in January 2002. Excluding the DSMS project, revenues from support
and services decreased by 16% to $21.8 million for the three months ended
September 30, 2002 from $26.1 million in the same period of 2001, and decreased
14% to $76.4 million for the nine months ended September 30, 2002 from $89.2
million in the same period of 2001. Excluding
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the DSMS project, the lower 2002 revenues from support and services are due to
lower implementation consulting services in 2002 resulting from the Company's
lower level of new license revenue bookings during 2002, as well as lower
services revenue from the multi-year British Energy project as it winds down
toward completion in early 2003. These decreases were offset by higher services
and web hosting revenue from the Magnox project, which started in the second
quarter of 2001. The Magnox contract represented 9.2% and 4.5% of the Company's
revenues for the three months ended September 30, 2002 and 2001, respectively,
and 12.2% and 2.3% of the Company's revenues for the nine months ended
September 30, 2002 and 2001, respectively.
From a geographic perspective, during the three months ended September 30,
2002, 70% of revenues were generated in North America, 26% of revenues were
generated in EMEA (Europe, Middle East and Africa), and the remaining 4% were
generated in APAC (Asia and the Pacific Rim), as compared to 57% of revenues
from North America, 42% from EMEA and 1% from APAC during the three months
ended September 30, 2001. During the first nine months of 2002, 70% of revenues
were generated in North America, 25% of revenues were generated in EMEA, and
the remaining 5% were generated in APAC, as compared to 63% of revenues from
North America, 34% from EMEA and 3% from APAC during the nine months ended
September 30, 2001. As most of the Company's contracts for the three and nine
months ending September 30, 2002 and 2001 are denominated in U.S. dollars,
foreign currency fluctuations have not significantly impacted the Company's
results of operations.
The Company had total deferred revenue of $29.3 million as of September 30,
2002 and $40.0 million as of December 31, 2001. The decrease in total deferred
revenue is due to the lower level of new license bookings during 2002. The
Company had deferred licensing revenue in the amount of $14.4 million at
September 30, 2002 and $21.1 million at December 31, 2001. The decrease in
deferred licensing revenue reflects more recognition of revenue from the
deferred license bookings generated prior to 2002 than was deferred during the
first nine months of 2002 from new licensing contracts.
Cost of Revenues. Cost of revenues consists of (i) personnel and related costs
for implementation and consulting services, (ii) personnel and related costs
for training and customer support services, (iii) amortization of license fees
paid to third parties for inclusion of their products in the Company's
software, and (iv) personnel, data maintenance and related costs for web
hosting services. Gross profits on license fees are substantially higher than
gross profits on services revenues, due to the relatively high personnel costs
associated with providing implementation, maintenance, consulting, training and
web hosting services.
The cost of licensing revenue was $0.4 million and $0.1 million for the three
month periods ended September 30, 2002 and 2001, respectively, and $2.4 million
and $0.5 million for the nine month periods ended September 30, 2002 and 2001,
respectively. Gross margins on licensing fees were 85% and 98% during the three
months ended September 30, 2002 and 2001, respectively, and were 79% and 96%
during the nine months ended September 30, 2002 and 2001, respectively. The
higher cost of licensing revenue in 2002 and lower 2002 margin are the result
of the product mix where license fees recognized in 2002 have been more
dependent on third party products than license fees recognized in 2001.
The cost of support and services was $13.4 million and $19.6 million for the
three month periods ended September 30, 2002 and 2001, respectively, and $43.7
million and $60.7 million for the nine month periods ended September 30, 2002
and 2001, respectively. Gross margins on support and services were 43% and 50%
during the three months ended September 30, 2002 and 2001, respectively, and
were 44% and 49% during the nine months ended September 30, 2002 and 2001,
respectively. The decrease in margin was a result of lower professional
services utilization with the demobilization of resources, due to the
suspension of the MoD's DSMS project, as well as lower overall service margins
due to the loss of higher margin services related to the DSMS project.
Total gross margin as a percentage of revenues decreased to 48% for the three
months ended September 30, 2002 from 55% for the same period in 2001, and
decreased to 49% for the nine months ended September 30, 2002 from 53% for the
same period in 2001. The decrease in overall gross margins is a result of
higher third party costs for license fees, lower service margins due to the
loss of higher margin services related to the DSMS project and also due to
lower professional services utilization, offset by a higher mix of license
revenues (which have a higher margin than services) to total revenues.
Research and Development. Research and development expenses consist of
personnel and related costs, computer processing costs and third party
consultant fees directly attributable to the development of new software
application products and enhancements to existing products.
Research and development expenses decreased 17% to $10.6 million in the three
months ended September 30, 2002 from $12.8 million in the same period of 2001,
and decreased 3% to $35.6 million in the nine months ended September 30, 2002
from
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$36.6 million in the same period of 2001. The decreases in research and
development expenses are due to staff reductions between the fourth quarter of
2001 and the second quarter of 2002, and the reduced use of outside
consultants.
As a percentage of total revenues, research and development expenses were 40%
and 29% for the three months ended September 30, 2002 and 2001, respectively,
and were 40% and 28% for the nine months ended September 30, 2002 and 2001,
respectively. The Company believes that a significant level of investment in
research and development is important to remain competitive. To date, the
Company has expensed all software development costs as incurred.
Sales and Marketing. Sales and marketing expenses include personnel costs,
sales commissions, and the costs of advertising, public relations, and
participation in industry conferences and trade shows.
Sales and marketing expenses increased 1% to $7.3 million in the three months
ended September 30, 2002 from $7.2 million in the same period of 2001, and
decreased 1% to $22.3 million in the nine months ended September 30, 2002 from
$22.4 million in the same period of 2001. The change from 2001 in sales and
marketing expense for both the three and nine month periods ended September 30
is insignificant in the aggregate. Increased spending on the new InSite hosted
product has been offset by a comparable reduction in spending related to
PassPort and EMPAC as the Company continues to review and rationalize ongoing
sales and marketing investments in the Company's core vertical and geographic
markets. As a percentage of total revenues, sales and marketing expenses were
27% and 16% for the three months ended September 30, 2002 and 2001,
respectively, and were 25% and 17% for the nine months ended September 30, 2002
and 2001, respectively.
