ITEM 1. BUSINESS
Edify Corporation ("Edify" or the "Company") is a leading supplier of enterprise self service software solutions that enable organizations to automate, integrate and personalize interactions with customers and employees through multiple channels, including the Internet, corporate intranets and the telephone. The Company's software addresses the growing need for organizations to automate, integrate and personalize interactions with customers and employees, yielding stronger, more profitable relationships. Originally, Edify's self service solutions enabled organizations to contain costs, to capitalize on emerging interactive media, and to leverage investments in enterprise systems and communications infrastructure. Over the past seven years, Edify has licensed its Electronic Workforce application development and runtime platform to over 1,200 customers for custom development of Web and telephone self service applications such as bank account inquiries and employee benefit enrollments. In the last three years, the Company introduced two software application products, the Electronic Banking System ("EBS") and the Employee Service System ("ESY"), as part of its strategy to establish leadership in the market for self service applications in the financial services and human resource market segments.
Edify's Electronic Workforce is a full-featured, scalable and flexible application development and runtime system that enables organizations to create and deploy custom self service applications through which users can conveniently and easily obtain access to a broad range of valuable information and services. Electronic Workforce's object-oriented architecture allows the incorporation of multiple media, enabling service applications through Web browsers, telephones, facsimiles, electronic mail and alphanumeric pagers. It also facilitates interaction with information content assembled from a variety of sources, including mainframe and client/server applications and relational databases. Electronic Workforce also includes a "visual" development environment that enables rapid development and adaptation of self service applications without writing lines of code.
Edify's Electronic Banking System is a software application product which offers financial institutions the means to deploy a suite of automated banking services via the World Wide Web (the "Web"). The Company's Employee Service System is a software application product that offers human resources ("HR") organizations the means to empower employees with direct access to information and services over corporate intranets. EBS and ESY each offer a fully integrated application suite, multiple access options including the Web and telephone and visual customization tools for rapid customization and integration with a wide range of back-office systems. They both are built on Edify's Electronic Workforce and utilize Web browser, Java and other technologies that address the customization requirements necessary for the application products market.
INDUSTRY BACKGROUND
In today's highly competitive global marketplace, customers and employees are increasingly demanding faster, more convenient and more interactive access to information and services. Competitive pressures are driving businesses to increase the quality of such services while containing costs. The delivery of richer, more cost-effective services has become critical in differentiating a company's product or service offerings and expanding its market share. While traditional information and automation systems have focused primarily on increasing the efficiency of core business operations, new opportunities exist to employ available and emerging technologies to automate and enhance an organization's interactions with its customers and employees.
Organizations traditionally have used trained service representatives to bridge the gap between customers and employees and the enterprise information systems that store and process account, employment, shipment or other information. Service representatives perform multiple functions, including receiving inquiries from customers or employees, using enterprise software applications to extract relevant information, implementing company policies and communicating responses to the inquiries. Reliance on people to perform these service functions is expensive and has inherent limitations in terms of scalability, flexibility and reliability. Labor costs tend to grow proportionately with increased demands for service, and the quality of service becomes more difficult to maintain as the number of service representatives increases. In addition, the time required to hire and train service personnel limits the speed with which organizations can respond to increasing customer demands or to new competitive service offerings. The solution to these service demands and challenges is to use technology to enable customers and employees to serve themselves through automated "self service" applications that provide direct and interactive access to enterprise information and services.
THE EVOLUTION OF SELF SERVICE
Self service applications have expanded rapidly over the last two decades as end users have become increasingly comfortable with self service and as new technologies have broadened end-user access to automated services and increasingly have enabled the development of full-featured applications. Each new technology has expanded the scope of self service applications rather than supplanted the earlier technologies. The evolution of these technologies and applications can be viewed in phases.
ACCEPTANCE PHASE. During the 1970s, automated teller machines ("ATMs") were an initial proving ground for the economic benefits and consumer acceptance of self service. ATMs not only provide the benefits of better customer service but also reduce the need for banks to build, staff and maintain expensive branch offices.
CONVENIENCE PHASE. During the 1980s, the availability of toll-free telephone service and touch-tone dialing provided an infrastructure that permitted self service over the telephone. This infrastructure has been exploited using voice processing technology and stand-alone interactive voice response ("IVR") systems. IVR systems, often operating in large call centers, provide convenient 24-hour access to information and services through touch-tone telephones, facsimile machines or alphanumeric pagers. Popular telephone self service applications include telephone banking, employee benefit enrollment, university student course registration and verification of customer order and shipment status. While telephone self service has continued to gain acceptance and grow due to the ubiquity of touch-tone telephones, Edify believes that the inherent user interface limitations of the telephone, such as the lack of a visual display and the small number of touch-tone keys, have limited the development of a larger self service automation market. However, current developments in voice recognition capabilities are helping to reduce such limitations by enabling the automation of activities that had previously been restricted by the small number of touch-tone keys.
In recent years, the development of the Web/intranet infrastructure has enabled users of personal computers operating Web browser software to access and interact with a broad range of information sources, independent of physical location and underlying computer design. The Web/intranet infrastructure shares many attributes of the telephone: widespread connectivity, widespread access to service and a simple, easy-to-use interface. Web browsers, however, offer advantages over the telephone, including a visual user interface, keyboard input and extensive support for alphanumeric, audio, video and text information types. Organizations are rapidly adopting Web browser and server software for both external customer communications via the Internet and internal employee communications via corporate intranets. The proliferation of telephone-based self service solutions, as well as the emergence of Web-based self service solutions, have provided end users with convenient "anytime, anywhere" access to information and services, resulting in improved customer service and greater customer satisfaction.
MASS CUSTOMIZATION PHASE. As technologies continue to advance for both telephone- and Web-based solutions, organizations will be able to deploy increasingly sophisticated self service applications. For example, organizations now can provide services for particular users or groups of users, utilizing information that the organization has accumulated about its individual customers, employees and suppliers. The Company believes that end users will demand that these services become increasingly personalized so they can take ownership of their own service needs. Organizations that offer these capabilities should be able to build and maintain stronger relationships with their constituencies.
The evolution from the "convenience" phase to the "mass customization" phase is complicating the self service infrastructure within the enterprise. Today, the self service landscape is comprised primarily of disjointed solutions that provide a single point of access to a single source of data. These point solutions result in duplicate connections to the enterprise systems in the back office, inconsistent interfaces for the customer and high maintenance costs. Point solutions also fail to provide a unified base of customer contact information with which customer service can be delivered regardless of media and contact point. There is an increasing need for integrated solutions supporting multiple media and aggregating data from the many islands of information in the enterprise. Such solutions enable end users to access any information via any media and are easier to create and maintain. At the same time, these solutions must incorporate the necessary flexibility, scalability and reliability to be capable of supporting sophisticated self service applications.
THE EDIFY SOLUTION
Edify's self service software solutions provide the following benefits:
PERSONALIZED, FEATURE-RICH SELF SERVICE APPLICATIONS. Edify's software enables organizations to deploy self service applications through which end users can conveniently and easily obtain access to a broad range of valuable information and services. Although an application may require access to information and services on a wide variety of disparate computer systems within the organization, it retrieves the information and presents the services to the end user in a unified, intuitive way. In addition, the architecture of Edify's software enables organizations to provide highly interactive self service applications that can be customized easily for and by the end user. The runtime system provides service functions interactively in response to user inquiries from an online personal computer or telephone as well as proactively in response to pre-set parameters. The Company's architecture also allows companies to target particular groups of users with specific services through cross-selling, narrowcasting of content and segmented service by class of user. These "one-to-one" capabilities enhance the value of the self service applications for the end user, thereby developing a stronger, more profitable relationship for the organization.
ACCESS THROUGH MULTIPLE FRONT-END MEDIA. The object-oriented architecture of Edify's software is designed to provide self service functions through a broad range of communications media, including Web browsers, telephones, facsimiles, electronic mail and alphanumeric pagers, either alone or in combination. This design has enabled the Company to provide end users with multiple points of entry to the system and to incorporate new communications media, such as the Web browser, as they have emerged to deliver a wider, more useful range of self service functions. In addition, the Company's software provides better, more differentiated types of service by supporting multiple combinations of communications media within the same application. For example, the Company's software allows Web users to initiate a direct telephone link to a customer service representative ("CSR") in a call center with a mouse click. The current page being viewed by the user "pops" onto the screen of the CSR, who can shadow the user's movements, thereby communicating more effectively. Edify's multiple media approach enables organizations to uniformly manage customer interactions.
BROAD INTEGRATION WITH BACK-OFFICE ENTERPRISE SYSTEMS AND COMMUNICATIONS MEDIA. In contrast to systems that are designed specifically for stand-alone Web or telephone applications, Edify's software is designed to integrate with a wide variety of computer and telecommunications technologies and products. These include mainframe, client/server and personal computer software applications, relational databases running locally or on distributed networks, Web servers, central offices or private branch exchanges ("COs" and "PBXs") and automated call distributors ("ACDs"). In addition, the Company has developed or is developing specific links to systems offered by CheckFree Corporation ("CheckFree"), First Data Corporation, Integrion Financial Network ("Integrion"), Microsoft Corporation ("Microsoft"), M&I Data Services, NCR Corporation ("NCR") and TransPoint in the financial services market and PeopleSoft Inc. ("PeopleSoft") and SAP AG ("SAP") in the human resources market. This broad integration capability enables Edify's solutions to access information from multiple back-office systems and to extend the information by assembling rich combinations of content from diverse sources and making them available to end users.
HIGHLY ADAPTABLE, "VISUALLY" DEVELOPED APPLICATIONS. Electronic Workforce includes an object-oriented visual development environment that enables developers to create and adapt custom self service applications rapidly. By positioning graphical icons on a workspace grid, a developer can define complete self service applications without writing lines of code. The visual development environment allows a developer to build new objects for often-used processes, such as obtaining and preparing information from a particular source, and then to reuse these objects in other applications. In addition to reducing the time to market for new custom applications, the Company believes that the adaptability of its development environment provides substantial cost savings over the life of an application. In addition, the visual customization tools for EBS and ESY enable developers to modify easily the look and feel of the application, define classes of users, segment functionality by user type and establish cross-selling rules and notification services.
SCALABILITY, RELIABILITY AND SECURITY. Edify's software architecture is designed to provide the high capacity and reliability necessary for large-scale deployment of self service applications. The Company's software operates on one or more networked computer servers allowing customers to expand capacity as the number of applications or users increases. The Company has successfully deployed customer applications with more than 20 networked servers and believes that its architecture is scalable beyond the size of such installed systems. In addition, the Company's software, optimized for Microsoft's Windows NT operating system, supports lightweight threads, message passing and symmetric multiprocessing to achieve greater scalability on a single server. The large-scale version of Edify's Electronic Workforce (EWF/LS) scales to 288 ports per server (according to a benchmarking study conducted by Compaq Computer Corporation ("Compaq")). Electronic Workforce has been designed with separate subsystems that isolate system faults and can accommodate the loss of one or more networked nodes without affecting service elsewhere in the system. In addition, Electronic Workforce manages security and resource contention in providing access to various enterprise systems and communications media.
THE EDIFY STRATEGY
The Company's objective is to become the leading provider of enterprise self service software used by organizations to automate, integrate and personalize interactions with customers and employees, yielding stronger, more profitable relationships. Edify's strategy includes the following key elements:
DEVELOP AND LEVERAGE LEADING TECHNOLOGIES FOR ENTERPRISE SELF SERVICE SOLUTIONS. Edify intends to capitalize on its object-oriented software architecture and visual development technology to extend the capabilities of Electronic Workforce to automate a wide range of service functions. The system architecture of Electronic Workforce enables organizations to create and manage functionally rich, intuitive customer- and employee-oriented services assembled and delivered through the integration of enterprise computer and telecommunications systems. The Company plans to continue to enhance the functionality of its self service solutions and to incorporate new technologies and standards as they evolve to offer more comprehensive solutions and to broaden the market acceptance and application of these solutions.
DEVELOP APPLICATION PRODUCTS FOR SPECIFIC MARKET SEGMENTS. Edify's market strategy is to apply its technology and experience in self service solutions to develop application products for certain market segments. As part of this strategy, the Company has introduced
fully integrated application products for the financial services and human resources markets, the Electronic Banking System and the Employee Service System. The Company's application products are designed to leverage its core Electronic Workforce technology and extend it utilizing Web, Java and other technologies which address the customization requirements necessary for the applications market. The Company's application products offer a suite of customizable application modules that provide specific self service functions for each target market. This modularity enables organizations to offer the services that meet their particular needs as they evolve over time. The Company is investing in the ongoing development of additional application modules for these products.
PARTNER WITH INDUSTRY-LEADING COMPANIES THAT PROVIDE COMPLEMENTARY SOLUTIONS. To augment its product offerings, the Company intends to evaluate opportunities to enter into partnerships, such as licenses with or investments in third parties that could deliver key existing complementary technologies. Edify's open, object-oriented software architecture can easily and quickly incorporate additional third-party technologies into its existing products, creating significant value for its customers. Edify intends to base its decisions to partner with, invest in or jointly develop additional solutions on the intellectual capital as well as the technological strengths of the third parties.