General and Administrative. General and administrative expenses include
personnel and other costs of the Company's finance, human resources and
administrative operations.
General and administrative expenses decreased 35% to $2.8 million in the three
months ended September 30, 2002 from $4.3 million in the same period of 2001,
and decreased 16% to $11.8 million in the nine months ended September 30, 2002
from $13.9 million in the same period of 2001. The decrease in general and
administrative expenses in the third quarter of 2002 is a result of lower
salaries and benefits from reduced headcount and lower lease costs due to the
elimination of redundant space in the Company's San Francisco, Dallas and
Pittsburgh offices (see Restructuring Expenses below). As a percentage of total
revenues, general and administrative expenses were 11% and 10% for the three
months ended September 30, 2002 and 2001, respectively, and were 13% (10%
excluding the $3.0 million of separation charges for the Company's departed
Chief Executive Officer and Chief Operating Officer expensed in the second
quarter of 2003) and 11% for the nine months ended September 30, 2002 and 2001,
respectively.
Restructuring Expenses. No additional restructuring expenses were incurred in
the third quarter ended September 30, 2002. In the second quarter of 2002, the
Company incurred restructuring expenses of $4.0 million. These expenses related
to a change in the Company's estimates of previously announced excess lease
costs associated with subleasing excess office space in San Francisco. In the
first quarter of 2002, the Company incurred $3.4 million of restructuring
expenses related to the suspension of the MoD's DSMS project and subsequent
demobilization and reduction in workforce, and elimination of excess leased
office space in Dallas and Pittsburgh. Included in these restructuring charges
were costs of approximately $947,000 for computer lease termination costs due
to the suspension of the DSMS project, approximately $728,000 of severance
payments related to the elimination of 81 global positions, and approximately
$1.7 million for lease termination costs associated with closing the Company's
Dallas office and reducing leased space in the Company's Pittsburgh office. The
Dallas lease expires December 31, 2005 and the Pittsburgh lease expires
September 30, 2005. The $2.2 million of restructuring charges for the first
quarter of 2001 relate to the relocation of certain administrative functions
from San Francisco to Atlanta.
In the second quarter of 2001, restructuring expenses of $8.0 million were
incurred, resulting from estimated excess lease costs associated with
subleasing redundant San Francisco office space and the relocation of certain
administrative functions from San Francisco to Atlanta.
In the third quarter of 2002 the Company announced that it was developing plans
for a reduction in workforce and other cost reductions, and that due to
unfavorable financial performance since the fourth quarter of 2001 and recently
completed reviews of worldwide operations, it would reconfigure its business
model to more effectively develop and support new product offerings and broader
distribution alternatives across the Company's product platforms. The Company
advised that these changes are designed to minimize the Company's reliance on
large-scale projects and broaden the Company's focus on expanded market
segments in order to create revenue growth. The first of these actions was
taken in July 2002, with the reduction of 31 positions in professional services
and administrative functions in the United States, Canada and Australia. In
addition, in August 2002 the Company announced that due to current customer and
development commitments, the initiatives announced in July 2002 are anticipated
to be completed by the end of the second quarter of 2003. It is anticipated by
the Company that these initiatives will
-16-
enable the Company to reduce its operating cost by over $7 million on an
annualized basis. Costs incurred to date in connection with these actions have
not been separately identified as restructuring charges.
The Company does not anticipate taking any significant further restructuring
charges relating to the suspension of the MoD DSMS project. The Company could
incur future charges or credits, in the event that the underlying assumptions
used to develop the Company's estimates of excess lease costs, such as the
timing and the amount of any sublease income, change. The Company could also
incur future charges which the Company cannot presently estimate for further
restructuring of the business.
Interest and Other Income. Interest and other income are generated from the
Company's investments in marketable securities and interest-bearing cash and
cash equivalents. Interest and other income decreased 93% to $31,000 for the
three month period ended September 30, 2002 from $0.5 million for the same
period in 2001, and decreased 44% to $1.0 million for the nine month period
ended September 30, 2002 from $1.8 million for the same period in 2001. The
decrease during the third quarter of 2002 was due to losses incurred on asset
disposals as well as lower interest income, as compared to the same period in
2001. The decrease for the nine months ended September 30, 2002 from the same
period in 2001 is due to lower interest income. The decrease in interest income
is a result of lower cash balances and a lower interest rate environment. The
Company expects a continuation of lower interest income based upon lower
expected cash balances and expected continuation of current low interest rates.
Provision (benefit) for Income Taxes. Income taxes include federal, state and
foreign income taxes. The income tax benefit for the three and nine month
periods ended September 30, 2002 results from a $4.7 million benefit
attributable to U.S. Federal income tax law change in 2002, which allows the
carryback of losses for five years instead of two years under the prior law.
For the nine month period ended September 30, 2002, the tax benefit of the new
law has been offset by a foreign income tax provision of $0.3 million. Income
taxes for the third quarter of 2001 relate to foreign operations, and for the
nine month period ending September 30, 2001 the net tax benefit arises from a
foreign tax loss carryback. Through September 30, 2002, the Company has a net
operating loss of approximately $36 million to carry forward which, subject to
certain limitations, may be used to offset future income through 2022.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2002, the Company's principal sources of liquidity
consisted of approximately $43.0 million in cash and cash equivalents, $1.7
million in short and long-term marketable securities, and $5.3 million in short
and long-term restricted cash, for a total of $50.0 million, as compared to
$63.8 million at December 31, 2001, and $63.1 million at September 30, 2001.
The Company's revolving credit facility for $15.0 million expires on May 31,
2003. Borrowings under the line of credit bear interest at the prime rate or
LIBOR rate plus 1.00%. There were $2.3 million in standby letters of credit
outstanding on this line of credit as of September 30, 2002.
During the first quarter of 2002, the Company generated a net loss of $9.5
million, due mainly to the suspension of the MoD's DSMS project, as well as a
slow-down in capital spending in the vertical markets that the Company serves.
The Company also generated a $15.1 million net loss during the second quarter
of 2002, due to the suspension of the MoD's DSMS project, a slow-down in
professional services, $4.0 million of related restructuring charges taken
during the second quarter of 2002, and $3.0 million of operating charges in
conjunction with the separation agreements for the Company's departing Chief
Executive Officer and Chief Operating Officer. During the third quarter of
2002, the Company incurred additional losses of $3.3 million due to a
continuation of the economic slow down, offset by income tax benefits from tax
loss carrybacks. These losses during the first, second and third quarters of
2002 triggered a default of the profitability and minimum tangible net worth
covenants within the Company's revolving bank line of credit. This default
requires the Company to establish and maintain a restricted compensating
balance with the lender, California Bank & Trust, equal to all outstanding
credit line and letter of credit usage. On April 1, 2002 the Company
established a restricted, interest bearing, compensating balance account for
$2.3 million, to support a standby letter of credit for the same amount, held
by the Company's San Francisco office landlord. No other usage of the line of
credit is anticipated and the Company intends to maintain the restricted
compensating balance for as long as required.
The lender provided the Company with waivers of the covenant defaults for the
first and second quarters of 2002. In addition, the lender has provided the
Company with a forward looking waiver for each quarter after the second quarter
of 2002, up to and including the quarter ending March 31, 2003 (the line of
credit expires on May 31, 2003), if the Company maintains the required
compensating balance. The Company is not in reliance on the line of credit,
except for the $2.3 million standby letter of credit.
-17-
Cash used in operating activities was $11.3 million for the nine months ended
September 30, 2002. The Company generated $27.1 million of cash from accounts
receivable reductions, which offset the cash used to finance the Company's $27.9
million net loss for the period and other working capital usage, including a
$10.6 million decrease in deferred revenue due to the Company recognizing more
license revenue from the deferred account than was added to the deferred account
from new license bookings during the first nine months of 2002.
Cash used in investing activities was $5.7 million for the nine months ended
September 30, 2002. The Company generated net cash of $1.9 million from the
sales/purchases of marketable securities. Capital expenditures were $2.6
million for the nine months ended September 30, 2002 and were made to support
the Company's internal information systems. Restricted cash increased by $5.0
million during the first nine months of 2002, which was related to the $2.3
million compensating balance necessary to support the Company's standby letter
of credit held by its San Francisco office landlord, and the $2.7 million
performance bond that was established in April 2002 for the Magnox project,
which matures in July 2003.
Cash used in financing activities was $1.0 million for the nine months ended
September 30, 2002, due to a $2.5 million repurchase of the Company's stock,
offset by $1.6 million generated from the exercise of employee stock options
and purchases from the employee stock purchase plan. In April 2002, the Company
entered into an agreement with Robert W. Felton, a founder of the Company and
former Chief Executive Officer and Chairman of the Board of Directors. Under
this agreement, the Company repurchased 500,000 shares of the Company's common
stock from Mr. Felton at a price of $5.00 per share, for an aggregate purchase
price of $2.5 million. As part of this agreement, Mr. Felton agreed not to
transfer or enter into any agreement to transfer the remainder of his shares of
the Company's common stock for a period of one year.
There was a positive $1.0 million impact on cash from the effect of foreign
exchange rate differences during the nine months ended September 30, 2002.
As of September 30, 2002, the Company's primary commitments are its leased
office space in Atlanta, San Francisco and Woking, England. The Company leases
its office space under non-cancelable lease agreements that expire at various
times through 2012.
The Company believes that its existing cash, cash equivalents, marketable
securities, and restricted cash, together with anticipated cash flows from
operations will be sufficient to meet its cash requirements for at least the
next 12 months; however, this belief is based upon management's assumption that
it will be successful in reducing or eliminating the Company's operating losses
in the next several quarters. If management is not successful in reducing
operating losses and additional sources of cash are not available to the
Company, this would result in a material adverse effect on the Company's
financial results. The foregoing statement regarding the Company's expectations
for continued liquidity is a forward-looking statement, and actual results may
differ materially depending on a variety of factors, including variable
operating results, continued operating losses, presently unexpected uses of
cash and the factors discussed under the section "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Factors Affecting
Future Performance."
FACTORS AFFECTING FUTURE PERFORMANCE
The Company's Operating Results May Fluctuate Significantly from
Quarter-to-Quarter.
The Company's operating results have fluctuated in the past, and the Company's
results may fluctuate significantly in the future. Prior to the third quarter
of 2001, the Company had generated net operating losses for the seven prior
quarters, starting with a $6.8 million loss in the fourth quarter of 1999,
increasing to a $20.2 million loss in the second quarter of 2000, and
decreasing subsequently to a $6.7 million loss in the second quarter of 2001.
Although the Company was profitable in the third and fourth quarters of 2001,
the Company generated operating losses of $9.5 million, $15.1 million and $3.3
million in the first, second and third quarters of 2002, and does not expect to
be profitable on a quarterly basis until some point in 2003, and may not be
profitable in future quarters. Operating results of the Company may fluctuate
from quarter to quarter, depending on a number of factors, including:
- - the relatively long sales cycles for its products;
- - delays or deferral in the completion of product implementation;
- - the variable size and timing of individual license transactions;
- - changes in demand for its products and services;
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- - market acceptance of new products, including Indus InSite(TM), its
web-based offerings and any next generation product offerings;
- - delays associated with product development, including the development
and introduction of new releases of existing products;
- - delays in payment or non-payment of large accounts receivable;
- - the development and introduction of new operating systems and/or
technological changes in computer systems that require additional
development efforts;
- - competitive conditions in the industry, including changes in the
pricing policies of the Company or its competitors;
- - changes in customer budgets;
- - the introduction of new products or product enhancements by the
Company or its competitors;
- - the Company's success in, and costs associated with, developing,
introducing and marketing new products, including the necessary
software and technology for Indus InSite(TM), its web-based offerings
and its next generation product initiatives;
- - product life cycles;
- - changes in the proportion of revenues attributable to licensing fees,
hosting fees and services;
- - changes in the level of operating expenses;
- - software defects and other product quality problems;
- - successful completion of customer funded development and
implementation projects;
- - success in expanding sales and marketing programs;
- - personnel changes, including changes in Company management;
- - changes in the Company's sales organization;
- - fluctuations in foreign currency exchange rates;
- - effect of SEC requirements and AICPA Statements of Position on the
Company's revenue recognition; and
- - other economic conditions, generally, or in specific vertical industry
segments.