ESTABLISH LEADERSHIP IN THE FINANCIAL SERVICES AND HUMAN RESOURCES MARKETS. While the Company markets its products across multiple markets, it emphasizes two key market segments: customer self service applications within the financial services industry and HR self service applications across multiple industries. The Company is focusing on these segments because they represent a large portion of the self service market and the Company has developed significant expertise in developing solutions for these segments. The Company focuses a significant portion of its sales and marketing activities on these two segments, including the establishment and expansion of distribution or joint marketing relationships with leading technology providers, outsourcers and integrators in each segment. In the financial services market, Edify has established relationships with CheckFree, Hewlett-Packard Company ("HP"), Integrion, Intuit Inc. ("Intuit"), M&I Data Services, Microsoft, NCR, Transaction Systems Architects, Inc. ("TSA") and TransPoint, among others. In the HR market, the Company has relationships with Cambridge Technology Partners ("CTP"), Foundation Technologies, Hunter Group, PeopleSoft and SAP, among others. In addition, the Company has introduced application suites for the financial services and human resources markets, EBS and ESY. The Company intends to invest significantly in these relationships and products in order to establish leadership in the financial services and human resources markets.
TARGET LARGE CALL CENTERS. The Company intends to market its Electronic Workforce software to large call centers for telephone-based customer service applications, in addition to its traditional focus on medium-sized call centers. In 1998, the Company introduced EWF/LS, the large scale version of Electronic Workforce. Optimized for the Windows NT operating system and supporting symmetric multiprocessing, EWF/LS allows organizations to scale with improved price-performance and smaller footprint. The Company believes that the increased scalability of Electronic Workforce, combined with its ability to integrate with a variety of access media and enterprise information and communications systems, has enabled the Company to more effectively target the large-scale call center market.
EXPAND DOMESTIC AND INTERNATIONAL DISTRIBUTION. To achieve broad adoption of its self service software, the Company believes that it must continue to pursue multiple distribution channels worldwide. The Company currently distributes products through a combination of field sales and indirect sales channels, including VARs, OEMs, outsourcers and international distributors. In order to facilitate sales of its application products and to leverage its installed base and distribution partners, Edify has established dedicated sales positions for application specialists, major customers and major partners. The Company pursues VARs with vertical market expertise, systems integration experience and geographical diversity. The Company's international distribution strategy is to penetrate key international markets by seeking additional regional distributors and by further developing its existing distributor relationships. Through its distributors, the Company currently has a presence in more than 24 countries. The Company's international expansion currently is focused on Asia/Pacific, Europe and South America, where the Company is investing resources in sales, marketing and technical personnel.
EXPAND IMPLEMENTATION CAPACITY AND EXPERTISE. The Company seeks to accelerate customer adoption and deployment of self service solutions by expanding its services consulting organization and leveraging its partnerships with third party integrators. Through its services organization, the Company has established expertise in assisting and training customers to perform integrations of diverse computer and communications systems as well as knowledge of user interface and design and a familiarity with the self service needs of its targeted market segments. The Company intends to continue to expand its services organization with experienced consultants who combine technical and application expertise. The Company believes that its services organization facilitates the success of its customers' implementations, strengthens its customer relationships and generates valuable feedback that the Company can apply to product enhancements. In addition, the Company has established relationships with third party integrators such as CTP and HP to assist customers with the successful implementation of Edify products. The Company believes these relationships will enable its customers to achieve efficient implementation of its products while decreasing the capacity strain on the Company's services organization.
The foregoing statements regarding the Company's strategy and intentions are forward-looking statements, and actual results may vary substantially depending upon a variety of factors, including the development of emerging markets for Web-based self service software, intense competition, evolving industry standards, changing customer needs, any product development delays, and the ability of the Company to manage any future growth and new distribution channels.
MARKETS, CUSTOMERS AND APPLICATIONS
MARKETS
The Company targets large organizations where there is a need to process substantial numbers of customer or employee service transactions efficiently. Electronic Workforce is best suited for organizations seeking to offer a variety of functionally rich services that can be rapidly deployed or modified, accessed by customers and employees through multiple communications media and integrated with existing or new enterprise applications and telecommunications systems. The Company has successfully installed solutions in the banking, consumer goods, energy/utilities, financial services, technology, universities, retail, insurance, telecommunications, healthcare, manufacturing and media sectors, among others. The Company currently participates in two major self service areas: customer self service across a number of industries, with an emphasis on banking and financial services, and employee self service focused on HR applications.
CUSTOMERS
As of December 31, 1998, Edify had, directly or indirectly through VARs or distributors, licensed its products to more than 1,200 customers. The following is a representative list of the Company's direct and indirect customers as of December 31, 1998 that accounted for more than $150,000 in revenue to Edify from January 1, 1997 through December 31, 1998. The Company believes that these customers are typical of the Company's customer base by virtue of the industries they represent and the types of applications they implement using the Company's products. Because the Company generally does not have long-term sales contracts with its customers, however, there can be no assurance that relationships with these or other customers will continue. No single customer accounted for more than 10% of the Company's total revenue in 1998.
CUSTOMER APPLICATIONS
Edify's software can be used in many applications, including the following representative applications:
CHASE MANHATTAN: EBS AND ESY APPLICATIONS. With $366 billion in assets, The Chase Manhattan Corporation is one of the world's premier financial services institutions. Chase first implemented Edify's Employee Service System to provide HR self service via the telephone and intranet for its 70,000 employees. ESY enables employees to access and modify personal information such as address, telephone and emergency contact and dependent information. Further, new hires can enroll in benefits and existing employees can register for training courses and participate in open enrollment. Following the success of this application, Chase elected to use Edify's Electronic Banking System to enhance its 400,000 customer-strong Online Banking service. Based on EBS, Chase Online Banking offers improved graphics, easier navigation and Internet access. It provides all Chase customers, consumers and small
businesses alike, with an easy, convenient way to do their day-to-day banking including transferring funds, paying bills and communicating with the bank. Additionally, Edify's OFX module allows Chase customers to download data directly into personal financial managers such as Microsoft Money or Quicken.
REPUBLIC INDUSTRIES: TELEPHONE AND WEB-BASED CALL CENTER HR APPLICATION. Republic Industries, a Fortune 150 company, is using the Employee Service System to offer open enrollment to its employees via the telephone. Republic employs 60,000 individuals dispersed among more than 500 subsidiaries in the auto retail, auto rental, and solid waste industries. Edify consultants deployed a bilingual (Spanish and English) IVR application that enables Republic's employees to self-enroll in benefits programs over the telephone combined with an integrated Web-based application for use by Republic's HR call center representatives. Employees can complete their enrollment process over the phone or transfer to a specially trained HR call center representative who has access to the employee's benefits history as well as life events profile and employment history. The representative is able to view all of the information the employee entered during the IVR session, saving the employee the time needed to repeat this information verbally, and the representative can complete the enrollment process at the employee's request. This Web-based application records key call statistics, including the employee's rating of the enrollment procedure, so that Republic Industries can fine-tune its benefits administration.
NET.B@NK: WEB AND TELEPHONE ELECTRONIC BANKING APPLICATION. Net.B@nk, which opened its virtual doors in October 1996, is the world's first FDIC-insured federal savings bank to offer a full line of financial services exclusively through the Internet. The bank's services are hosted by Edify partner NCR Corporation with BISYS Group, Inc. as the bank's core processing center. Edify's EBS application allows Net.B@nk customers to access account balances, review and search for transactions, transfer funds between accounts, place a stop payment and communicate with the bank via secure electronic mail. Customers can also review their banking activity and download the data to a personal financial manager, pay bills, transfer funds and communicate with the bank via e-mail. Net.B@ank also offers high-interest checking accounts, ATM, debit and credit cards, money market accounts, CDs, brokerage services, mortgage loans and more. As a result of such offerings, Net.B@nk had over 17,500 customers and deposits of $283 million by the end of 1998.
INTERMEDIA COMMUNICATIONS: ADVANCED CALL CENTER APPLICATION. The nation's largest independent competitive local exchange carrier has incorporated Edify's EWF/LS along with Genesys computer telephony integration software and other best-of-breed Windows NT-based industry-standard components to provide a mission-critical, 24 hour, 7-day a week customer call center in Tampa, Florida. Plans are underway to expand this capability to other locations serving Intermedia's growing network of customers. Edify's IVR application, running on Compaq hardware, uses the customer's dialed number (DNIS) and identification number as well as the customer's response to prompts about the problem to route the call to an appropriate CSR. By tightly integrating with the Clarify front-office system and a Visual Basic desktop, the Edify IVR application enables the CSR to view a profile of the customer's account while addressing the call. Additionally, the CSR can provide customers with a tracking number, which can subsequently be used to get automated updates on various requests.
PRODUCTS
Edify currently offers three self service software products: the Electronic Workforce, the Electronic Banking System and the Employee Service System. Electronic Workforce is an integrated development and runtime platform utilized for the creation and management of custom self service solutions. EBS and ESY are application products that address the needs of the financial services and human resources markets, respectively. EBS and ESY are built on top of the Electronic Workforce and incorporate Web, Java and other technologies that address the customization requirements necessary for the application product market. Versions through 4.x of Electronic Workforce and 1.x of EBS and ESY operate on Intel-based hardware platforms using IBM Corporation's ("IBM") OS/2 operating system.
In October 1997, the Company began shipping Electronic Workforce Release 5, which is optimized for Microsoft's Windows NT operating system. In December 1997, the Company began shipping EBS Release 2 and ESY Release 2, both of which are optimized for Windows NT. By transitioning to the Windows NT platform, Edify's products are able to provide an extended open architecture, enhanced visual development tools and larger scale deployment for high-end applications.
Throughout 1998, the Company continued to develop new products. In June 1998, Edify began to ship the large scale version of its EWF product (EWF/LS). EWF/LS enables Edify to compete in the high-end call center market. In December 1998, the Company shipped Release 3 of EBS, which incorporates end-to-end support for online bill presentment and payment, and the industry's first internet banking module designed specifically for commercial banks' small business customers.
ELECTRONIC WORKFORCE
Edify's Electronic Workforce, which began shipping in the first quarter of 1992, is a full-featured, scalable and flexible application development and runtime system that enables organizations to create and deploy custom self service applications that automate, integrate and personalize interactions with customers and employees. Electronic Workforce's object-oriented architecture allows the incorporation of a broad range of media, enabling self service applications through Web browsers, telephones, facsimiles, electronic mail and alphanumeric pagers, either alone or in combination. It also facilitates interaction with information content assembled from a variety of sources, including mainframe and client/server applications and relational databases, all in a way that is transparent to the end user. Electronic Workforce comprises three primary components, which are licensed separately:
WORKFORCE OBJECTS. Workforce Objects are advanced high-function software objects that provide access to a variety of enterprise information systems through a broad range of media. Workforce Objects are the core building blocks of Electronic Workforce applications, enabling them to perform tasks such as answering a telephone, operating a host application or exchanging information through Web browsers.
WORKFORCE APPLICATION BUILDER. The Workforce Application Builder is an object-oriented, visual development environment used to assemble and customize self service applications using Workforce Objects. Workforce Application Builder provides developers with a visual framework for process automation through which complex associations of media, information sources and application functions may be represented in a simple and conceptual way. By positioning graphical icons on a workspace grid, a developer can define complete self service applications without writing lines of code.
WORKFORCE APPLICATION SERVER. The Workforce Application Server is a robust, open runtime environment that schedules resources and activities, manages resource usage, tracks application status and reacts and responds to changing conditions. These features simplify the task of developing self service applications by eliminating the need to program such functions within each application. In addition, they give administrators the ability to manage large-scale systems efficiently where many applications need to be scheduled and share resources concurrently. Workforce Application Server can be installed on multiple networked servers and can work in a coordinated fashion to achieve high levels of service capacity. It is designed to work with the Workforce Application Builder so that applications can be developed, tested and installed online without interruption of ongoing service.
Electronic Workforce components are licensed according to capacity and according to functionality. Capacity is determined by the number of concurrent users on a server. Functionality is determined primarily by the end-user communications media and by the access methods to a customer's back-office systems that are supported by the software. Typical software licenses with associated maintenance and consulting contracts begin at approximately $75,000, and large customer contracts can exceed $1 million.
ELECTRONIC BANKING SYSTEM
The Electronic Banking System, which began shipping in September 1996, is a software application product that offers financial institutions the means to deploy a suite of automated banking services via the World Wide Web. EBS is built on top of the Electronic Workforce and incorporates Web, Java and other technologies that address the customization requirements necessary for the application product market. EBS is the first product to combine Web banking services with optional electronic banking capabilities that support self service via telephones, facsimiles and personal financial management software. EBS comprises three components: a fully integrated application suite for web banking; multiple electronic delivery options including telephone, facsimile and personal financial managers; and visual customization tools for rapid customization and integration with a wide range of back-office systems.
The Electronic Banking System's application suite utilizes a user interface framework that includes a tool set which enables banks to incorporate their unique brands, logos and product names into the application. EBS currently includes the following integrated application modules: home banking, small business banking, electronic bill presentment and payment, dynamic target marketing, checkbook transaction register, multi-lingual & multi-currency support for international banking, personal profile, proactive notification, message center and customer service teleconferencing. EBS also offers integration modules for leading technology vendors such as CheckFree, Integrion and TransPoint for bill presentment and payment processing, and offers an OFX integration module for communication with personal financial management software programs such as Microsoft Money and Intuit Quicken.