Changes in operating expenses or variations in the timing of recognition of
specific revenues resulting from any of the these factors can cause significant
variations in operating results from quarter to quarter and may in some future
quarter result in losses or have a material adverse effect on the Company's
business or results of operations.
Market Acceptance of Indus InSite(TM) and Other New Products
In March 2002, the Company launched its hosted, Internet-based EAM product,
Indus InSite(TM). There can be no assurance that any of the Company's new or
enhanced products, including Indus InSite(TM), its web-based offerings, or any
of its next generation of products will be sold successfully or that they can
achieve market acceptance. The Company's future success with Indus InSite(TM),
its web-based offerings and other next generation product offerings will depend
on its ability to accurately determine the functionality and features required
by its customers, as well as the ability to enhance its products and deliver
them in a timely manner. The Internet market is an emerging market that may
undergo rapid technological change. The Company cannot predict the present and
future size of the potential market for Indus InSite(TM), its web-based
offerings or any of its next generation of products. The Company may incur
substantial costs to enhance and modify its products and services in order to
meet the demands of this potential market.
The Company May Not Be Able to Successfully Consolidate Its EMPAC and InSite
Products
In October 2002, the Company announced its plans to consolidate it EMPAC and
InSite products onto a single development platform. The Company also announced
that its existing EMPAC and MPAC-UX customers would be offered a migration path
to the consolidated platform. There can be no assurance that the Company can
successfully consolidate these two products onto a single development platform
or that the Company's existing EMPAC and MPAC-UX will migrate to the new
development platform, or that the Company can quickly and cost-effectively
affect such migrations. Difficulties or delays in consolidating these two
products or in migrating customers to the new development platform could result
in a material adverse effect on the Company's business, results of operations
and financial condition.
Risks Related to Delays in Product Development
The Company has in the past experienced delays in product development, and there
can be no assurance that the Company will not experience further delays in
connection with its current product development or future development
activities. In October 2002, the Company announced an accelerated development
schedule for Indus InSite(TM) and the planned consolidation of two products,
EMPAC and Indus InSite(TM), onto a single development platform. If the Company
is unable to develop and introduce new products, or enhancements to existing
products, or to execute the consolidation of EMPAC and Indus InSite(TM)
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development platforms, in a timely manner in response to changing market
conditions or customer requirements, it may affect the Company's ability to
execute the consolidation of the EMPAC and Indus InSite(TM) products and the
Company's business, operating results and financial condition will be
materially and adversely affected. Because the Company has limited resources,
the Company must effectively manage and properly allocate and prioritize its
product development and enhancement efforts and its efforts relating to newer
products and operating systems. There can be no assurance that these efforts
will be successful or, even if successful, that any resulting products or
operating systems will achieve customer acceptance.
Lengthy Implementations and Other Professional Services Engagements
Following license sales, the implementation of the Company's PassPort and EMPAC
products and their extended solutions generally involves a lengthy process,
including customer training and consultation. In addition, the Company is often
engaged by its existing customers for other lengthy professional services
projects. A successful implementation or other professional services project
requires a close working relationship between the Company, the customer and, if
applicable, third party consultants and systems integrators who assist in the
process. These factors may increase the costs associated with completion of any
given sale, increase the risks of collection of amounts due during
implementations or other professional services projects, and increase risks of
cancellation or delay of such projects. Delays in the completion of a product
implementation or with any other professional services project may require that
the revenues associated with such implementation or project be recognized over
a longer period than originally anticipated, or may result in disputes with
customers regarding performance by the Company and payment by the customers.
Such delays in the implementation have caused, and may in the future cause,
material fluctuations in the Company's operating results. Similarly, customers
may typically cancel implementation projects at any time without penalty, and
such cancellations could have a material adverse effect on the Company's
business or results of operations. Because the Company's expenses are
relatively fixed, a small variation in the timing of recognition of specific
revenues can cause significant variations in operating results from quarter to
quarter and may in some future quarter result in losses or have a material
adverse effect on the Company's business or results of operations.
Risk Associated with Magnox Electric Plc ("Magnox") Implementation and Indus
Hosting
In the third quarter of 2001, the Company announced that Magnox Electric Plc
("Magnox") had selected the Company to provide work management and compliance
system software for eight nuclear stations. The Company is providing a total
business solution, including the PassPort product suite, implementation
services, and five years of application hosting via Indus' web hosting
services. Magnox is a wholly owned subsidiary of British Nuclear Fuels Ltd
("BNFL"), operating BNFL's nuclear power stations. The project is scheduled to
include site implementations through the second quarter of 2003. The Magnox
contract represented 12.2% of the Company's revenues for the nine months ended
September 30, 2002. Due to the size of this project and the recent percentage
of revenue it represents, problems with the successful and timely completion of
the implementation could have a material adverse effect on the future financial
results or financial position of the Company. Moreover, Indus has limited
experience hosting its Passport product and if there are problems with the
Indus web hosting services that result in the cancellation or material
alteration of the contract for any reason may have a material adverse effect on
the future financial results or financial position of the Company.
Risk Associated with the United Kingdom's Ministry of Defense ("MoD") Agreement
On January 2, 2002, the Company announced that the MoD had reduced the scope of
its DSMS project due to budget constraints in the MoD's fiscal year, which
ended March 31, 2002. On January 24, 2002, the Company announced that it
received notification that the MoD has suspended all current contractual work
on this project, as it reviews its priorities against long-term resource
availability. The MoD has not advised the Company when this review will be
completed. The DSMS contract represented 23.3% of the Company's revenues for
the twelve months ended December 31, 2001. The Company generated a $27.9
million net loss during the first nine months of 2002, due in significant part
to the suspension of the MoD's DSMS project, including $3.4 million of related
restructuring charges. The Company cannot assure investors that the DSMS
project will be resumed, or if it is resumed what the scope of work will
involve. Moreover, the Company has demobilized resources that were working on
the DSMS project and in the event that the DSMS project is resumed, there can
be no assurance that the Company will be able to remobilize its resources in a
timely and efficient manner.
Risks Associated with Liquidity and Bank Line of Credit
As of September 30, 2002, the Company's principal sources of liquidity
consisted of approximately $50.0 million in cash and cash equivalents, short
and long-term marketable securities, and short and long-term restricted cash,
as compared to $63.8 million at December 31, 2001. The Company believes that
its existing cash, cash equivalents, marketable securities, and restricted
cash, together with anticipated cash flows from operations will be sufficient
to meet its cash requirements for at least
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the next 12 months; however, this belief is based upon management's assumption
that it will be successful in reducing or eliminating the Company's operating
losses in the next several quarters. If management is not successful in
reducing operating losses and additional sources of cash are not available to
the Company, this would result in a material adverse effect on the Company's
financial position.
The Company generated net losses during each of the first three quarters of
2002. The loss during the first quarter of 2002 triggered a default of the
profitability and minimum tangible net worth covenants contained in the
Company's bank line of credit. As a result of this default, the Company is
required to maintain a compensating balance, equal to all outstanding credit
line and letter of credit usage, with the lender. Other than a continuing $2.3
million standby letter of credit, no other usage of the line of credit is
anticipated and the Company has funded the compensating balance without
negatively impacting the operations of the business. However, the lender's
requirement that the Company maintain a compensating balance for all credit
line usage effectively negates the Company's ability to use the bank line of
credit for any reason other than its current letter of credit purposes and
could negatively impact the Company's liquidity. The lender has provided the
Company with a waiver for the first and second quarters of 2002. In addition,
the lender has provided the Company with a forward looking waiver for each
quarter after the second quarter of 2002, up to an including the quarter ending
March 31, 2003 (the line of credit expires on May 31, 2003), if the Company
maintains the required compensating balance. The Company is not in reliance on
the line of credit, except for the $2.3 million standby letter of credit.
Market Acceptance of Indus InSite(TM) Depends, In Part, on the Continued
Acceptance of the Internet for Business Transactions
The development of the Internet as a medium for business transactions, and
asset management in particular, is in a relatively formative stage. As Indus
continues to develop and market Indus InSite(TM) and other Internet-based
products, the success of those products will depend on the continued use and
development of the Internet as a tool for the transaction of business, and
asset management in particular. Indus cannot assure investors that the
infrastructure or complementary services necessary to maintain the Internet
will be developed or maintained. If the Internet fails as a medium for business
transactions, and asset management in particular, it would have a material
adverse affect on the market acceptance of Indus InSite(TM) and other
Internet-based products we develop.
Security Risks and Concerns May Deter the Use of the Internet, Which Could
Adversely Affect the Market Acceptance of Indus InSite(TM)
A significant barrier to the adoption and success of Internet-based products
like Indus InSite(TM) is the secure transmission of confidential information
over public networks. Advances in computer capabilities, new discoveries in the
field of cryptography or other events or developments could result in
compromises or breaches of security systems. If any well-publicized compromises
of security were to occur, it could have the effect of substantially reducing
the use of the Internet for commerce and communications. Anyone who circumvents
the security measures for Indus InSite(TM) could misappropriate proprietary
information or cause interruptions in the services Indus provides through Indus
InSite(TM) and its other Internet-based products. The Internet is a public
network, and data is sent over this network from many sources. In the past,
computer viruses, software programs that disable or impair computers, have been
distributed and have rapidly spread over the Internet. Computer viruses could
be introduced into the Indus InSite(TM) system or those of the Company's
customers or suppliers, which could disrupt Indus InSite(TM) or make it
inaccessible to customers. Indus may be required to expend significant capital
and other resources to protect against the threat of security breaches or to
alleviate problems caused by breaches. To the extent that the Company's
activities may involve the storage and transmission of proprietary information,
security breaches could expose the Company to a risk of loss or litigation and
possible liability. The Company's security measures may be inadequate to
prevent security breaches, and the adoption of Indus InSite(TM) and the
Company's business in general would be materially harmed if the Company does
not prevent them.
Decrease in Demand for the Company's Products and Services and the Overall EAM
Market
In recent quarters the Company has experienced a decrease in demand for its
PassPort and EMPAC products and related services, which the Company believes is
due to unfavorable general economic conditions and decreased capital spending
by companies in the industries the Company serves. If these economic conditions
persist, the Company's business, results of operations and financial condition
are likely to be materially adversely affected.
Moreover, overall demand for enterprise software products and services in
general may grow slowly or decrease in upcoming quarters and years because of
unfavorable general economic conditions, decreased capital spending by
companies in need of EAM solutions or otherwise. This may reflect a saturation
of the market for enterprise software solutions generally, as well as
deregulation and retrenchment affecting the way companies purchase EAM
software. To the extent that there is a slowdown in
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the overall market for EAM software, the Company's business, results of
operations and financial condition are likely to be materially adversely
affected.
Changes in Management
The Company has had significant turnover at the executive management level from
2000 through September 2002, including the appointment of a new Chief Financial
Officer in April 2002 and a new Chief Executive Officer in July 2002, the
elimination of the Chief Operating Officer position in July 2002, and the
appointment of a new Executive Vice President of Worldwide Operations in
September 2002. The current executive management team has only recently begun
to work together, and they may be unable to integrate and work effectively as a
team. There can be no assurance that the Company will be able to motivate and
retain the current executive management team or that they will be able to work
together effectively. If the Company loses any members of its executive
management team or they are unable to work together effectively, the Company's
business, operations and financial results could be adversely affected.
Hiring and Retaining Employees
The Company's future success depends, in significant part, upon the continued
service of its key technical, sales and senior management personnel, as well as
its ability to attract and retain new personnel. For example, the Company is in
the process of restructuring its sales force and is actively recruiting to fill
several key sales positions. Competition for qualified sales, technical and
other personnel is intense, and there can be no assurance that the Company will
be able to attract, assimilate or retain additional highly qualified employees
in the future. If the Company is not able to hire and retain personnel to fill
the positions created by its internal restructuring, particularly in senior
management positions, its business, operating results and financial condition
would be materially adversely affected. Additions of new personnel and
departures of existing personnel, particularly in key positions, can be
disruptive and have a material adverse effect on the Company's business,
operating results and financial condition.