Edify intends to develop additional application modules for EBS to enable customers to expand the range of services offered through EBS. In addition, EBS has been designed using the visual customization tools of Electronic Workforce, enabling EBS customers and Edify partners to develop custom Web banking modules that integrate with the EBS Web user interface framework. With this customization capability, financial institutions can offer differentiated services ahead of their competition while still gaining the economies of scale traditionally achieved with pre-built solutions. Finally, use of the Electronic Workforce software provides a scalable and highly reliable runtime environment, meeting requirements for high-capacity, mission-critical implementations.
As of December 31, 1998, EBS had been licensed to more than 100 customers. EBS pricing, including the application and implementation services, begins at approximately $150,000. Actual pricing varies depending upon the number of modules desired, the capacity requirements of the system and the level of customization and integration support.
EMPLOYEE SERVICE SYSTEM
The Employee Service System, which began shipping in June 1997, is a software application product that offers human resources organizations the means to empower employees with direct access to information and services over corporate intranets. ESY addresses the growing need for HR organizations to reduce administrative costs while expanding the availability and value of employee services. Similar to EBS, ESY comprises three components: a fully integrated application suite for employee self service; multiple access options including Web, telephone, electronic mail, kiosk and facsimile; and visual customization tools for rapid customization and integration with a wide range of back-office systems.
ESY offers a suite of integrated application modules that automate the most common and time-intensive employee transactions managed by HR organizations. ESY currently includes the following integrated application modules: benefits enrollment, personal profile, direct deposit, electronic paystub, W-4, leave status, benefits summary, employee directory, job posting and training registration.
As with EBS, the Company intends to develop additional application modules for ESY. In addition, in order to facilitate integration with human resources information systems, Edify offers a pre-built integration module for PeopleSoft's HRMS and can provide integration with SAP. ESY also has been designed using the visual customization tools of Electronic Workforce, enabling ESY customers and Edify partners to develop custom application modules that integrate with the ESY Web user interface framework. In addition, ESY includes a visual customization tool that enables easy customization of the user interface and other graphical elements. Finally, also similar to EBS, the use of the Electronic Workforce software provides a scalable and highly reliable runtime environment, meeting requirements for high-capacity, mission-critical implementations.
As of December 31, 1998, ESY had been licensed to 40 customers. ESY pricing, including the application and implementation services, begins at approximately $150,000. Actual pricing varies depending upon the number of modules desired, the capacity requirements of the system and the level of customization and integration support.
SALES AND MARKETING
The Company's sales strategy is to pursue opportunities with large organizations in the United States through its field sales force and services organization, and to penetrate various targeted market segments through multiple indirect distribution channels, including VARs, international distributors, OEMs and joint marketing partners. To support its selling efforts, the Company conducts comprehensive marketing programs which include direct mail, phone- and Web-based lead generation, advertising, trade shows, an annual users and developers conference, and ongoing customer communication programs. As of December 31, 1998, the Company's sales and marketing organization consisted of 137 employees, including 40 quota-carrying salespeople.
DOMESTIC FIELD SALES FORCE. The Company employs a field sales force to market its products and services directly in the United States. Field sales representatives are assigned quotas and are compensated for all Company revenue resulting from their assigned territory and specialty. While the sales cycle varies from customer to customer, it typically ranges from one month to over a year and averages six months. In order to sell the application products and to generate increased levels of repeat sales more effectively, the Company has assigned sales representatives to focus on application products and on the Company's installed base.
VALUE ADDED RESELLERS. VARs license and distribute the Company's software to build and implement self service solutions for their customers in various market segments. VARs often provide specialized application or systems integration expertise in the installation, development and support of self service applications. The Company maintains an organization to recruit, train and provide ongoing support for its VARs. As of December 31, 1998, the Company had more than 50 domestic VARs.
STRATEGIC ACCOUNTS. Over time, some of the Company's customers and channel partners account for a significant amount of revenue. In 1998, the Company began identifying certain of these customers and partners as "strategic accounts." The Company has assigned sales representatives to focus 100% of their efforts on one or more of these accounts in order to provide increased support for and maximize revenue from these accounts.
OEMS. The Company has agreements with Aspect Telecommunications Inc. ("Aspect") and NEC America, Inc. ("NEC") under which Aspect and NEC licensed the Company's software technology to provide solutions to the call center market. Additionally, in the first quarter of 1999, Edify entered into an agreement with ACI Worldwide, Inc. to provide solutions to the financial services market.
INTERNATIONAL SALES. International revenues accounted for 5% or less of total net revenues for each of the years ended December 31, 1998, 1997 and 1996. The Company maintains distribution relationships with distributors in Canada, Europe, Asia/Pacific and South America. The Company's ability to expand its Web-based applications internationally is limited by the general acceptance of the Internet and intranets in other countries. The Company's ability to expand its telephony applications internationally is limited to those countries where there is regulatory approval of the third-party telephony hardware supported by Edify software. Because Edify depends on third-party suppliers to certify such telephony hardware and obtain regulatory approval on a country by country basis, there can be no assurance that such approval will exist or continue to exist in the future.
STRATEGIC RELATIONSHIPS
As part of its objective of establishing leadership in the self service software market, particularly for financial services and human resources, the Company has established strategic relationships with leading technology providers, outsourcers and integrators in these markets. These relationships enable the Company to interoperate with new technologies, lend the Company significant visibility and credibility within the self service market and provide the Company with access to their large customer bases. The Company intends to leverage these relationships and to develop additional strategic relationships.
In the financial services market, Edify has established relationships with CheckFree, Electronic Data Systems, HP, Integrion, Intuit, M&I Data Services, Microsoft, NCR, TSA, TransPoint and Unisys Corporation, among others. In the HR market, the Company has relationships with CTP, Foundation Technologies, Hunter Group, PeopleSoft and SAP, among others. In the call center market, the Company has relationships with Aspect, Compaq, Fujitsu Limited, Genesys Telecommunications Laboratories, NEC, Nuance Communications, RightPoint Software and Rockwell.
EDIFY SERVICES
Edify services are an important component of the complete solution that Edify offers its customers. The Company's services organization provides customers and distribution partners with fee-based consulting, education and support services. As of December 31, 1998, the Company had 169 people in its services organization. The Company charges for its consulting, education and support offerings separately from the license fees charged for the Company's software.
CONSULTING SERVICES. The Company's consulting organization provides full lifecycle consulting to its direct customers who wish to outsource their software installation, design, application development and implementation. Edify's consulting team has expertise in systems integration, knowledge of user interface and design, and familiarity with the self service needs of its targeted market segments.
EDUCATION SERVICES. The Company offers a comprehensive education program to its customers and partners. Courses are offered for each of the Company's product lines to meet the needs of application developers, system administrators and project managers. Courses are offered at the Edify "U" education facilities located at the Company's offices in Santa Clara, California and Waltham, Massachusetts. In addition, the Company provides onsite training, upon request, at customer facilities. As of December 31, 1998, the Company had trained more than 1,400 people to develop self service applications with its software.
SUPPORT SERVICES. The Company offers a choice of support plans. Through these plans, Edify provides customers and partners with technical support, new software releases and documentation and online support. Edify's technical support engineers help diagnose and resolve technical questions. Edify's product development engineers develop new software releases and enhance the functionality, quality and performance of existing software applications. Additionally, Edify's technical publications organization develops new documentation for major releases, and online support, offered out of the technical support organization, includes a support website that provides "one-stop" access to technical information.
PRODUCT DEVELOPMENT
The statements made herein regarding the Company's products and product enhancements under development are forward-looking statements, and the actual results for such products or enhancements could differ materially from those projected as a result of a variety of factors, including those contained in this "Product Development" section and elsewhere in this Report.
The market for Edify's products is characterized by rapid technological change, changes in customer requirements, frequent new product introductions and enhancements and emerging industry standards. The Company must continually change and improve its
products in response to changes in operating systems, application software, computer and telephony hardware, networking software, programming tools and computer language technology. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. In particular, the market for self service application products has only recently begun to develop and is rapidly evolving. The Company's success will depend upon its ability on a timely and cost-effective basis to enhance its current products and to develop new products that meet changing market conditions, which include changing customer needs, new competitive product offerings, emerging industry standards and changing technology. There can be no assurance that the Company will be successful in developing and marketing, on a timely and cost-effective basis or at all, fully functional and integrated product enhancements or new products that respond to technological change, updates or enhancements to third party products used in conjunction with the Company's products, changes in customer requirements or emerging industry standards, or that the Company's enhanced or new products will be accepted by customers. Any failure by the Company to anticipate or respond adequately to changing market conditions, or any significant delays in product development or introduction, could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company's software development team is composed of members with experience in Internet and Web technology, financial services and human resources application software, visual programming design, object-oriented software development, computer telephony integration, voice processing and large-scale real-time subsystems. The Company believes this assembly of diverse technical expertise contributes to the highly integrated functionality of its products. The Company's ability to attract and retain highly qualified employees will be the principal determinant of its success in maintaining technological leadership.
Product development expenses were $12.0 million in 1998, $10.1 million in 1997 and $5.8 million in 1996. To date, all software development costs have been expensed as incurred. The total product development staff consisted of 89 full-time employees as of December 31, 1998. All of the Company's products have been developed internally by its product development staff. Product development expenses have increased over recent quarters as the Company increased product development staff to develop versions of its products for the Windows NT platform. The Company believes significant investments in product development are required to remain competitive. As a consequence, the Company intends to increase the dollar amount of its product development expenditures in the future.
The Company's current development efforts are focused on enhancements to the Windows NT versions of Electronic Workforce, EBS and ESY. These enhancements include increased scalability and functionality for Electronic Workforce and additional application modules for EBS and ESY. There can be no assurance that these development efforts will be completed within the Company's anticipated schedules or that, when completed, they will have the features necessary to make them successful in the marketplace. Moreover, software as complex as that developed by the Company may contain undetected errors when first introduced or as new versions are released. Errors in new products may be found after commencement of commercial shipments, resulting in loss or delay of market acceptance. Future delays in the development or marketing of product enhancements or new products, including presently contemplated new features of the Company's software products for Windows NT, could result in a material adverse effect on the Company's business, financial condition and results of operations.
COMPETITION
The market for self service software and services is rapidly evolving, extremely competitive and subject to rapid technological change. The Company expects competition to increase in the future from existing competitors and from companies that may enter the Company's existing or future markets with similar or substitute solutions that may be less costly or provide better performance or functionality than the Company's products. Many of the Company's current and potential competitors have longer operating histories, greater name recognition, larger installed customer bases and significantly greater financial, technical, marketing and other resources than the Company. To be successful in the future, the Company must continue to respond promptly and effectively to the challenges of changing customer requirements, technological change and competitors' innovations. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could materially adversely affect the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, financial condition and results of operations.
The Company's current and potential competitors include Internet software and tools vendors, Web application vendors, business application vendors and stand-alone IVR vendors. In the market for Web-based self service solutions, the Company's primary competition has been from system integrators, potential customers' internal information systems departments that build applications with custom code and Web development tool vendors. In the future, the Company expects competition from Netscape Communications Corporation, Microsoft and others to increase. In addition, the Company expects database vendors such as Oracle Systems Corporation, Informix Corporation and Sybase, Inc. to provide many of the capabilities needed in the development of Web self service applications. Any of these companies could use its superior financial resources, market power and installed base of customers to
compete effectively against the Company. The Company believes that the principal competitive factors in the Web self service market segment are breadth and depth of application functionality, support for multiple communications media, speed of application development, integration with mainframe and client/server computer systems, price, reliability and scalability of product offerings, third-party distribution, company reputation, application development expertise and customer service and support. Although the Company believes that its products and services currently compete favorably with respect to such factors, there can be no assurance that the Company can maintain its competitive position against current and potential competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Such competition could materially adversely affect the Company's ability to sustain current pricing levels and could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company expects to encounter increased competition from companies offering Internet application products that compete with the Company's application products and custom applications of the Company's software. The Company's Electronic Banking System competes with solutions from BroadVision, Inc., IBM and Security First Technologies, among others. The Company believes that the principal competitive factors in this market are application functionality, ease-of-use, adaptability of applications, integration with on-premise enterprise applications, and systems and support for multiple media. Although the Company believes that its products and services compete favorably on the basis of these factors, there can be no assurance that the Company can maintain its competitive position against current and potential competitors.
Web browser and Web server technology offers vendors of business application software a means to extend their products to provide self service capabilities over the Web or intranets. The Company expects that application vendors such as Baan Company N.V., Oracle, PeopleSoft, SAP and others will market new or enhanced products offering Web-based self service capabilities. These products could dilute materially the value of the Company's Employee Service System with customers who use applications licensed from such vendors. Such enhanced offerings could materially and adversely affect the Company's market position, business, financial condition and results of operations.
For telephone self service solutions, the Company competes principally with stand-alone IVR vendors such as Brite Voice Systems, Inc., InterVoice, Inc., Lucent Technologies Inc. ("Lucent"), Periphonics Corporation, Syntellect Technology Corporation and TALX Corp. The Company believes that the principal competitive factors in the telephone self service market segment are the same as those for the Web-based self service market. Although the Company believes that it competes favorably on the basis of these factors, there can be no assurance that the Company can maintain its competitive position against current and potential competitors. Certain of the Company's IVR competitors have introduced products supporting Web applications. Such competition could materially adversely affect the Company's ability to compete and could have a material adverse effect on the Company's business, financial condition and results of operations.