In addition, the Company underwent several reductions in force during 2002,
largely in response to the suspension of the DSMS project by the MoD and
general weakness in capital expenditures in the industries that the Company
serves. The Company may not be able to rehire these people, or hire other
qualified personnel, if the DSMS project is resumed or when general economic
conditions improve, which could adversely affect the Company's future operating
results.
Risks Related to Restructuring
Over the last several years the Company has undertaken several internal
restructuring initiatives. For example, during 2000 and 2001, the Company
restructured some of its operations by, among other things, relocating its
corporate headquarters and administrative functions to Atlanta, Georgia from
San Francisco, California, which resulted in the elimination of 56 global
positions. In March 2002, the Board of Directors approved a formal
restructuring plan that, among other things, resulted in the elimination of 81
global positions and the closing of the Company's Dallas office. In July and
August 2002, the Company announced that, due to unfavorable financial
performance since the fourth quarter of 2001 and recently completed reviews of
worldwide operations, it would reconfigure its business model and is developing
plans for one or more reductions in workforce and other cost reductions to
restructure and resize the business. The first of these restructuring actions
was taken in July 2002, with the reduction of 31 positions in professional
services and administrative functions in the United States, Canada and
Australia. These types of internal restructurings have operational risks,
including reduced productivity and lack of focus as the Company terminates some
employees and assigns new tasks and provides training to other employees. In
addition, there can be no assurance that the Company will achieve the
anticipated cost savings from these restructurings and any failure to achieve
the anticipated cost savings could cause the Company's financial results to
fall short of expectations and adversely affect the Company's financial
position.
The Company has taken charges for restructuring expenses, including an $8.0
million charge in the second quarter of 2001, a $3.4 million charge in the
first quarter of 2002, and a $4.0 million charge in the second quarter of 2002,
and there can be no assurance that additional charges for restructuring
expenses will not be taken in future quarters. Significant future restructuring
charges could cause financial results to be unfavorable.
Managing Operations
Changes to the Company's business and customer base have placed a strain on
management and operations. Previous expansion had resulted in substantial
growth in the number of Company employees, the scope of its operating and
financial systems and the geographic area of its operations, resulting in
increased responsibility for management personnel. The planned
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restructuring (discussed above in Risks Related to Restructuring) has recently
placed additional demands on management. In connection with this planned
restructuring, the Company will be required to effectively manage its
operations, improve its financial and management controls, reporting systems
and procedures on a timely basis, and to train and manage its employee work
force. There can be no assurance that the Company will be able to effectively
manage its operations during this restructuring and failure to do so would have
a material adverse effect on its business, operating results and financial
condition.
Intense Competition
The EAM market is intensely competitive. In order to remain competitive, the
Company must continually enhance its baseline software and integration products
and develop new products in a timely fashion. The Company believes that the
principal competitive factors in its businesses will be:
- - product performance and functionality;
- - the Company's ability to develop new products and new releases of
existing products in a timely fashion;
- - adaptability to new trends driven by technology and customer
requirements;
- - cost of internal product development as compared with cost of purchase
of products supplied by outside vendors;
- - cost of ongoing maintenance; and
- - time-to-market with, market acceptance of, enhancements to
functionality of, new services and new products, including Indus
InSite(TM).
The Company's success also depends significantly on its ability to develop more
advanced products more quickly and less expensively than its existing and
potential competitors and to educate potential customers of the benefits of
licensing the Company's products. Some of the Company's competitors have
substantially greater financial, technical, sales, marketing and other
resources, as well as greater name recognition and a larger customer base, than
the Company, which may allow them to introduce products with more features,
greater functionality and lower prices than the Company's products. These
competitors could also bundle existing or new products with other, more
established products in order to effectively compete with the Company.
In addition, because there are relatively low barriers to entry for the
software market, the Company expects additional competition from other
companies. Increased competition is likely to result in price reductions,
reduced gross margins and loss of sales volume, any of which could materially
and adversely affect the Company's business, operating results, and financial
condition. Any material reduction in the price of the Company's products would
negatively affect its gross revenues and could have a material adverse effect
on its business, operating results, and financial condition. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors, and the failure to do so would have a material adverse
effect upon the Company's business, operating results, and financial condition.
Rapid Technological Change; Need to Develop New Products; Requirement for
Frequent Product Transitions
The industries in which the Company participates are characterized by rapid
technological change, evolving industry standards in computer hardware and
software technology, changes in customer requirements and frequent new product
introductions and enhancements. The introduction of products embodying new
technologies, the emergence of new standards or changes in customer
requirements could render the Company's existing products obsolete and
unmarketable. As a result, the Company's success will depend in part upon its
ability to continue to enhance existing products and expand its products,
continue to provide enterprise products and develop and introduce new products
that keep pace with technological developments, satisfy increasingly
sophisticated customer requirements and achieve customer acceptance. Customer
requirements include, but are not limited to, product operability and support
across distributed and changing heterogeneous hardware platforms, operating
systems, relational databases and networks. There can be no assurance that any
future enhancements to existing products or new products developed by the
Company will achieve customer acceptance or will adequately address the
changing needs of the marketplace. There can also be no assurance that the
Company will be successful in developing and marketing enhancements to its
existing products or new products incorporating new technology on a timely
basis.
If the Company Fails to Comply with Laws or Government Regulations, it May Be
Subject to Penalties and Fines
The Company is not directly subject to regulation by any governmental agency,
other than regulations applicable to businesses generally, and there are
currently few laws or regulations addressing the products and services provided
by the Company. The Company does, however, license its products and provide
services, from time to time, to the government, government agencies, government
contractors and to other customers that are in industries regulated by the
government. As a result, the Company's operations, as they relate to its
relationships with governmental entities and customers in regulated industries,
are governed by
-23-
certain laws and regulations. These laws and regulations are subject to change
without notice to the Company. In some instances, compliance with these laws
and regulations may be difficult or costly, which may negatively affect the
Company's business and results of operations. In addition, if the Company fails
to comply with these laws and regulations, it may be subject to significant
penalties and fines that could materially negatively affect the Company's
business, results of operations and financial condition.
Risks Related to Growth of International Operations
International revenues (from sales outside the United States) accounted for
approximately 32%, 31% and 41% of total revenues in 1999, 2000 and 2001. During
the three and nine months ending September 30, 2002, international revenues
accounted for approximately 37% and 35% of total revenues, respectively. The
Company maintains an operational presence in the United Kingdom, Canada,
Australia, France and Japan. In addition, the Company has established sales and
support offices in England, France, Australia and Japan, and expects
international sales to continue to be a significant component of its business.
However, there can be no assurance that the Company will be able to maintain or
increase international market demand for its products. In addition,
international expansion may require the Company to establish additional foreign
operations and hire additional personnel. This may require significant
management attention and financial resources and could adversely affect the
Company's operating margin. To the extent the Company is unable to expand
foreign operations in a timely manner, its growth, if any, in international
sales will be limited, and its business, operating results and financial
condition could be materially and adversely affected.
Risks Related to Foreign Exchange Rate Fluctuations
At September 30, 2002, a significant portion of the Company's cash was held in
Pound Sterling and other foreign currencies (Australian Dollars, Canadian
Dollars, Euros, Japanese Yen, and French Francs). In the future, the Company
may need to exchange some of the cash held in Pound Sterling, or other foreign
currencies, to U.S. Dollars. The Company does not engage in hedging
transactions, and an unfavorable foreign exchange rate at the time of
conversion to U.S. Dollars would adversely affect the net fair value of the
foreign denominated cash upon conversion.
Risks Related to International Operations Generally
The Company's international business also involves a number of additional
risks, including:
- - lack of acceptance of localized products;
- - cultural differences in the conduct of business;
- - longer accounts receivable payment cycles;
- - greater difficulty in accounts receivable collection;
- - seasonality due to the annual slow-down in European business activity
during the Company's third fiscal quarter;
- - unexpected changes in regulatory requirements and royalty and
withholding taxes that restrict the repatriation of earnings;
- - tariffs and other trade barriers; and
- - the burden of complying with a wide variety of foreign laws.
The Company's international sales are generated through its international sales
subsidiaries and indirect sales channel partners creating a risk of foreign
currency translation gains and losses. To the extent profit is generated or
losses are incurred in foreign countries, the Company's effective income tax
rate may be materially and adversely affected. In some markets, localization of
the Company's products will be essential to achieve market penetration. The
Company may incur substantial costs and experience delays in localizing its
products, and there can be no assurance that any localized product will ever
generate significant revenues. There can be no assurance that any of the
factors described herein will not have a material adverse effect on the
Company's future international sales and operations and, consequently, its
business, operating results and financial condition.
Dependence on Proprietary Technology
The Company's success is heavily dependent upon its proprietary technology. The
Company relies on a combination of the protections provided under applicable
copyright, trademark and trade secret laws, confidentiality procedures and
licensing arrangements, to establish and protect its proprietary rights. As
part of its confidentiality procedures, the Company generally enters into
non-disclosure agreements with its employees, distributors and corporate
partners, and license agreements with respect to its software, documentation
and other proprietary information. Despite these precautions, it may be
possible for unauthorized third parties to copy certain portions of the
Company's products or to reverse engineer or obtain and use
-24-
information that the Company regards as proprietary, to use the Company's
products or technology without authorization, or to develop similar technology
independently. Moreover, the laws of some other countries do not protect the
Company's proprietary rights to the same extent, as do the laws of the United
States. Furthermore, the Company has no patents and existing copyright laws
afford only limited protection. The Company has made source code available from
time-to time for certain of its products and providing such source code may
increase the likelihood of misappropriation or other misuses of the Company's
intellectual property. Accordingly, there can be no assurance that the Company
will be able to protect its proprietary software against unauthorized third
party copying or use, which could adversely affect the Company's competitive
position.
Risks of Infringement
The Company is not aware that any of its products infringe the proprietary
rights of third parties. There can be no assurance; however, that a third party
will not assert that the Company's technology violates its patents or other
proprietary rights in the future. As the number of software products in the
industry increases and the functionality of these products further overlap, the
Company believes that software developers may become increasingly subject to
infringement claims. Any such claims, with or without merit, can be time
consuming and expensive to defend or could require the Company to enter into
royalty and licensing agreements. Such royalty or license agreements, if
required, may not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.
Lengthy Sales Cycle; Large Order Size
The purchase and implementation of the Company's software products by a
customer generally involves a significant commitment of capital over a long
period of time, with the risk of delays frequently associated with large
capital expenditures and implementation procedures within an organization, such
as budgetary constraints and internal approval review. During the sales
process, the Company may devote significant time and resources to a prospective
customer, including costs associated with multiple site visits, product
demonstrations and feasibility studies, and experience significant delays over
which the Company will have no control. Any such delays in the execution of
orders have caused, and may in the future cause, material fluctuations in the
Company's operating results.
Dependence on Licensed Technology from Third Parties
Elements of the Company's products are licensed from third parties under
agreements, which may include certain warranties and representations that the
Company typically seeks to pass through to the end users through contractual
provisions. Reliance on software licensed from third parties can materially
impact the cost of licensing revenue and reduce gross margins on licensing fees
for some software modules or products. Moreover, the loss of the Company's
right to use and license such technology could limit the Company's ability to
successfully market certain modules or products. While the Company believes
that it would be able to either license or develop alternatives to such
component technologies, there can be no assurance that the Company would be
able to do so, or that such alternatives would achieve market acceptance or be
available on a timely basis. Failure to obtain the necessary licenses or to
develop needed technologies could have a material adverse effect on the
Company's business, operating results and financial condition.
Risk of Software Defects; Product Liability
The sale and support of the Company's products may entail the risk of product
liability claims. The license agreements of the Company typically contain
provisions designed to limit exposure to potential product liability claims. It
is possible, however, that the limitation of liability provisions contained in
such license agreements may not be effective as a result of federal, state or
local laws or ordinances or unfavorable judicial decisions. A successful
product liability claim brought against the Company relating to its product or
third party software embedded in the Company's products could have a material
adverse effect upon the Company's business, operating results and financial
condition.