PROPRIETARY RIGHTS
The Company's success is heavily dependent upon its proprietary technology. The Company relies primarily on a combination of copyright, trade secret and trademark laws, nondisclosure and other contractual provisions and technical measures to protect its proprietary rights. The Company seeks to protect its software, documentation and other written materials through trade secret and copyright laws, which provide only limited protection. In addition, the Company holds two United States patents, has three United States patent applications pending (one of which has also been filed internationally) and intends to seek further United States and international patents on its technology. There can be no assurance that any patents held by the Company will not be challenged and invalidated, that patents will issue from any of the Company's pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength or be issued in all countries where the Company's products can be sold to provide meaningful protection or any commercial advantage to the Company. As part of its confidentiality procedures, the Company generally enters into nondisclosure agreements with its employees, consultants, distributors and corporate partners and limits access to and distribution of its software, documentation and other proprietary information. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use the Company's products or technology that the Company considers proprietary, and third parties may attempt to develop similar technology independently. In particular, the Company provides its existing and potential distribution partners with access to its product architecture and other proprietary information underlying the Company's licensed software. Policing unauthorized use of the Company's products is difficult, and, while the Company is unable to determine the extent to which piracy of its software products exists, software piracy can be expected to be a persistent problem. In addition, effective protection of intellectual property rights may be unavailable or limited in certain countries. Accordingly, there can be no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology.
In April 1996, the Company received a letter from Lucent inviting the Company to negotiate a license of Lucent's patents. Lucent asserted that certain of the Company's products infringe certain of Lucent's patents and offered to license those patents to the
Company for a substantial payment. In November 1997, the Company received a letter from Lucent in which Lucent made similar assertions with respect to other patents it holds. In November 1998, the Company entered into an agreement with Lucent (the "Lucent Settlement"), under which each party released the other from claims of past infringement and settled their patent disputes. Under the Lucent Settlement, Edify paid Lucent a one-time fee of $5 million. The one-time settlement fee released the Company from all claims, demands and rights of action which Lucent may have on account of any infringement or alleged infringement of any of Lucent's patents that are covered by the Lucent Settlement. In connection with the Lucent Settlement, the Company will pay Lucent a minimum annual royalty fee of approximately $500,000 up to a maximum of approximately $700,000 in each of the fiscal years from 1999 to 2004. In addition, in fiscal years 2005 and 2006, if the Company exceeds certain revenue targets that are specified under the Lucent Settlement, the Company will be required to pay additional amounts.
In the future, the Company may receive additional communications from other parties asserting that the Company's products, trademarks or other proprietary rights require a license of intellectual property rights or infringe, or may infringe, on their property rights. As the number of software products in the industry increases, and the functionality of these products further overlaps, the Company believes that software developers may become increasingly subject to infringement claims. Any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company, or at all, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation to determine the validity of any claims could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks, whether or not such litigation is determined in favor of the Company. In the event of an adverse ruling in any such litigation, the Company may be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology, or obtain licenses to infringing technology. The failure of the Company to develop or license a substitute technology could have a material adverse effect on the Company's business, financial condition and results of operations.
EMPLOYEES
As of December 31, 1998, the Company had a total of 442 employees, including 89 in product development, 137 in sales and marketing, 169 in services and customer support, and 47 in administration and finance. Of these, one was in Spain, five were in the United Kingdom and the remainder was located in the United States. The Company's future performance depends to a significant degree upon the continued contributions of members of the Company's senior management and other key research and development, sales and marketing personnel and its continuing ability to identify, attract, train and retain other highly skilled managerial, engineering, sales and marketing and services personnel. Competition for highly qualified personnel is intense, and there can be no assurance that the Company will be successful in attracting, assimilating and retaining the necessary personnel in the future. None of the Company's employees is represented by a labor union. The Company has not experienced any work stoppages and considers its relations with its employees to be good.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing and product development facility occupies approximately 130,000 square feet of leased space in Santa Clara, California. In addition, the Company leases offices in Waltham, Massachusetts, Dallas, Texas, and London, England. The Company believes that its existing facilities, together with certain options to expand its existing facilities, are adequate for its current needs but that it may need to seek additional space in the future. The Company believes that suitable additional space or alternative space will be available in the future, as needed, on commercially reasonable terms.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
Mr. Crowe has been President, Chief Executive Officer and a director of the Company since co-founding the Company in 1990. From 1982 to 1990, he held various management and marketing positions at Rolm Corporation ("Rolm"), a telecommunications equipment manufacturing company, most recently as General Manager. Mr. Crowe received a Bachelor of Arts degree in History from Dartmouth College in 1978 and a Masters degree in Business Administration from Stanford University in 1982.
Mr. Begun has been Vice President of Edify Services since April 1995. From March 1992 to April 1995, he was the President and Chief Executive Officer of Wyatt Software Services, Inc., a human resources software development company and a subsidiary of The Wyatt Company, a benefits and compensation consulting company. Mr. Begun also served as President of the David Corporation, a subsidiary of The Wyatt Company, from January to April 1995. From October 1988 to March 1992, he was an Administrative Systems Practice Leader and a senior systems consultant at The Wyatt Company. Mr. Begun received a Bachelor of Science degree in Chemistry from Cornell University in 1966.
Mr. Brown joined the Company as Vice President of Worldwide Sales in May 1998. From January 1994 to May 1998, he held the position of Senior Vice President of Worldwide Field Operations, among other vice president of sales positions, at Auspex Systems, Inc, a network attached storage company. Mr. Brown also served as Vice President of Marketing of the UNIX Systems Group within Unisys Corporation from January 1992 to January 1994. Mr. Brown received a Bachelor of Commerce degree from the University of Witwatersrand in 1974 and a Masters degree in Business Administration from the University of South Africa in 1982.
Dr. Jolissaint has been Vice President and Chief Technical Officer of the Company since co-founding the Company in 1990. From 1978 to 1990, he held various engineering management positions at Rolm. In October 1989, he was elected a Senior Member of the Technical Staff at Rolm. Dr. Jolissaint received a Bachelor of Science degree in Electrical Engineering from Louisiana State University in 1965 and Master of Science and Ph.D. degrees in Electrical Engineering from Stanford University in 1966 and 1972, respectively.
Mr. Pollock joined the Company as Vice President of Worldwide Marketing in November 1998. From May 1996 to October 1998, he was Executive Vice President of Portera Systems, an enterprise application outsourcing company. Mr. Pollock also served as Vice President of Worldwide Marketing for Claris Corporation from April 1988 to April 1996. From June 1987 to April 1988, he held positions in product marketing at Microsoft Corporation and from June 1986 to May 1987, he held positions in product marketing at Apple Computer. Mr. Pollock received a Bachelor of Science degree in Business and Cybernetic Systems from San Jose State University in 1985 and a Masters degree in Business Administration from Stanford University in 1987.
Mr. Soward has been Vice President of Business Development since January 1999. From July 1998 to December 1998 he was the Vice President of Product Marketing and from April 1995 to June 1998 he was Director of Product Marketing for Edify. Prior to joining the Company, Mr. Soward served as Senior Product Manager for Call Center Applications at Rolm from October 1992 to March 1995. From January 1986 to September 1992, he also held various product management positions in the voice processing, multimedia and call center business segments at Rolm when it was part of IBM and then Siemens. Mr. Soward received a Bachelor of Science degree in Business Administration from the University of California, Berkeley in 1979.
Mr. Sutton joined the Company as Vice President of Engineering in June 1998. From May 1997 to February 1998, he was Vice President of Product Development and Technology at Micro Focus Group Plc, a developer of enterprise software development environments. From January 1997 to April 1997, he was Vice President of Product Development at Unison Software, Inc., a network management software company. Mr. Sutton also held the position of Vice President of Development at Avalon Software, an enterprise resource planning ("ERP") company, from January 1996 to January 1997; Information Handling Services, an information content provider company, from September 1994 to January 1996; Informix, a database and tools company, from March 1993 to June 1994; and ASK Computer Systems, an ERP company, from December 1991 to March 1993. From January 1980 through December 1991, he held the positions of Software Development Engineer and General Manager at Hewlett-Packard Company. Mr. Sutton received a Bachelor of Science degree in Management, specializing in Computer Science and Marketing, from the Massachusetts Institute of Technology in 1967, and a Masters of Science degree in Management, specializing in Computer Science and Marketing, from the Massachusetts Institute of Technology in 1968.
Ms. Tomlinson has been Vice President of Human Resources since April 1996. From March 1995 to April 1996, she was Vice President of Human Resources for the Desktop Document Systems Division of Xerox Corporation. Ms. Tomlinson also served as Director of Human Resources for Synopsys, Inc. from June 1992 to March 1995. From July 1983 to June 1992, she held human resource management positions with Apple Computer, Inc. Ms. Tomlinson received a Bachelor of Arts degree in Sociology from Pomona College in 1979.
Ms. Vinella has been Chief Financial Officer of the Company since August 1990, Vice President of Finance and Administration since August 1994 and Secretary since February 1996. Prior to joining the Company, she served as Director of Finance at Lumisys, Inc., a medical equipment company, from 1988 to 1990, and as Director of Finance and Chief Financial Officer at Spectra Logic Corporation, a disk and tape controller manufacturer, from 1982 to 1987. Ms. Vinella received a Bachelor of Science degree in Accounting from the University of San Francisco in 1976 and a Masters degree in Business Administration from Stanford University in 1982.
PART II
ITEM 5
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's stock has been traded on the Nasdaq National Market since the Company's initial public offering in May 1996 under the symbol EDFY. The following table sets forth, for the periods indicated, the high and low bid prices for the Company's common stock as reported by Nasdaq:
As of December 31, 1998, there were approximately 351 holders of record of the Company's common stock.
The Company has never paid cash dividends on its common stock. The Company currently intends to retain earnings, if any, for use in its business and does not anticipate paying any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes thereto included elsewhere in this Report.
The following tables set forth certain unaudited consolidated statement of operations data for each of the four quarters in 1997 and 1998, as well as the percentage of the Company's total net revenues represented by each item. The unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements contained herein and include all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of such information when read in conjunction with the Company's consolidated financial statements and notes thereto appearing elsewhere in this Report. The Company believes that quarter-to-quarter comparisons of its financial results are not necessarily meaningful and should not be relied upon as an indication of future performance.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of Operations includes forward-looking statements that reflect the Company's current views with respect to future matters such as revenue sources, levels and growth, spending levels, international operations, gross profit and capital needs. Actual results may differ materially from the results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include those discussed below as well as those discussed elsewhere in this Report.
OVERVIEW
The Company develops, markets and supports enterprise self service software solutions that enable organizations to automate, integrate and personalize interactions with customers and employees through multiple channels, including the Internet, corporate intranets and the telephone. The Company commenced operations in May 1990 to address the issues facing organizations needing to provide more and better service through a broad range of interactive media while containing costs. The Company was engaged principally in research and development through the first quarter of 1992, when it made its initial product shipments of its principal product, Electronic Workforce. Since that time, the Company has released new versions of Electronic Workforce at least annually.
The Company derives revenues from licenses of its software products and fees for services related thereto. The Company currently markets Electronic Workforce across multiple industries, emphasizing customer self service applications within the financial services industry and employee self service applications deployed by human resources organizations. In addition, the Company has introduced two software application products for Web-based self service applications in the financial services and human resources markets, the Electronic Banking System and the Employee Service System, both of which are built on Electronic Workforce and incorporate Web, Java and other technologies that address the customization requirements necessary for the application products market. The Company began shipping EBS in September 1996 and began shipping ESY in June 1997.
The Company markets its products through its own field sales force, as well as through VARs and OEMs, and markets its services directly to its customers and distribution partners. The typical size of a direct transaction (including software licenses and services) ranges from $100,000 to $300,000 and can be over $1,000,000 for large applications. Most indirect licenses are smaller and do not include a service component, resulting in substantially lower revenues per transaction to the Company. In 1998, the Company derived approximately 53% of its revenues from software licenses and 47% from fees for services. The Company generally recognizes revenue from the licensing of software products upon shipment and revenue from service contracts ratably over the contract period or as the services are performed.
As of December 31, 1998, the Company had an accumulated deficit of $17.3 million. The Company intends to make ongoing investments in its sales, marketing, research and development, customer support and administrative infrastructure over the near term. Operating results for future periods are subject to numerous uncertainties, and there can be no assurance that the Company will achieve or sustain profitability on an annual or quarterly basis. The Company's prospects must be considered in light of the risks encountered by companies in new and rapidly evolving markets. The Company does not believe that prior percentage rates of revenue growth are sustainable or indicative of future growth. The ability of the Company to achieve revenue growth and profitability in the future will depend on a number of factors, many of which are outside of the Company's control. In particular, growth and profitability will depend on the Company's success in marketing versions of and developing enhancements to its products that run on the Windows NT platform as well as the Company's success in marketing its application products. The Company's inability to implement these key elements of its growth strategy would result in a material adverse effect on its business, financial condition and results of operations.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of total net revenues, consolidated statement of operations data for the periods indicated:
NET REVENUES
Total net revenues were $70.9 million, $57.1 million and $33.0 million in 1998, 1997 and 1996, respectively, representing increases of 24.2% from 1997 to 1998 and 72.8% from 1996 to 1997. The Company's revenues are principally derived from software licenses and fees for services, which are generally charged separately. Revenues are recorded net of reserves for potential product returns and allowances. No single customer exceeded 10% of total net revenues in 1998, 1997 or 1996. In each of 1998, 1997 and 1996, 5% or less of the Company's total net revenues were derived from international sales. Over time, the Company intends to expand its operations outside the United States and enter additional international markets. International operations entail a number of risks including those associated with product customization and regulatory compliance, and there can be no assurance that such expansion will be successful.
LICENSE REVENUES. Revenues from licenses were $37.4 million, $34.1 million and $20.1 million in 1998, 1997 and 1996, respectively, representing increases of 9.7% from 1997 to 1998 and 69.3% from 1996 to 1997. The increases in license revenues from 1996 to 1998 were attributable to several factors, including an increase in unit volume as a result of the market's growing awareness and acceptance of Electronic Workforce, the introduction of the Electronic Banking System in September 1996, the introduction of the Employee Service System in June 1997, increased follow-on business from existing customers, and expansion of the Company's field sales force and indirect distribution channels. The prices of the Company's Electronic Workforce licenses have remained relatively constant from 1996 to 1998. The Company does not believe that the historical growth rates of license revenues will be sustainable or are indicative of future results.
SERVICES AND OTHER REVENUES. Services and other revenues consist primarily of fees from consulting, post-contract customer support and, to a lesser extent, education and installation services. Services and other revenues were $33.5 million, $23.0 million and $12.9 million in 1998, 1997 and 1996, respectively, representing increases of 45.9% from 1997 to 1998 and 78.3% from 1996 to 1997. Services and other revenues increased as a percentage of total net revenues to 47.3% in 1998 from 40.3% in 1997 and 39.0% in 1996. These increases in services and other revenues occurred primarily due to increased demand for consulting services, as well as increases in post-contract customer support, education and installation services associated with the increased installed base of the Company's software. Consulting services primarily are contracted for under time and material arrangements. The Company does not expect historical growth rates of its services revenues to be sustainable in the future. To the extent services and other revenues increase as a percentage of total net revenues, overall gross profit margins may be adversely impacted.
COST OF REVENUES
COST OF LICENSE REVENUES. Cost of license revenues consists primarily of the cost of product media, product duplication, documentation and royalties paid to third parties under technology licenses. Cost of license revenues was $1,328,000, $889,000 and $450,000 in 1998, 1997 and 1996, respectively, representing 3.6%, 2.6% and 2.2% of the related license revenues for the respective years. The increase in absolute dollars and the cost of license revenues as a percentage of license revenues from 1996 to 1998 was due primarily to the costs of third-party technology used for particular customers as well as increases in shipments of the Company's software products.
COST OF SERVICES AND OTHER REVENUES. Cost of services and other revenues consists primarily of personnel-related costs and fees for third-party consultants incurred in providing consulting, post-contract customer support, education and installation services to customers. Cost of services and other revenues was $23.7 million, $17.6 million and $10.6 million in 1998, 1997 and 1996, respectively, representing 70.6%, 76.5% and 82.6% of the related services and other revenues for the respective years. The increases in absolute dollars from 1996 to 1998 were due primarily to increases in personnel-related costs as the Company continued to expand its consulting, customer support, education and installation services organizations. The increases in gross profit margins from 1996 to 1998 were due primarily to increased demand for consulting services, as well as increases in post-contract customer support and installation services associated with the increased installed base of the Company's software. The Company does not expect historical growth rates of its gross profit margins to be sustainable. The cost of services and other revenues as a percentage of services and other revenue may vary between periods due to the amount and mix of services provided by the Company and to varying levels of expenditures to build the services organization. Any significant decline in the demand for the Company's consulting services would have a material adverse impact on the Company's revenues and, as a result of the under-utilization of consulting personnel, on the Company's gross profit and results of operations.
OPERATING EXPENSES
PRODUCT DEVELOPMENT. Product development expenses were $12.0 million, $10.1 million and $5.8 million, or 16.9%, 17.6% and 17.6% of total net revenues, in 1998, 1997 and 1996, respectively. Product development expenses consist primarily of salaries and other related expenses for research and development personnel, as well as the cost of facilities and depreciation of capital equipment. The increase in absolute dollars from 1997 to 1998 was due primarily to increased staffing related to the development of the Company's application products and ongoing enhancements to Electronic Workforce. The decrease in product development costs as a percentage of net revenue from 1997 to 1998 was due primarily to the growth in total net revenue. The increase in absolute dollars from 1996 to 1997 was attributable primarily to increased staffing related to development of application products and ongoing enhancements to Electronic Workforce and an increase in personnel-related costs associated with the development of the Company's Windows-based software, which was delivered in the fourth quarter of 1997. The Company believes that significant investments in product development are required to remain competitive. As a result, the Company expects that product development expenses will increase in absolute dollars in the future and will not decline significantly as a percentage of total net revenues from their current levels.
In accordance with Statement of Financial Accounting Standards No. 86, the Company expects to capitalize eligible computer software development costs upon the achievement of technological feasibility, subject to net realizable value considerations. The Company has defined technological feasibility as completion of a working model. To date, the Company believes its process for developing software was essentially completed concurrently with the establishment of technological feasibility and, accordingly, no software development costs have been capitalized in the accompanying consolidated balance sheet.
SALES AND MARKETING. Sales and marketing expenses were $31.5 million, $21.6 million and $15.4 million, or 44.5%, 37.8% and 46.5% of total net revenues, in 1998, 1997 and 1996, respectively. Sales and marketing expenses consist primarily of salaries and commissions earned by sales and marketing personnel and promotional expenses. The increases in absolute dollars in sales and marketing expenses from 1996 to 1998 and as a percentage of total net revenues from 1997 to 1998 were due primarily to the expansion of the Company's field and indirect sales operations and increased marketing activities. The reduction in sales and marketing expenses as a percentage of total net revenues from 1996 to 1997 was due primarily to the growth in total net revenues. The Company expects to continue to expand its field sales and marketing efforts, its third-party VAR distribution channel and its operations outside the United States and, therefore, anticipates that sales and marketing expenditures will increase in absolute dollars in the future. In addition, sales and marketing expenses as a percentage of total net revenues may fluctuate between periods due to varying levels of expenditures to build the sales and marketing organizations.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $5.7 million, $4.6 million and $2.9 million, or 8.1%, 8.1% and 8.9% of total net revenues, in 1998, 1997 and 1996, respectively. General and administrative expenses consist primarily of salaries and other related expenses of administrative, executive and financial personnel and outside professional fees. The increases in
absolute dollars from 1996 to 1998 were attributable primarily to the increase in the provision for doubtful accounts and the addition of staff and increased infrastructure costs to support the growth of the Company's business. The reduction in general and administrative expenses as a percentage of total net revenues from 1996 to 1997 was due primarily to the growth in total net revenues. The Company expects to continue to expand its staffing, information systems and other items related to infrastructure and, therefore, anticipates that general and administrative expenses will increase in absolute dollars in the future.
INTELLECTUAL PROPERTY SETTLEMENT. Intellectual property settlement represents a non-recurring charge of $5 million related to the resolution of the Company's patent discussions with Lucent in November 1998. See Note 4 of Notes to Consolidated Financial Statements for further discussion of this settlement.
INTEREST INCOME. Interest income, which consists of interest earned from the Company's cash, cash equivalents and short-term investments, was $2.0 million, $2.1 million and $1.6 million in 1998, 1997 and 1996, respectively. The increase from 1996 to 1997 was due primarily to an increase in average investment balances from the proceeds of the Company's initial public offering. The reduction from 1997 to 1998 was due primarily to a decrease in average investment balances primarily resulting from the intellectual property settlement in 1998.
INTEREST EXPENSE. Interest expense, which relates primarily to capital lease obligations, was $148,000, $125,000 and $123,000 in 1998, 1997 and 1996, respectively.
PROVISION FOR INCOME TAXES
The provision for income taxes was $125,000, $344,000 and $44,000 in 1998, 1997 and 1996, respectively. No provision for federal income taxes was required through 1996, as the Company had not been profitable on an annual basis from its inception through 1996. As of December 31, 1998, the Company had federal and state net operating loss carryforwards of approximately $11.7 million and $4.5 million, respectively. The federal net operating loss carryforwards expire in various years from 2008 through 2018, and the state net operating loss carryforwards expire in years 1999 through 2003. As of December 31, 1998, the Company also had federal and state research and development tax credit carryforwards of approximately $1,156,000 and $893,000, respectively. The Company has provided a valuation allowance against 100% of the deferred tax assets, including that related to the carryforwards.
The Company's accounting for deferred taxes under Statement of Financial Accounting Standards No. 109 involves the evaluation of a number of factors concerning the realizability of the Company's deferred tax assets. To support the Company's conclusion that a 100% valuation allowance was required, management primarily considered such factors as the Company's history of operating losses, the nature of the Company's deferred tax assets, the lack of significant firm sales backlog, no significant excess of appreciated asset value over the tax basis of the Company's net assets and the absence of taxable income in prior carryback years. Although management's operating plans assume taxable and operating income in future periods, management's evaluation of all the available evidence in assessing the realizability of the deferred tax assets indicates that such plans are not considered sufficient to overcome the available negative evidence.
LIQUIDITY AND CAPITAL RESOURCES
From inception through April 1996, the Company financed its operations and met its capital expenditure requirements primarily through private sales of preferred stock, totaling $24.1 million. On May 2, 1996, the Company completed its initial public offering of 2,875,000 shares of its Common Stock at a price of $15.00 per share. Proceeds to the Company from this offering were approximately $38.9 million, net of underwriting discounts and other offering costs. At December 31, 1998, the Company's cash, cash equivalents and short-term investments totaled $34.8 million.
At December 31, 1998 and 1997, the Company also had available an $8.0 million unsecured revolving bank line of credit. The line of credit agreement will expire in December 1999 and contains certain financial covenants, with which the Company was in compliance at December 31, 1998. Borrowings accrue interest at the bank's prime rate. As of December 31, 1998 and 1997, there were no borrowings outstanding under this line of credit.
In 1998, $5.4 million of cash was used in operating activities, resulting primarily from the Company's intellectual property settlement payment of $5.0 million and an increase in accounts receivable of $6.3 million due to an increase in revenues and average days sales outstanding, offset by depreciation and amortization of $4.5 million and increases in accounts payable and accrued expenses of $3.2 million. In 1997, $673,000 of cash was provided by operating activities, resulting primarily from net income of $4.0 million, depreciation and amortization of $3.2 million and increases in accrued expenses and unearned revenue of $2.0 million, offset by an increase in accounts receivable of $8.9 million due to an increase in revenues and average days sales outstanding. In 1996, $4.0
million of cash was provided by operating activities, resulting primarily from depreciation and amortization of $1.6 million and increases in accrued expenses and unearned revenue of $5.5 million, partially offset by an increase in accounts receivable of $3.2 million.
In 1998, 1997 and 1996, the Company's investing activities have consisted primarily of purchases and sales of short-term investments and purchases of property and capital equipment. Capital expenditures, including equipment acquired under capital leases, were $4.9 million, $4.4 million and $5.5 million in 1998, 1997 and 1996, respectively, which were primarily for expansion of the Company's facilities and purchases of computer and network equipment for the Company's growing employee base. The Company expects that its capital expenditures will increase as the Company's employee base grows. The Company's principal commitments consist primarily of leases on its facilities and its equipment. In 1998, net cash generated from financing activities of $2.0 million was related primarily to proceeds from the issuance of the Company's common stock through its Employee Stock Purchase Plan and stock option exercises.
At December 31, 1998, the Company's working capital was $44.2 million. The Company has no significant capital spending or purchase commitments other than normal purchase commitments and commitments under facilities and capital leases. The Company believes that its working capital, together with its bank line of credit and cash flows from operations, if any, will be sufficient to meet its working capital and capital expenditure requirements for at least the next 12 months.
BUSINESS RISKS
This section on "Business Risks" includes forward-looking statements that reflect the Company's current views with respect to future matters such as factors that can affect the Company's operating results, technological change, the markets for the Company's products, the Company's sales channels and the stability and availability of compatible technology. Forward-looking statements are subject to risks and uncertainties. Actual results may differ materially from the results and outcomes discussed in the forward-looking statements. This section contains cautionary statements that identify important factors, including certain risks and uncertainties, that could cause actual results or outcomes to differ materially from those in the forward-looking statements in this section and elsewhere in this Report.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's revenues, margins and operating results have fluctuated in the past, and are expected to continue to fluctuate in the future, on an annual and quarterly basis as a result of a number of factors, such as demand for the Company's products, including new products and product enhancements, the mix of products and services sold, the mix of distribution channels through which the Company's products are sold, customer order deferrals in anticipation of new products or product enhancements, purchasing patterns of value added resellers and customers, Company decisions regarding hiring and other expenses, and competitive conditions in the industry. In particular, the Company plans to increase its operating expenses to expand its sales and marketing operations, expand its distribution channels, expand its international operations, fund greater levels of product development, broaden its consulting services and customer support capabilities and increase its administrative infrastructure. A relatively high percentage of the Company's expenses is fixed in the short term as the Company's expense levels are based, in part, on its expectations as to future revenues. If revenues fall below expectations, expenditure levels could be disproportionately high as a percentage of total net revenues, and operating results would be immediately and adversely affected.