Effect of Securities and Exchange Commission ("SEC") Requirements and American
Institute of Certified Public Accountants ("AICPA") Statements of Position on
the Company's Revenue Recognition
In October 1997, the AICPA issued Statement of Position No. 97-2 "Software
Revenue Recognition" ("SOP 97-2"), which superceded SOP No. 91-1. SOP No. 97-2,
as amended by SOP No. 98-4 and SOP No. 98-9, was effective for the Company's
fiscal year beginning June 1, 1998 and provides guidance on applying accounting
principles generally accepted in the United States for software recognition
transactions. In December 1999, the SEC issued Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements" ("SAB 101") which provides
further revenue recognition guidance. The accounting
-25-
profession continues to review certain provisions of SOP No. 97-2 and SAB 101
with the objective of providing additional guidance on implementing consistent
standards for software revenue recognition. Depending on the outcome of these
reviews and the issuance of implementation guidelines and interpretations, the
Company may be required to change its revenue recognition policies and business
practices, and such changes could have a material adverse impact on the
Company's business, results of operations or financial position.
Pending Litigation
The Company is involved in certain pending litigation with former employees
that, if resolved unfavorably to the Company, may require the Company to pay
material cash payments in settlement. Any such payment could adversely affect
the cash position of the Company. See Part II - Item 1 - "Legal Proceedings"
for further discussion.
-26-
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company's cash flow can be exposed to market risks in the form of changes
in interest rates in its short-term borrowings available under its revolving
bank line of credit as well as its investments in certain available-for-sale
securities. The Company's cash management and investment policies restrict
investments to highly liquid, low risk debt instruments. The Company currently
does not use interest rate derivative instruments to manage exposure to
interest rate changes. A hypothetical 100 basis point adverse move (decrease
in) interest rates along the entire interest rate yield curve would adversely
affect the net fair value of all interest sensitive financial instruments by
approximately $0.5 million at September 30, 2002.
We provide our services to customers in the United States, Europe, Asia Pacific
and elsewhere throughout the world. As a result, our financial results could be
affected by factors such as changes in foreign currency exchange rates or weak
economic conditions in foreign markets. Sales are primarily made in U.S.
Dollars; however, as we continue to expand our operations, more of our
contracts may be denominated in Australian and Canadian Dollars, Pound
Sterling, Euros and Japanese Yen. A strengthening of the U.S. Dollar could make
our products less competitive in foreign markets. A hypothetical 5% unfavorable
foreign currency exchange move versus the U.S. Dollar, across all foreign
currencies, would adversely affect the net fair value of foreign denominated
cash, cash equivalent and investment financial instruments by approximately
$1.2 million at September 30, 2002.
ITEM 4. CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures (as such term is
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934, as amended) as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"). Based on such evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that, as of the
Evaluation Date, our disclosure controls and procedures are effective in
alerting them on a timely basis to material information relating to Indus
(including its consolidated subsidiaries) required to be included in our
reports filed or submitted under the Securities Exchange Act or 1934, as
amended.
(B) CHANGES IN INTERNAL CONTROLS.
Since the Evaluation Date, there have not been any changes in our internal
controls or other factors that could significantly affect such controls.
-27-
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In June 2000, the Company was served with a demand for arbitration by William
Grabske, the Company's former Chief Executive Officer. Mr. Grabske seeks
enforcement of a purported Settlement Agreement and Mutual Release. The demand
seeks severance pay and reimbursement of expenses of approximately $1.0 million
plus interest, options to purchase approximately 200,000 shares of stock in the
Company, and fees and costs. The Company intends to vigorously contest Mr.
Grabske's demand and has asserted various counterclaims.
The Company does not believe that, individually or in aggregate, the legal
matters to which it is currently a party are likely to have a material adverse
effect on its results of operations or financial condition.
From time to time, the Company is involved in other legal proceedings
incidental to the conduct of its business. The outcome of these claims cannot
be predicted with certainty. The Company intends to defend itself vigorously in
these actions. However, any settlement or judgment may have a material adverse
effect on the Company's results of operations in the period in which such
settlement or judgment is paid or payment becomes probable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The Company did not file any Reports on Form 8-K during the quarter
ended September 30, 2002.
The following exhibits are filed herewith or are incorporated by
reference.
EXHIBIT
NUMBER DESCRIPTION
10.1 Amendment to the Indus International, Inc. 1997 Director Option Plan
10.2 Employment Agreement dated September 16, 2002 by and between Indus International, Inc. and Gregory J. Dukat
10.3 Change of Control Severance Agreement dated September 16, 2002 by and between Indus International, Inc.
and Gregory J. Dukat
99.1 Chief Executive Officer and Chief Financial Officer certifications pursuant to 18 U.S.C.ss.1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
-28-
SIGNATURE
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.
INDUS INTERNATIONAL, INC.
(Registrant)
Date: November 14, 2002
/s/ Jeffrey A. Babka
-------------------------------------------
Jeffrey A. Babka
Executive Vice President Finance and
Administration and Chief Financial Officer
Principal Financial & Accounting Officer
-29-
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
SECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Thomas R. Madison, Jr., Chief Executive Officer of Indus International,
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Indus
International, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of the date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and that
the audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material weaknesses
in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
By: /s/ Thomas R. Madison
-------------------------------
Thomas R. Madison, Jr.
Chairman of the Board and
Chief Executive Officer
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CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
SECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Jeffrey A. Babka, Chief Financial Officer of Indus International, Inc.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Indus
International, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of the date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and that
the audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002
By: /s/ Jeffrey A. Babka
------------------------------------------
Jeffrey A. Babka
Executive Vice President Finance and
Administration and Chief Financial Officer
-31-
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
10.1 Amendment to the Indus International, Inc. 1997 Director Option Plan
10.2 Employment Agreement dated September 16, 2002 by and between Indus International, Inc. and Gregory J. Dukat
10.3 Change of Control Severance Agreement dated September 16, 2002 by and between Indus International, Inc.
and Gregory J. Dukat
99.1 Chief Executive Officer and Chief Financial Officer certifications pursuant to 18 U.S.C.ss.1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
-32-