The Company historically has operated with little backlog because its products are generally shipped as orders are received. As a result, license revenues in any quarter depend on the volume and timing of, and the Company's ability to fill, orders received in that quarter. Individual orders for the Company's products typically are for relatively large dollar amounts. The Company also believes the purchase of its products is relatively discretionary and generally involves a significant commitment of capital resources. Therefore, any downturn in any potential customer's business, or any loss or delay of individual orders for any reason, could have a significant impact on the Company's revenues and quarterly results. In addition, because the Company typically recognizes a substantial portion of its total revenue from transactions booked and shipped in the last weeks, or even days, of the quarter, the magnitude of quarterly fluctuations may not become evident until very late in a particular quarter. Revenues are difficult to forecast because the market for the Company's products is rapidly evolving. The Company's sales cycle, including initial order, provision of services and follow-on sales, averages six months, but varies substantially from customer to customer and can range from one month to over one year from initial contact. Furthermore, the Company expects that sales derived through indirect channels, which are harder to predict and may have lower margins than direct sales, will increase as a percentage of total net revenues. In addition, as a result of recently issued guidance on software revenue recognition, license agreements entered into during a quarter may not meet the Company's revenue recognition criteria. Therefore, even if the Company meets or exceeds its forecast of aggregate licensing and other contracting activity, it is possible that the Company's revenues would not meet expectations. Although the Company's revenue growth has made it difficult to determine whether the Company's business has been subject to seasonal variations, the Company believes that some of its customers
tend to make product purchase decisions in the fourth quarter as a result of purchase cycles related to expiration of budgetary authorizations.
Based upon all of the foregoing, the Company believes that its quarterly revenues, expenses and operating results could vary significantly in the future, and that period-to-period comparisons should not be relied upon as indications of future performance. The Company may also choose to reduce prices or increase spending in response to competition or to pursue new market opportunities. If new competitors, technological advances by existing competitors, or other competitive factors require the Company to invest significantly greater resources in research and development efforts, the Company's operating results in the future may be adversely affected. There can be no assurance that the Company will be able to grow in future periods or that it will be able to sustain its level of total revenues or its rate of revenue growth on a quarterly or annual basis. In particular, the rate of revenue growth decreased in 1998 compared to 1997. During 1998, the Company experienced actual performance that did not meet financial market expectations. It is likely that, in some future quarters, the Company's operating results will again be below the expectations of stock market analysts and investors. In such event, the price of the Company's common stock could be materially adversely affected.
RISKS OF EXPANSION TO WINDOWS NT OPERATING SYSTEM. The Company's future success will depend on its ability to develop, sell, implement and support new software products and enhancements of current products on a timely basis in response to changing customer needs, competition, technological developments and emerging industry standards. Furthermore, the Company's future success will depend on its ability to convert existing customers and partners to the Windows NT operating platform. Versions through 4.x of Electronic Workforce and 1.x of EBS and ESY run on IBM's OS/2 operating system. In October 1997, the Company released its first version of Electronic Workforce Release 5 for the Windows NT operating system. In December 1997, the Company released initial versions of EBS and ESY for Windows NT. Because these products are still relatively new, many customers licensing these versions have not yet fully deployed the product and undetected errors may remain in these versions. The existence of any such errors may delay the release of future versions and adversely affect the acceptance of these products, either of which could have a material adverse effect on the Company's business, operating results and financial condition. In addition, certain features of the OS/2 versions of the Company's software are not available on currently available Windows NT-based versions. Accordingly, the Company is devoting significant engineering and development resources to develop enhancements to the versions of its products that run on the Microsoft Windows NT operating system. It is possible that the newness of or lack of features on the Windows NT-based versions of its products will cause potential customers to defer or forgo purchases of current or future versions of these products, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's future success will depend upon the timely and successful introduction of new versions of its Windows NT-based products. There can be no assurance that the Company will be successful in developing, on a timely basis or at all, fully featured Windows NT-based versions of its products or that such versions, if developed, will achieve customer acceptance. Failure by the Company to develop new Windows NT-based versions successfully and in a timely manner would have a material adverse effect on the Company's business, financial condition and results of operations.
The Company intends to invest a significant majority of its product development resources on products and product enhancements for the Windows NT operating system. The Company must manage the effect on its existing OS/2 customers of this focus on the Windows NT operating system. There can be no assurance that updates to and enhancements for the Company's OS/2-based products will be sufficient to encourage its OS/2 customers to continue to purchase additional software or services from the Company. In addition, the Company must provide its customers with an economically reasonable and technologically feasible migration path from the OS/2-based products to the Windows NT-based products. There can be no assurance that the Company's OS/2 customers will migrate to the Company's Windows NT-based products. The failure of a significant number of its existing OS/2 customers to purchase additional software or services from the Company, for any reason, would have a material adverse effect on the Company's business, operating results and financial condition.
EMERGING MARKET; UNPROVEN ACCEPTANCE OF THE COMPANY'S APPLICATION PRODUCTS. Certain of the Company's products and features have been introduced only recently. In September 1996, the Company began shipping the Electronic Banking System, its first application product. In June 1997, Edify began shipping its Employee Service System. The emerging self service application products markets are rapidly changing and are characterized by an increasing number of new entrants whose products compete with those of the Company. Demand for and market acceptance of these products and services are subject to a high level of uncertainty. Moreover, much of the industry software and infrastructure supporting the use of the Company's products in these markets, particularly the Web, is new and unproven. In addition, portions of the markets for the Company's products and services are new and evolving, and it is difficult to predict the future growth of this market. There can be no assurance that a viable market for self service application products will develop or be sustainable. If the market fails to develop, develops more slowly than expected or becomes saturated with competitors, or if the Company's products and services do not achieve or sustain market acceptance, the Company's business, financial condition and results of operations would be materially adversely affected.
LENGTHY SALES CYCLE. The licensing of Edify's software is often an enterprise-wide decision by prospective customers and generally requires the Company to engage in a lengthy sales cycle and to provide a significant level of education to prospective
customers regarding the use and benefits of its software. Due in part to the business-critical nature of certain of the Company's software applications and the associated hardware, software and consulting expenditures, potential customers tend to be cautious in making product acquisition decisions. In addition, the licensing of the Company's software involves a significant commitment of capital and the attendant delays frequently associated with approving large capital expenditures and reviewing new technologies that affect key operations. For these and other reasons, the sales cycle for the Company's products can range from one month to over one year, averages six months and is subject to a number of significant risks, including customers' budgetary constraints and internal acceptance reviews, over which the Company has little or no control. Consequently, if sales forecasted from a specific customer for a particular quarter are not realized in that quarter, the Company is unlikely to be able to generate revenue from alternate sources in time to compensate for the shortfall. As a result, and due to the relatively large size of a typical order, a lost or delayed sale could have a material adverse effect on the Company's quarterly operating results. Moreover, to the extent that significant sales occur earlier than expected, operating results for subsequent quarters may be adversely affected.
DEPENDENCE UPON DEVELOPMENT OF MARKETING CHANNELS. An integral part of the Company's strategy is to develop multiple distribution channels, including a field sales force, VARs and OEMs. The Company intends to increase its reliance on third-party distribution partners in the future. The Company is expending and intends to continue to expend significant resources to develop the VAR channel. VARs and OEMs are not, however, subject to any minimum purchase or resale requirements and can cease marketing the Company's products at any time. Certain VARs and OEMs also offer competing products that they produce or that are produced by third parties. There can be no assurance that the Company's existing VARs will continue to provide the level of services and technical support necessary to provide a complete self service solution to the Company's customers, that they will transition smoothly to sales of new products or enhancements of existing products, or that they will not emphasize their own or third-party products to the detriment of the Company's products. The loss of VARs, the failure of such parties to perform under agreements with the Company, or the inability of the Company to attract and retain new VARs with the technical, industry and application expertise required to market the Company's products successfully in the future could have a material adverse effect on the Company's business, financial condition and results of operations. To the extent that the Company is successful in increasing its sales through VARs, those sales will be at discounted rates, and revenue to the Company for each such sale will be less than if the Company had licensed the same products to the customer directly.
The Company plans to expand its field sales force and its marketing organization. The Company's future success depends upon the increased productivity of its existing field sales force and the ability of the Company to integrate and train new sales personnel. There can be no assurance that the Company's efforts will be successful, that the cost of such efforts will not exceed the revenue generated, or that the Company's sales and marketing organization will be able to compete successfully against the significantly more extensive and well-funded sales and marketing operations of many of the Company's current or potential competitors. The Company's inability to manage its internal expansion effectively could have a material adverse effect on the Company's business, financial condition and results of operations.
MANAGEMENT OF A RAPIDLY CHANGING BUSINESS. The rapid development of an infrastructure necessary for the Company to exploit the market opportunities for its products requires an effective planning and management process. The Company has recently experienced changes in its operations that have placed significant demands on the Company's administrative, operational and financial resources. In 1998, the Company increased its staff from 349 to 442 employees and its total net revenues by 24%. The Company is expanding its sales and marketing organizations, developing its distribution channels to penetrate different and broader markets, funding increasing levels of research and development, and growing its support organization to accommodate the increasing installed base of products. The growth in the Company's customer base and product offerings has placed, and any future growth is expected to continue to place, a significant strain on the Company's management and operations, including its sales, marketing, customer support, research and development, finance and administrative operations. The Company's officers as a whole have had limited experience in managing large or rapidly growing business organizations. The Company's ability to compete effectively and its future growth, if any, will require the Company to continually improve its financial and management controls, reporting systems and procedures on a timely basis, implement new systems as necessary, and expand, train and manage its employee workforce. There can be no assurance that the Company's controls, systems or procedures will be adequate to support the Company's operations. The failure of the Company's management to respond effectively to changing business conditions could have a material adverse effect on the Company's business, financial condition and results of operations.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL. The Company's future performance depends to a significant degree upon the continued contributions of members of the Company's senior management and other key research and development, sales and marketing personnel. Loss of any key persons could have a material adverse effect on the Company's business, financial condition and results of operations. The Company does not have employment agreements with any of its key personnel. In addition, the Company believes that its future success will depend upon its continuing ability to identify, attract, train and retain other highly skilled managerial, engineering, sales and marketing and services personnel. Competition for such personnel is intense. There can be no
assurance that the Company will be successful in attracting, assimilating and retaining the necessary personnel, and the failure to do so could have a material adverse effect on the Company's business, financial condition and results of operations.
RELIANCE ON STABILITY AND AVAILABILITY OF THIRD-PARTY SOFTWARE AND HARDWARE. The Company's products involve integration with products and systems developed by third parties. A significant portion of the Company's installed base of products runs on the OS/2 operating system, and the Company is therefore dependent upon the continued viability of the OS/2 operating system and upon IBM's continuing support for the OS/2 operating system. In the fourth quarter of 1997, the Company released Windows NT-based versions of its products and intends to focus future product development efforts on Windows NT. Accordingly, the Company also is dependent upon the continued viability of that operating environment. In addition, the current versions of the Company's products are designed to function only with Natural MicroSystems Corporation's voice hardware cards and software drivers and Intersolv Inc.'s QELib for database connectivity. If any of these third-party products should become unavailable for any reason, fail under operation with the Company's products or fail to be supported by their respective vendors, it would be necessary for the Company to redesign its products. There can be no assurance that any redesign could be accomplished in a cost-effective or timely manner. The Company or its customers could also experience difficulties integrating the Company's products with other hardware and software. Furthermore, should new releases of these operating systems, voice hardware cards and software drivers or database connectivity software occur before the Company develops products compatible with such new releases, any resulting decline in demand for the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and software products are coded to accept two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than one year, computer systems and software used by many companies may need to be upgraded to comply with such "Year 2000" requirements.
The Company is currently taking steps to address Year 2000 issues in the following three areas: (1) the Company's products; (2) internal systems; and (3) readiness of third party vendors and business partners. The Company has assigned a Year 2000 project team to develop and implement the Year 2000 readiness effort for its domestic and international operations. The project has executive sponsorship and is regularly reviewed by senior management, the Board of Directors and the Audit Committee.
The Company has designed and tested its current products to be Year 2000 compliant. However, since all customer situations cannot be anticipated, particularly those involving third-party products, the Company may see an increase in warranty and other claims as a result of the Year 2000 transition. As such, the impact of customer claims could have a material adverse impact on the Company's business, financial condition and results of operations.
The Company's internal systems include both information technology systems such as financial and order entry systems and non-information technology systems such as telephones and facilities. In August 1998, the Company completed the installation of a Year 2000 compliant ERP system, which includes the Company's order entry, project accounting and financial systems. The Company expects to resolve remaining Year 2000 compliance issues substantially through normal replacement and upgrades of software by June 1999. In January 1999, the Company initiated a comprehensive inventory and evaluation of all desktop systems and expects to complete this process by April 1999. The additional costs of remediation are not expected to be material to the Company's financial condition or results of operations. However, if significant new non-compliance issues are identified, the Company's business, financial condition and results of operations could be materially adversely affected.
In December 1998, the Company completed the process of sending detailed questionnaires to critical suppliers and business partners to certify Year 2000 compliance. Where practicable, the Company will attempt to mitigate its risk with respect to the failure of suppliers and business partners to be Year 2000 ready. However, such failures remain a possibility and could have an adverse impact on the Company's business, financial condition and results of operations.
The Company has estimated a preliminary budget of approximately $300,000 for investigating and remedying issues related to Year 2000 compliance involving software or systems used in its internal operations. Costs that have already been incurred to replace and upgrade software and systems in the Company's ordinary course of business are not included in the estimated budget. While the Company has dedicated substantial resources towards attaining Year 2000 compliance, there can be no assurance that the Company's Year 2000 compliance program will be completed on time. In addition, there can be no assurance that there will not be interruption of operations or other limitations of system functionality or that the Company will not incur substantial costs to avoid such limitations. Any failure to effectively monitor, implement or improve the Company's operational, financial, management and technical support systems could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company, which could
have a material adverse effect on the Company's business, financial condition and results of operations. In addition, even if the Company's products are Year 2000 compliant, other systems or software used by the Company's customers may not be Year 2000 compliant. The failure of such non-compliant third-party software or systems could affect the perceived performance of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. The most likely worst case scenarios include hardware failure and the failure of infrastructure services provided by government agencies, systems vendors and other third parties (e.g., electricity, telephone service, water transport, internet services, etc.). The Company is in the process of completing its contingency planning for high risk areas at this time and is scheduled to commence contingency planning for medium to low risk areas by the end of the fiscal year. The Company expects its contingency plans to include, among other things, manual "work-arounds" for software and hardware failures, as well as substitution of systems, if necessary.
For a discussion of additional business risks, see "Business-Product Development," "-Competition," "-Proprietary Rights" and "Management's Discussion and Analysis of Financial Condition and Results of Operations-Overview."
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK DISCLOSURES
The following discussion about the Company's market risk disclosures contains forward-looking statements. Forward-looking statements are subject to risks and uncertainties. Actual results could differ materially from those discussed in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates and foreign currency exchange rates. The Company does not have derivative financial instruments for hedging, speculative or trading purposes.
INTEREST RATE SENSITIVITY
The Company maintains a short-term investment portfolio consisting mainly of income securities with an average maturity of less than one year. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. The Company has the ability to hold its fixed income investments until maturity, and therefore, the Company would not expect its operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on its securities portfolio.
The Company's cash equivalents and short-term investments have generally been available-for-sale. Gross unrealized gains and losses were not significant as of December 31, 1998.
The following table presents the principal amounts and related weighted-average yields for the Company's fixed rate investment portfolio (in thousands, except average yields).
FOREIGN CURRENCY RISK
The Company believes that its exposure to currency exchange fluctuation risk is insignificant because the Company's transactions with international vendors are generally denominated in U.S. dollars, which is considered to be the functional currency of the Company and its subsidiary. The currency exchange impact on intercompany transactions was immaterial in 1998.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements of the Company required by this item are set forth at the pages indicated at Item 14(a). The Supplementary Data required by this item are incorporated by reference from Item 6 hereof.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item with respect to the directors of the Company is incorporated by reference from the definitive proxy statement for the Company's 1999 annual meeting of stockholders to be filed with the Commission pursuant to Regulation 14A not later that 120 days after the end of the fiscal year covered by this Report (the "Proxy Statement") under the caption "PROPOSAL NO. 1-ELECTION OF DIRECTORS." The information relating to the executive officers of the Company is set forth in Part I of this Report under the caption "Item 4A. Executive Officers of the Registrant."
Information required by this item with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference from the Proxy Statement under the caption "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the Proxy Statement under the captions "EXECUTIVE COMPENSATION," "PROPOSAL NO. 1-ELECTION OF DIRECTORS-DIRECTOR COMPENSATION" and "COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the Proxy Statement under the captions "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the Proxy Statement under the caption "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form:
(b) Reports on Form 8-K:
None.
INDEPENDENT AUDITORS' REPORT
The Board of Directors Edify Corporation:
We have audited the accompanying consolidated balance sheets of Edify Corporation and subsidiary (the "Company") as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Edify Corporation and subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
Mountain View, California KPMG LLP January 25, 1999
EDIFY CORPORATION
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
See accompanying notes to consolidated financial statements.
EDIFY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes to consolidated financial statements.
EDIFY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to consolidated financial statements.
EDIFY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
EDIFY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY
Edify Corporation and its subsidiary (the "Company") develops and markets enterprise self service software and provides application development consulting, installation and post-contract customer support services. The principal markets for the Company's products are i) human resource and customer service departments for a wide variety of companies, and ii) banking and financial services companies. The Company was incorporated on October 19, 1989, and in April 1996, the Company reincorporated as a Delaware corporation. Edify EMEA Ltd., a wholly-owned subsidiary, was incorporated on December 17, 1997, and is located in London, England.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Edify Corporation and Edify EMEA Ltd. All significant intercompany accounts and transactions have been eliminated in consolidation.
Foreign Currency Translation and Transactions
The Company has determined that the functional currency of its foreign subsidiary is the U.S. dollar and translates monetary assets and liabilities at year-end exchange rates, and inventories, property and non-monetary assets and liabilities at historical rates. Gains and losses from these transactions are included in the consolidated results of operations and are immaterial.
Use of Estimates
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid instruments with a maturity of three months or less at the time of purchase to be cash equivalents.
Short-Term Investments
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities" requires entities to classify investments in debt and equity securities with readily determinable fair values as "held-to-maturity," "available-for-sale" or "trading," and establishes accounting and reporting requirements for each classification. In accordance with SFAS No. 115, the Company has classified its investments in debt securities as available-for-sale. The cost of securities sold is based upon the specific identification method.
Credit Risk Concentrations and Fair Values of Financial Instruments
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash investments and accounts receivable. The Company's cash investments are held with several financial institutions and generally consist of commercial paper, money market deposits, government agency securities, bankers' acceptances, certificates of deposit and corporate bonds. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers comprising the Company's customer base.
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value due to the short maturity of those instruments. The fair value of capital leases is not estimated, but reflects the contractual present value owed to non-related parties.
Property and Equipment
Property and equipment are stated at cost. Equipment under capital leases is stated at the lower of fair value or the present value of the minimum lease payments at the inception of the lease.
Depreciation of property and equipment is computed on a straight-line basis over the estimated useful lives of the respective assets, generally three years for equipment and office furniture and the shorter of the useful life of the asset or the remaining lease term for leasehold improvements. Equipment under capital leases is amortized on a straight-line basis, generally 42 months.
Software Development Costs
Product development costs include costs related to software products that are expensed as incurred until the technological feasibility of the product has been established. After technological feasibility is established, any additional software development costs would be capitalized in accordance with SFAS No. 86. Through December 31, 1998, the Company believes its process for developing software was essentially completed concurrently with the establishment of technological feasibility, and, accordingly, no software development costs have been capitalized to date.
Revenue Recognition
Revenue on the licensing of software products is generally recognized upon shipment, net of estimated allowances for product returns. Software license revenues are recognized upon shipment only if persuasive evidence of an arrangement with the vendor exists, the vendor's fee is fixed or determinable, and collection of the resulting receivables is deemed probable. In certain contracts, shipment is defined as delivery of a product master for noncancelable product licensing arrangements under which the customer has certain software reproduction and distribution rights. Revenue on post-contract customer support and service contracts is recognized ratably over the contract period and as the services are performed, respectively. Fixed price consulting contract revenues are recognized based on the percentage of completion method. Estimated losses are recorded in the period in which they become known. Time and materials contracts are recognized as services are performed.
In October 1997, the Accounting Standards Executive Committee ("AcSEC") of the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") No. 97-2, "Software Revenue Recognition." Effective January 1, 1998, the Company adopted SOP 97-2. SOP 97-2 generally requires revenue recognized from software arrangements to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, consulting, education services, installation or post-contract customer support. Fair values are based upon vendor specific objective evidence ("VSOE"). If evidence of fair value for each element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist, or until all elements of the arrangement are delivered.
In February 1998, AcSEC issued SOP 98-4, "Deferral of the Effective Date of SOP 97-2." The SOP defers the effective date for applying the provisions regarding VSOE of fair value until the AcSEC can reconsider what constitutes such VSOE. There was no material change to the Company's accounting for revenues as a result of the adoption of SOP 98-4.
In December 1998, AcSEC issued SOP 98-9, "Software Revenue Recognition, with Respect to Certain Arrangements," which requires recognition of revenue using the "residual method" in a multiple element arrangement when fair value does not exist for one or more of the delivered elements in the arrangement. Under the "residual method," the total fair value of the undelivered elements is deferred and subsequently recognized in accordance with SOP 97-2. There was no material change to the Company's accounting for revenues as a result of the adoption of SOP 98-9.
Net Income (Loss) Per Share
Basic earnings per share is computed using the weighted-average number of shares of common stock outstanding. Diluted earnings per share is computed using the weighted-average number of shares of common stock and, when dilutive, convertible preferred stock outstanding and common equivalent shares from options to purchase common stock and warrants outstanding using the treasury stock method.
Stock-Based Compensation
The Company accounts for its employee stock-based compensation plans using the intrinsic-value method.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in financial statements. The Company had no items of other comprehensive income in all periods presented.
Business Segments
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. Therefore, the Company has made the required disclosures in Note 9 to these consolidated financial statements.
Income Taxes
The Company accounts for income taxes under the asset and liability method of accounting. Under the asset and liability method, deferred tax assets and liabilities are recognized based on the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in operating results in the period that includes the enactment date. A valuation allowance is established to reduce deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Recently Adopted Accounting Standards
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which provides guidance on accounting for the costs of computer software intended for internal use. SOP 98-1 must be adopted by the Company for periods beginning after December 15, 1998 and is not expected to have a material impact on the Company's consolidated results of operations or financial position.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-up Activities," which provides guidance on accounting for start-up activities, including organization costs. SOP 98-5 must be adopted by the Company for periods beginning after December 15, 1998, and is not expected to have a material impact on the Company's consolidated results of operations or financial position.
Reclassifications
Certain items in these consolidated financial statements have been reclassified to conform to the current period presentations.
(3) NET INCOME (LOSS) PER SHARE
The following table sets forth the computation of net income (loss) per share (in thousands, except per share data):
As of December 31, 1998, there were options to acquire 3,627,498 shares of common stock with weighted-average exercise prices of $6.16 which could potentially dilute basic earnings per share in the future but which were not included in diluted per share results for the year ended December 31, 1998. These options were excluded because the Company had a net loss in 1998 and to do so would have been antidilutive.
As of December 31, 1997, there were options to acquire 816,027 shares of common stock with weighted-average exercise prices of $16.49 which could potentially dilute basic earnings per share in the future but which were not included in diluted per share results for the year ended December 31, 1997. These options were excluded because the exercise price was greater than the average market price of the common stock for the year ended December 31, 1997, and, therefore, these options would be antidilutive for the purposes of this calculation.
As of December 31, 1996, there were options to acquire 2,373,989 shares of common stock with weighted-average exercise prices of $6.29 which could potentially dilute basic earnings per share in the future but which were not included in diluted per share results for the year ended December 31, 1996. These options were excluded because the Company had a net loss in 1996 and to do so would have been antidilutive.
(4) BALANCE SHEET AND STATEMENT OF OPERATIONS COMPONENTS
Investments
Under the provisions of SFAS No. 115, debt and equity securities classified as available-for-sale securities for which cost approximated market value as of December 31, 1998 and 1997 with maturities generally within one year, consisted of the following (in thousands):
These investments were classified on the consolidated balance sheet as follows (in thousands):
Gains and losses from sales of available-for-sale securities were not significant for the years ended December 31, 1998, 1997 or 1996.
Property and Equipment
A summary of property and equipment is as follows (in thousands):
Property and equipment as of December 31, 1998 and 1997 includes equipment under capital leases of approximately $2,658,000 and $2,658,000, respectively, and related accumulated amortization of approximately $2,406,000 and $1,978,000, respectively.
Accrued Expenses
A summary of accrued expenses is as follows (in thousands):
Unearned Revenue
A summary of unearned revenue is as follows (in thousands):
Note Receivable from Stockholder
In September 1995, the Company received a note for $17,500 in exchange for 50,000 shares of restricted common stock. The note is to be repaid semiannually based on the vesting terms of the underlying shares, which are dependent on certain performance milestones. The note is due no later than March 2002, with interest at 8% compounding semiannually.
Intellectual Property Settlement
In April 1996, the Company received a letter from Lucent inviting the Company to negotiate a license of Lucent's patents. Lucent asserted that certain of the Company's products infringe certain of Lucent's patents and offered to license those patents to the Company for a substantial payment. In November 1997, the Company received a letter from Lucent in which Lucent made similar assertions with respect to other patents it holds. In November 1998, the Company entered into an agreement with Lucent (the "Lucent Settlement"), under which each party released the other from claims of past infringement and settled their patent disputes. Under the Lucent Settlement, Edify paid Lucent a one-time fee of $5 million, which was recorded as intellectual property settlement expense. The one-time settlement fee released the Company from all claims, demands and rights of action which Lucent may have on account of any infringement or alleged infringement of any of Lucent's patents that are covered by the Lucent Settlement.
(5) INCOME TAXES
The provision for income taxes in 1998, 1997 and 1996 was as follows (in thousands):
Total income tax expense differs from expected income tax expense (computed by applying the U.S. federal corporate income tax rate of 34% to net income (loss) before taxes) as follows (in thousands):
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of December 31, 1998 and 1997 are presented below (in thousands):
The net change in the total valuation allowance for the year ended December 31, 1998 was an increase of $2,863,000. The Company's accounting for deferred taxes under SFAS No. 109 involves the evaluation of a number of factors concerning the realizability of the Company's deferred tax assets. To support the Company's conclusion that a 100% valuation allowance was required, management primarily considered such factors as the Company's history of operating losses, the nature of the Company's deferred tax assets, the lack of significant firm sales backlog, no significant excess of appreciated asset value over the tax basis of the Company's net assets, and the absence of taxable income in prior carryback years. Although management's operating plans assume taxable and operating income in future periods, management's evaluation of all the available evidence in assessing the realizability of the deferred tax assets indicates that such plans are not considered sufficient to overcome the available negative evidence.
The Company has net operating loss carryforwards for federal purposes of approximately $11.7 million. These carryforwards expire in various years from 2008 through 2018. In addition, the Company has net operating loss carryforwards for California purposes of approximately $4.5 million. These carryforwards expire in years 1999 through 2003. The Company also has research and development tax credit carryforwards of approximately $1,156,000 and $893,000 for federal and state tax purposes, respectively. The federal research and development tax credit carryforwards expire in years 2005 through 2018. There is no expiration provision for California research and development tax credit. In addition, the Company has foreign tax credits and alternative minimum tax credit of $95,000 and $4,000, respectively. The foreign tax credits expire in years 2001 through 2003. There is no expiration provision for the alternative minimum tax credit. Included in gross deferred tax assets above is approximately $650,000 related to stock option compensation for which the benefit, when realized, will be recorded to stockholders' equity.
The Internal Revenue Code of 1986, and applicable state tax laws, impose substantial restrictions on the ability of the Company to utilize net operating loss and research and development tax credit carryforwards in the event of an "ownership change." During 1992, the Company underwent an ownership change. As a result of the change of ownership, the federal tax losses incurred through that date, approximately $3.1 million, are subject to an estimated annual limitation of approximately $550,000. In addition, federal research and development tax credit carryovers of approximately $150,000 are also subject to this annual limitation on a tax converted basis; however, they cannot be utilized until the restricted net operating loss carryforwards have been utilized. In the event that additional ownership changes occur, there may be additional restrictions on the future use of research and development tax credits and net operating loss carryforwards existing at that date.
(6) STOCKHOLDERS' EQUITY
Preferred Stock
The Board of Directors has authority to issue up to 5,000,000 shares of preferred stock in one or more series and to fix the powers, designations, preferences and rights of each series and any qualifications, limitations or restrictions thereon without any further vote or action by the stockholders.
Common Stock
The Company has periodically sold shares of common stock to its employees, directors and other individuals under Restricted Stock Purchase Agreements (the "Agreements") at prices not less than the fair market value of such stock at the date of issuance as determined by the Board of Directors. Pursuant to the Agreements, the Company has the option to repurchase the unvested common stock at the original purchase price in the event that an individual ceases to be an employee or director of the Company. The stock generally vests either (a) to the extent of 20% of the shares upon the first 12-month anniversary of the employee's hire date and an additional 1/48 of the unvested shares ratably over the following 48 months or (b) to the extent of 25% of the shares upon the first 12-month anniversary of the employee's hire date and an additional 1/36 of the unvested shares ratably over the following 36 months. As of December 31, 1998, 12,290 shares were subject to repurchase.
Stockholder Rights Plan
On August 7, 1998, the Board of Directors adopted a stockholder rights plan designed to protect the long-term value of the Company for its shareholders during any future unsolicited acquisition attempt. In connection with the plan, the Board declared a dividend of one preferred share purchase right for each share of the Company's common stock outstanding on August 14, 1998 (the "Record Date") and further directed the issuance of one such right with respect to each share of the Company's common stock that is issued after the Record Date, except in certain circumstances. The rights will expire on August 10, 2008. The rights are initially attached to the Company's common stock and will not trade separately. If a person or a group (an "Acquiring Person") acquires 20 percent or more of the Company's common stock, or announces an intention to make a tender offer for the Company's common stock, the consummation of which would result in a person or group becoming an Acquiring Person, then the rights will be distributed (the "Distribution Date"). After the Distribution Date, each right may be exercised for one-hundredth of a share of a newly designated Series A Junior Participating Preferred Stock, par value of $0.001 per share, at an exercise price of $70.00. The preferred stock has been structured so that the value of one-hundredth of a share of such preferred stock will approximate the value of one share of common stock.
(7) INCENTIVE AND BENEFIT PLANS
1996 Directors Stock Option Plan
In March 1996, the Company adopted the 1996 Directors Stock Option Plan (the "Directors Plan") and reserved 100,000 shares of common stock for issuance under this plan. In August 1998, the authorized number of shares was increased to 175,000. Under the Directors Plan, each eligible director was automatically granted an initial option to purchase 7,500 shares. Each eligible director who first becomes a member of the Board thereafter will automatically be granted an option to purchase 15,000 shares upon joining the Board. At each Annual Meeting of Stockholders of the Company, each eligible director will automatically be granted an additional option to purchase 7,500 shares if such director has served continuously as a member of the Board since the date of grant of such director's initial option. All options issued under the Directors Plan vest as to 1/48 of the shares per month, provided the optionee continues as a member of the Board or as a consultant to the Company. As of December 31, 1998, 112,500 shares at a weighted-average exercise price of $13.98 had been granted under the Directors Plan, and 35,744 shares were exercisable.
1996 Equity Incentive Plan and 1990 Stock Option Plan (the "Incentive Plans")
The Company's 1996 Equity Incentive Plan became effective on May 2, 1996 and serves as the successor to the Company's 1990 Stock Option Plan. The 1996 Equity Incentive Plan provides for the grant of stock options and stock bonuses and the issuance of restricted stock by the Company to its employees, officers, directors, consultants, independent contractors and advisers. Under the 1990 Stock Option Plan, options were granted to employees, officers, directors, consultants, independent contractors and advisers to purchase common stock at not less than the fair market value of the Company's common stock at the grant date (for incentive stock options) or 85% of the fair market value of such common stock (for nonqualified stock options). Shares under options for both plans generally become exercisable to the extent of 25% upon the first 12-month anniversary of the grant date and an additional 1/36 of the unvested shares vesting ratably over the following 36 months, and expire 10 years from the grant date. At the May 1998 Annual Meeting of Stockholders of the Company, 1,225,000 additional shares were authorized for the Incentive Plans. At December 31, 1998, the Company had reserved 5,128,377 shares of common stock for issuance under these plans and 1,613,379 shares remained available for grant.
In July 1998, the Board of Directors approved the repricing of all incentive stock options granted during the period from May 1, 1996 through July 24, 1998. The repricing does not include incentive stock options granted to the Company's officers or Board of Directors. Employees had the choice of exchanging any stock options granted from May 1, 1996 through July 24, 1998 for new options that would have a new exercise price of $8.625, the then current market value of the Company's stock. Options to purchase 1,096,393 shares of common stock were exchanged under this option repricing program.
A summary of activity under the Directors Plan and the Incentive Plans is as follows:
In 1996 and 1995, the Company recorded deferred compensation of $303,000 and $601,000, respectively, for the difference between the grant price and the deemed fair value of the common stock underlying certain options granted during the year. Deferred compensation amounts are being amortized over the vesting period of the individual options, generally four years. Amortization of deferred compensation was approximately $126,000, $247,000 and $416,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
The following table summarizes information as of December 31, 1998:
1996 Employee Stock Purchase Plan
In March 1996, the Company adopted the 1996 Employee Stock Purchase Plan (the "Purchase Plan") and reserved 300,000 shares of common stock for issuance under this plan. At the May 1997 Annual Meeting of Stockholders of the Company, 300,000 additional shares were authorized for the Purchase Plan, and again, at the May 1998 Annual Meeting of Stockholders of the Company, 300,000 additional shares were authorized for the Purchase Plan. The Purchase Plan permits eligible employees to acquire shares of the Company's common stock through payroll deductions of between 2% and 10% of their compensation, up to an aggregate total payroll deduction not to exceed $21,250 in any calendar year. Each offering under the Purchase Plan is for a period of twenty-four months, and each offering period consists of four purchase periods, each six months in length. The purchase price for the Company's common stock purchased under the Purchase Plan is 85% of the lesser of the fair market value of the Company's common stock on the first day of the applicable offering period or on the last day of the respective purchase period. In 1998 and 1997, 235,842 and 190,439 shares, respectively, were issued under the Purchase Plan at an average purchase price of $7.94 and $10.78, respectively.
Retirement and Savings Program
The salary deferral "401(k)" plan allows employees to defer up to 20% of their salary subject to certain limitations. The Company may make discretionary contributions to the plan; however, no employer contributions have been made since inception.
Accounting for Stock-Based Compensation Under SFAS No. 123
The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for options granted to employees under its stock plans. Had compensation cost for the Company's three stock plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method prescribed under SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's operating results and results per share would have changed to the pro forma amounts indicated below (in thousands, except per share amounts):
The fair value of each option grant and Purchase Plan share issuable during 1998, 1997 and 1996 is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's employee and director stock options and shares issuable under the Purchase Plan have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee and director stock options and shares issuable pursuant to the Purchase Plan.
(8) COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its offices under various noncancelable operating lease agreements that expire in years 1999 through 2002. The Company leases certain equipment under capital leases. As of December 31, 1998, minimum lease payments under all noncancelable lease agreements were as follows (in thousands):
Rent expense was approximately $2,444,000, $2,012,000 and $1,149,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Rent expense under office leases is recognized on a straight-line basis over the term of the lease. The difference between the amounts paid and the amounts expensed is classified as deferred rent in the accompanying consolidated balance sheets.
Commitments
In connection with the Lucent Settlement (see Note 4), the Company will pay Lucent a minimum annual royalty fee of approximately $500,000 up to a maximum of approximately $700,000 in each of the fiscal years from 1999 to 2004. In addition, in fiscal years 2005 and 2006, if the Company exceeds certain revenue targets that are specified under the Lucent Settlement, the Company will be required to pay additional amounts.
The Company is party to various other matters arising in the ordinary course of its business. In the opinion of management, these proceedings will not have a material adverse effect on the Company's financial position or results of operations.
(9) SEGMENT REPORTING
The Company has adopted the provisions of SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the reporting by public business enterprises of information about operating segments, products and services, geographic areas and major customers. The method for determining what information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance.
The Company's chief operating decision-maker is considered to be the Company's Chief Executive Officer ("CEO"). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by product and service line for purposes of making operating decisions and assessing financial performance. The Company operates in three operating segments: software, post-contract customer support services and application development consulting services.
Net revenue information regarding the Company's operating segments are as follows (in thousands):
The Company's export sales are principally in Europe and Asia/Pacific. In each of 1998, 1997 and 1996, 5% or less of the Company's total net revenues were derived from international sales. Accordingly, the Company does not produce reports that measure performance of revenues by geographic region.
The Company evaluates the performance of its operating segments based on revenues only. The Company does not assess the performance of its segments on other measures of income or expense, such as depreciation and amortization, operating income or net income. In addition, as the Company's assets are primarily located in its corporate office in the United States and not allocated to any specific segment, the Company does not produce reports that measure the performance based on any asset-based metrics. Therefore, segment information is presented only for revenues.
No single customer accounted for greater than 10% of revenues in any period presented.
(10) LINE OF CREDIT
The Company has an $8 million line of credit, which expires in December 1999 and bears interest at the prime rate. At December 31, 1998, $8 million was available for borrowing. As of December 31, 1998 and 1997, there were no borrowings outstanding under this line of credit.
EDIFY CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (in thousands)
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(1) Includes charges to unearned revenue.
(2) Includes write-offs of accounts and credits issued.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
Edify Corporation
Date: March 29, 1999 /s/ Stephanie A. Vinella -------------------------------------- Stephanie A. Vinella Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below on March 29, 1999 by the following persons on behalf of the registrant and in the capacities on the date indicated.
INDEX TO EXHIBITS
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* Management contract or compensatory arrangement.
** Confidential treatment has been requested with respect to certain portions of this exhibit. Such portions have been omitted from this filing and have been filed separately with the Securities and Exchange Commission.
(1) Incorporated by reference to the Exhibit of the same number to Registrant's Form 10-K for the year ended December 31, 1996.
(2) Incorporated by reference to Exhibit 3.1 to Registrant's Current Report on Form 8-K filed on August 11, 1998.
(3) Incorporated by reference to Exhibit 3.2 to Registrant's Registration Statement on Form 8-A (No. 000-28480) filed on August 11, 1998 (the "Form 8-A").
(4) Incorporated by reference to Exhibit 4.02 to Registrant's Registration Statement on Form S-1 (No. 333-02020), declared effective on May 2, 1996 (the "Form S-1").
(5) Incorporated by reference to Exhibit 4.1 to the Form 8-A.
(6) Incorporated by reference to the Exhibit of the same number to the Form S-1.
(7) Incorporated by reference to Exhibit 4.06 to Registrant's Registration Statement on Form S-8 (No. 333-61109) filed on August 10, 1998 (the "Form S-8").
(8) Incorporated by reference to Exhibit 4.07 to the Form S-8.
(9) Incorporated by reference to Exhibit 4.05 to the Form S-8.
(10) Incorporated by reference to the Exhibit of the same number to Registrant's Form 10-Q for the quarter ended March 31, 1998.